A non-profit is an organization that serves the public interest. Its mission and operations are charitable, educational, scientific, religious or literary in nature. A non-profit does not declare a profit but rather utilizes all revenue net of operating expenses. No part of the ownership or assets are assigned to benefit any one person or group of people.
Non-profits can be unincorporated or incorporated entities, partnerships, or cooperatives, although most nonprofits are corporations. At a minimum, most states require a non-profit to have a board of directors, maintain a set of bylaws and hold an annual meeting. The definitive factor in determining an organization’s non-profit status is its legal structure—whether or not it was legally formed as a non-profit organization.
Tax exempt status
The U.S. tax code section 501(c) exempts certain organizations from federal corporate income tax, qualifies the organization for discounts on postal rates, and grants the organization access to government and private grants. In order to qualify for tax-exempt status, a non-profit organization must be incorporated and complete an application along with Form 1023 (a 3-year projected budget for a start-up). If the organization is accepted, it will receive a Determination Letter from the IRS. Tax-exempt organizations are required to complete and submit an annual 990 tax form to the IRS, as opposed to the 1120 form required of non-tax-exempt non-profits and for-profit organizations.
The corporate structure of non-profits
The corporate structure of non-profit organizations is becoming increasingly complex. The need to find alternative sources of revenue and the constant push to respond to member needs are prompting many non-profits to diversify their services and create new entities. Whether or not these entities take on the structure of a subsidiary, partnership, affiliate or chapter depends on the purpose and the tax and legal implications of the venture. Some of the entities that non-profits may create include:
- Subsidiaries - An entity in which the parent company owns greater than 50% of the voting shares of the entity.
- Partnerships - An entity in which the parent company owns 50% or fewer of the voting shares of the entity.
- Non-profit Subsidiaries - An incorporated entity in which the parent company has control of the board and fiscal management and has the right to dissolve the organization.
- Affiliates - A partnership in which the non-profit owns 50% or fewer of the voting shares or contributes equally to the financial investment, has board representation, and does not retain the sole right to dissolve the organization.
- Chapters - An entity created or chartered by an international, national, regional or state organization that follows the same mission and bylaws. Chapters may or may not be incorporated and may have separate boards. Each chapter should have their own pay.
Classes of non-profit/tax exempt business
Charitable organizations 501(c)(3)
- Foundations
- Educational organizations
- Hospitals, clinics and healthcare organizations
- Literary organizations
- Museums
- Organizations to prevent cruelty to children or animals
- Organizations for public safety testing
- Scientific organizations
- YMCAs, YWCAs, boys’ and girls’ clubs
Social Service Agencies/Social Welfare Organizations 501(c)(4)
- Civic leagues
- Homeless shelters
- Legal aid organizations (can also be assigned to 501(c)(20))
Veterans Associations 501(c)(23)
Burial and Cemetery Associations 501(c)(13)
Trade and Professional Associations 501(c)(6)
- Professional associations representing building and trade industries
- Bar associations
- Professional associations representing service industries
- Associations of sports professionals
- Chambers of commerce
- Business leagues
Social Clubs 501(c)(7)
- Recreational clubs
- Golf and country clubs
- Dog club
- Yacht club
Fraternal Beneficiary Societies 501(c)(8) or 501(c)(10)
- Fraternities and sororities
- Fraternal orders of police
Non-Profit Cooperatives 501(c)(12)
- Mutual rural water or irrigation companies
- Mutual cooperative telephone companies
- Mutual cooperative electric/power companies
- Miscellaneous cooperatives
What you should know about non-profits
When reviewing the applicant’s website, the underwriter will review the following to get an understanding of the organization.
History
Most non-profits will indicate on their website that they are a non-profit organization. This information can usually be found in the “About us” or “History“ section of the organization’s website. This section may also provide a list of the board of directors and a description of the organization’s mission or purpose.
Program & services
For social service organizations, determine what services they are providing to their clients such as;
- Job training
- Job placement
- Rehabilitation programs
Depending on the organization’s level of training, Victor may be able to provide a stand-alone miscellaneous professional liability policy to cover this exposure.
Programs for trade/professional organizations:
- Accreditation
- Certification
- Standard Setting
Depending on the level of the program, Victor may be able to provide a sublimit for accreditation, certification and standard setting.
Financials
Non-profit organizations will post their recent financial report or tax returns on their website. This information is helpful to determine if their financial condition is acceptable.
Subsidiaries
It is common for a non-profit organization to have subsidiaries, such as a foundation or limited liability company (LLC). Knowing the structure of the non-profit is important. It is also important for the underwriter to gather exposure information; for example, is the subsidiary purchasing their own policy? Does the non-profit control at least 50% of the subsidiary? Does the subsidiary have its own financial statements? Do they have their own employees?
Questions you should ask about the structure of non-profits
- Do you have an organizational chart on which all your subsidiaries, affiliates and chapters are identified? This will assist in distinguishing between actual entities versus programs or activities.
- Do the chapters, subsidiaries or affiliates have separate boards from the main entity?
- Is the main entity separately incorporated?
- Is the main entity a paper company or operating company?
Why are these questions important? Consider the following examples:
- A low income housing development corporation typically has a non-profit parent who sets up several paper companies to hold the individual properties for which they will receive HUD funding and create individual limited partnerships for the financial management of each property.
- A professional medical association can have an affiliated non-profit foundation, a for-profit subsidiary that publishes its medical journal, a for-profit subsidiary that markets insurance products and manages the group insurance trust, a political action committee (PAC), and chapters in each state.
- A non-profit golf and country club can be owned by a for-profit parent company.
- A construction trade association could have a non-profit foundation, a non-profit subsidiary that manages a homeowners warranty fund, and a joint apprenticeship training fund in partnership with a union.
The insurance contract
Generally, a non-profit D&O policy is intended to provide defense costs and indemnity coverage to the entity, its directors, officers, trustees, employees, volunteers and committee members for loss from lawsuits that allege internal mismanagement of the entity. It is not intended to provide coverage for loss from lawsuits that deal with the quality of professional services delivered.
Gray areas include:
- Services provided by staff attorneys
- Referral services or consulting services provided by an association
- Social services provided by volunteers
Who is covered?
In most cases, the definition of insured and any endorsements naming any additional insureds define who is covered under the policy. Generally, independent contractors, members, outside consultants, and other companies who enter into contract with the insured are not covered because underwriters seek to cover only entities and individuals who are under the control of the entity.
Coverage often depends on the capacity in which the defendant was acting when the alleged wrongful act was committed. Some carriers are unwilling to provide full coverage for the for-profit subsidiaries or partnerships.
What is covered?
The insuring clauses, definition of claim, definition of wrongful act and any additional coverage endorsements will outline what is intended to be covered under the contract. Excluded allegations are outlined in the exclusions section of the policy and in any additional exclusionary endorsements attached to the policy.
Most common D&O exclusions:
- Fraudulent and criminal acts
- Bodily injury and property damage
- Fiduciary liability
- Prior or pending litigation
- Pollution
- Insured versus insured
- Breach of contract
- Professional services
- Sexual or physical abuse/molestation
- SEC claims
Important policy issues to review with a policyholder:
- Claims reporting requirements
- Hammer clauses or settlement provisions
- Retention and any coinsurance requirements
- Provisions relating to reporting of mergers and acquisition
- Claims-made vs. occurrence policies - your clients should understand that under a claims-made policy, claims must be made during the policy period to be covere
- Defense provisions - if the policy is a duty to defend policy, the insured may not retain counsel and handle the case without the insurer if they seek coverage under the policy
The underwriter’s perspective
To properly evaluate a risk, the underwriter must understand the structure, nature of operations and activities, current financial condition, and loss history of an organization and its subsidiaries. At Victor, our underwriters require the following:
Minimum information required
- A complete application (with financials)
- Organization website
- Loss runs (5 years)
- Tax form 990 or audited financials
Supplemental information
- Bylaws and articles of Incorporation
- The employee handbook (if 25 or more employees)
- List of the board of directors
The most common reasons an underwriter might decline a risk include loss history, financial condition or operations that fall outside of their defined underwriting guidelines.
Exposures a non-profit faces
Underwriters also consider whether or not the entity has a human resources manager, training for managers and employees on the employment policies and procedures, or a progressive discipline and grievance process, EPL loss history, trends of employment practices, and claims for the particular class of business. Evaluation of the following exposures involves review of the number of employees and volunteers, the entity’s employment policies and procedures, and the employee handbook.
- Wrongful termination
- Discrimination (gender, age, sexual orientation, religion)
- Negligent supervision
- Sexual harassment
- Intentional infliction of emotional distress
Underwriters review at least two years of annual financial data and look for positive trends in revenue growth and diversification, strong fund balance, low debt to equity ratio, strong working capital, appropriate percentage of expenditures on programs and services, net income trends that don’t damage the fund balance, positive cash flow, reasonable debt repayment schedule and notes free from negative events. Evaluation of the following exposures involves a thorough review of the financial statements.
- Financial mismanagement and bankruptcy
- Breach of fiduciary duty
- Fraud
Publication of medical journals, standards and specifications and technical journals carry the greatest exposure. Evaluation of the following exposures involve review of the insured’s publications and website.
- Publishing liability
- Plagiarism
- Copyright infringement
- Misappropriation of ideas
Best practices
Below is a short list of best practices. This is by no means a complete list, but rather a baseline for good risk mitigation practices.
- Board members should participate in and document meetings.
- Non-profits should establish, publish and enforce policies and procedures for employment issues, and provide regular training to staff and managers
- When faced with threat of litigation, or a situation that may lead to litigation, a non-profit should consult experts like attorneys, human resources consultants and claims experts
- A non-profit should establish financial oversight committees and conduct frequent audits. It is a good idea to engage a CPA to conduct a full annual audit and a review of internal controls
- Non-profits should take advantage of the growing number of resources available to assist them with corporate governance and risk management issues.
To learn more, email managementliability.us@victorinsurance.com or connect with your business development contact.