As a national insurer of nonprofits we are often asked what do their directors and officers need to know about their fiduciary responsibilities and can they insure for their errors or omissions. Just do an Internet search on "fiduciary duties of nonprofit directors and officers" and be treated to 150,000 articles describing the responsibilities, but only a few that drill down very deeply on the insurance issues.
You'll frequently see references to the duties of care, loyalty and obedience, how the "business judgment" rule can work both for and against directors and officers, and how indemnification is achieved. So once you're up to speed on all that, let's look at how the insurance mechanism fits in.
What It Is, What It Isn't
Fiduciary liability insurance (FLI) is not fidelity bonding that would respond to claims of embezzlement or other criminal activity. For that you need a fidelity bond or employee and volunteer dishonesty coverage.
FLI can cover ERISA liabilities, although ERISA coverage is more commonly found in the bond market.
For the most part, FLI protects the organization, its directors, officers, and employees. It is common in the nonprofit sector for coverage to extend to volunteers and in some cases even to interns and students-in-training. The coverage will attach if a claim is made that the organization or an insured person breached its duty as a fiduciary. Some carriers use the Side A (insured person), Side B (each claim) approach, while others combine all insureds into one form.
There are also a variety of exclusions related to claims by one insured against another. For example, some forms exclude claims brought by or on behalf of the "Organization" (usually a defined term). Others exclude claims by or on behalf of an individual "insured person" (also defined).
In underwriting fiduciary liability coverage in the nonprofit sector, carriers require certain controls be in place including, but not limited to:
- Articles of Incorporation filed with the respective state
- Bylaws have been accepted by the Board of Directors
- Board meetings are held at regular intervals and minutes are on file
- 501(c)(3) status has been granted by the IRS
- State tax exemption status has been granted
- Filing has been completed, where required, with the Registry of Charitable Trusts or similar state entity
- Payroll and other taxes are timely paid
- Workers' compensation is in place for employees
- Reports to regulatory and funding agencies are submitted timely
- Regular review of financial and business dealings to protect the organization's tax exempt status
- Full disclosure of any self-dealing transactions
- Annual review and approval of budget
- Review periodic financial reports at least quarterly
- Annual review of executive compensation
- Ensure that appropriate internal controls are in place
Some of the more common exclusions include:
- Breach of contract (typically found in CGL forms or endorsements)
- Fines, penalties and sanctions
- Punitive damages (unless insurable in the respective jurisdiction)
- Personal profit or advantage
- Fraud or dishonesty
- Costs of complying with equitable relief, including but not limited to, injunctions, restraining orders or restitution
It is this last exclusion that can be the most troublesome. While fiduciary claims are rare in the nonprofit sector (see below), the most common involve audits or investigations by grantors and funding agencies that conclude funds were improperly used or distributed. If the claim is for restitution, the agency will need to manage that with its own funds.
And From The Claims Files
Data from over 23 years of directors and officers claims files at the Nonprofits Insurance Alliance Group indicates the very low frequency of fiduciary liability claims.
Of the 1,633 claims reported during that time, 85% involved employment liability claims, including ADA discrimination. That's a whole other article.
Another 7% were breach of contract claims, for which we provide defense costs only coverage.
Wage and hour claims totaled 5%, for which we also provide defense costs only coverage.
A mere 3% (52 claims over 23 years) were for fiduciary liability. Interestingly, many of those involved investigations by state attorneys general. None of those involved any loss payments and only one involved defense costs over $5,000. Only one claim required a loss payment to a client who had improperly been denied services.
So In Conclusion
In order to attract responsible board members, nonprofit agencies need to have directors and officers liability coverage in place that includes fiduciary liability. We recommend that such coverage also include:
- Defense costs payable as they are incurred (rather than through a reimbursement mechanism)
- Defense costs in addition to the liability limits
- Broad definition of who is an insured
- Broad employment practices liability coverage
- No deductible (other than for large nonprofits)
- Broad definition of what constitutes a "claim"
- Event trigger or occurrence basis rather than claims made
With that said and in place, the good news based on our data is that fiduciary liability claims are very infrequent in the nonprofit sector and generally cost little to defend.
