Most hospital and health system board members give little thought to the indemnification agreements and insurance that their organizations provide that might afford them protection in the event of a wide variety of litigation. Unfortunately, trustees are not protected as much as they might expect by indemnification agreements and directors and officers liability insurance. Agreements may not be enforceable, and insurance may not be collectable, due to circumstances beyond the trustee’s or the hospital’s control.
The insurance industry has created special D&O insurance policies for the corporate world to protect directors against unprotected exposures, but few nonprofit hospitals provide this enhanced benefit to their trustees.
In examining a trustee’s potential exposure, it is important to consider three things: the law creating and, in some respects, limiting his or her liabilities; the scope of indemnification available to the trustee from the organization; and the adequacy of insurance available to address trustee exposures and act as a backstop to indemnification.
1. Liability. In many jurisdictions, nonprofit hospitals and systems have organizational structures similar to corporations. Although such organizations are not owned by shareholders, they are generally governed by a board of trustees, which has a role similar to the board of directors in a corporation. Beginning in the 1980s, various states and the federal government passed what are commonly called volunteer protection statutes or charitable immunity laws. However, they are not a perfect source of protection for trustees for several reasons:
- In many states, immunity is limited only to charitable enterprises or nonprofit entities that do not exceed a certain size;
- In many states, only uncompensated trustees and other volunteers are fully free from liability;
- State laws do not necessarily protect hospitals and trustees from claims arising under federal law;
- Liability limitations typically only apply to negligent misconduct. Many states do not extend the protection to the more serious allegations of reckless, grossly negligent or intentional misconduct;
- Immunity laws generally apply only to settlements and judgments, and not to the costs of defense.
2. Indemnification. Although trustees generally enjoy the same indemnification rights as their for-profit counterparts, the rights can be limited by the extent of indemnification financially available. And in the case of charitable organizations, using funds for indemnification that otherwise could be used to further the charitable mission of the organization may raise the hackles of donors and community members.
There are few instances where indemnification is specifically prohibited by law. Most jurisdictions will expressly prohibit indemnification where there has been a final adjudication of a breach of the duty of loyalty, misconduct undertaken in bad faith, intentional or knowing violations of law, or unlawful distributions of dividends.
Aside from these prohibited categories and instances in which the hospital is unable to indemnify because of solvency issues, it also may resist indemnification. Many battles take place when the board that is called upon to make the indemnification decision is not the same board, in whole or in part, that is subject to the claim at issue. There may be bad feelings between the former and present board members, and the current trustees may not be inclined to grant indemnification unless the former board members force them to do so through litigation. Not only is such litigation costly to both sides, its outcome is uncertain.
3. Adequacy of insurance. After considering the benefits of laws limiting liability, there remain two fundamental sources of concern for trustees. First, as discussed above, the indemnification agreement may not be honored by the organization. Second, the insurance coverage may be limited due to exclusions or otherwise may be used to pay for the defense of claims against the hospital itself, its employees or volunteers.
Although the D&O policies procured by many nonprofit hospitals are similar to the same type of policy purchased by a public company, there are key differences.
Historically, D&O liability insurance policies contained two basic insurance grants — Side A and Side B. Side A insures directors and officers for their wrongful conduct resulting in a claim against them for which they are not lawfully indemnified by the corporation and could not be permissibly indemnified. Side B, or corporate reimbursement coverage, insures the corporate entity, but only to the extent it, in fact, lawfully indemnified the directors and officers for their wrongful conduct resulting in a claim. Beginning in the 1990s, coverage for public companies was extended to the corporation itself for securities claims brought against it, which is so-called entity, or Side C, coverage.
Unlike in the case of the limited Side C securities claim coverage for public companies, Side C coverage for a hospital typically extends to all claims from all sources, limited only by a contractual liability exclusion. The most frequent sources of hospital claims are employment-related, claims by government agencies and regulators, antitrust claims, and other claims from individuals. Serious as these claims often are, most are directed solely against the hospital itself and not against individual trustees. But because trustees must share the insurance protection with the hospital they serve, they may find it severely eroded or completely exhausted for claims directed wholly or in part against them, even more so than in the public company context where the entity coverage is limited to securities claims.
As public company directors and officers had similar concerns with sharing their insurance limits with the entity, they began to demand broader protection for their duties on behalf of the organization, and insurance companies responded with a new product: Side A Only D&O insurance. The solution developed to address these concerns in the public company arena should have direct applicability in the hospital sphere as well.
Side A Only Policies
Originally, Side A Only coverage occasionally was purchased by the largest of corporations that had little concern with the financial protection that insurance could bring to their balance sheets. Rather, they desired this form of “sleep insurance” (meaning it enables the insured to sleep soundly at night) to comfort outside directors whose only real fear was the unlikely scenario of a corporate insolvency that would render their corporate indemnification protection worthless.
Over the past 15 years, however, Side A Only coverage has become more prevalent in the public company arena. U.S.-based insureds likely spend as much as $1 billion in premiums to buy this additional coverage and virtually none of it is bought by nonprofit organizations. Like the case with Side A of the traditional D&O policy, Side A Only policies protect only the individual director or officer for claims that are not indemnified.
In addition to affording independent directors and executive officers a degree of sleep insurance and a backstop in the event of organization insolvency, Side A Only policies supplement the traditional D&O policy by providing additional limits of liability for claims that are not indemnifiable as a matter of law.
There are three types of Side A Only policies:
1. Basic Side A Only:
- usually is purchased in parallel with the organization’s regular D&O policy, so it only covers when the original policy cannot or does not pay;
- usually is not broader than the original policy;
- is noncancelable, which protects the insured individual against the risk that the carrier will cancel the policy in the event of financial restatements. Failure to pay premiums may be a cause for cancellation, but, otherwise, an insured should not take the risk of the carrier deciding it no longer liked an account or line of business;
- is non-rescindable, which can happen when the carrier believes that the risk is misrepresented by the applicant. When a policy is rescinded, the premium plus interest is paid to the insured, and the policy is cancelled back to inception;
- provides additional limits of liability that only can be accessed by the directors and officers, not by the corporate entity.
2. Side A Only Enhanced: This policy provides all of the benefits listed under Basic Side A Only, but with additional coverage for the individual:
- when the organization is financially unable or wrongfully refuses to indemnify;
- when the standard form D&O policies wrongfully disclaim coverage;
- by providing limits over underlying Employment Practices Liability Insurance, which is insurance that covers the organization, its employees and trustees from employee claims for wrongful termination, discrimination, harassment and related torts;
- by providing typically broader coverage than standard D&O policies, and may provide additional coverage otherwise excluded by those policies.
3. D&O Side A DIC: The best Side A Only policies typically are written on a “difference in condition,” or DIC, basis. Essentially, that allows the Side A Only policy to provide coverage on a primary basis for matters not covered under the primary D&O program, provided there is no independent basis for precluding coverage under the Side A Only policy.
These policies typically do not define what is meant by difference in condition, but it should be specified in the contract that the coverage is triggered whenever one or more of the following four situations occurs and the loss may exceed the available limits of liability under the underlying policies.
- Any action is undertaken to rescind one or more of the underlying policies;
- Coverage under one or more of the underlying policies is wrongfully denied by those insurers;
- One or more of the underlying insurers becomes insolvent or otherwise financially incapable of paying loss that is otherwise covered under its policy;
- One or more of the underlying insurers denies coverage based upon some exclusionary or restrictive provision that is not effectively contained within the Side A Only coverage.
Side A Only policies are available from many insurers. As evidence of the appeal of Side A Only coverage, insureds in the corporate world buy Side A Only policies with substantial limits.
Why Haven’t Hospitals Purchased These Types of Insurance?
The short answer is that these institutions and their trustees have yet to be fully educated about their benefits.
Trustees’ need for this coverage is the same as that of public corporations, and even exacerbated by the fact that the entity coverage under a hospital’s standard D&O policy is much broader than the limited securities claim coverage available to public companies. Thus, there is an even greater chance that insurance limits that should have been available to the trustees will have been eroded by payments on claims against only the hospital or other organization.
Additionally, because premiums for hospital D&O coverage are far lower than premiums in the public company sector, Side A Only coverage should be less expensive. Counsel, risk managers and anyone else involved in the insurance procurement process needs to be aware of this valuable added protection and take steps to assess how much Side A Only DIC insurance should be purchased for their hospital trustees. The hospital owes this to the trustees to protect them in the event of an institutional insolvency that effectively precludes any ability to indemnify, as well as possible legal prohibitions against indemnification in certain situations.
Richard Betterley, CMC (email@example.com), is president of Betterley Risk Consultants Inc., Sterling, Mass. Joseph P. Monteleone, Esq. (firstname.lastname@example.org), is a partner in the New York office of Tressler LLP.