The prospect of litigation is prompting change across the D&O insurance market, offsetting some positive signs  

By Melanie Scarborough, contributing editor

 

 

The FDIC recently ignited what is likely to become a fire storm of litigation by authorizing lawsuits aimed at recovering $20 billion from former officials of failed banks. Almost all of the money the agency collects will come from D&O insurance, an inevitability with ramifications for banks, insurers, and directors.

Among the most immediate impacts is the formation of a two-tiered market. “For the healthy banks—those that are stable, have good numbers, and are clearly going to thrive—D&O coverage is readily available, even competitive,” says Chris Taylor, president, Financial Institutions, Zurich North America. “For a bank that has horrible financials—maybe has already been issued a Memorandum of Understanding—even keeping D&O insurance is hard.” Any bank with operations that raise questions for underwriters may not get the same terms and conditions on renewal. Troubled banks should expect to pay a lot of money for stripped-down coverage, he says, “if they’re lucky enough to get coverage at all.”  

Dollar Bank, Pittsburgh, renewed its D&O insurance last April at a slightly lower premium with no change in coverage or policy language. Yet General Counsel Andy McGhee is aware that not all the banks in that market are so fortunate. “Since we’re a strong bank, we’re not seeing it, but others are seeing changes in coverage, with new exclusions and downward limits.”

Being a mutual institution helps keep Dollar Bank’s premiums low because it doesn’t carry coverage limitations as high as a stock institution would. Another advantage is that the bank tends to have long-term directors. “We need people who are familiar with the mutual form and value it, and they’re not that easy to find,” McGhee says.

Despite Dollar Bank’s stability and a relatively flat D&O insurance market in the Pittsburgh market, the bank’s broker told McGhee to expect a slightly higher premium when the bank renews its policy this April.

Change in policies
Higher premiums even for healthy banks are likely as D&O insurance carriers scramble to recover their losses from litigation. “From my discussions with Oklahoma banks and their current insurers, they are certainly nervous about the approach that the FDIC is taking,” says Marty Hansen, president and CEO of First State Bank, Fairfax, Okla.  He expects D&O premiums to be especially high in Georgia and the “sand states,” but warns bankers in the rest of the country not to think they won’t be affected as well: “Those higher premiums will trickle down to the rest of us eventually.”

Hansen also anticipates that meeting with underwriters will become more costly and time-consuming.

Speaking from his years of experience with Zurich, Taylor confirms Hansen’s prediction. “Underwriting oversight always increases when the economy is difficult,” he says. “Carriers look at financials harder and give less leeway.” For instance, community banks in the past often purchased D&O insurance on a three-year basis, he says. Today, far fewer three-year policies are being offered because of the struggling economy.

As another hedge against loss, insurance carriers are adding regulatory exclusion clauses to D&O policies, exempting them from paying claims brought by the FDIC.  

“There’s been some bounce-back in the economy and the paying back of TARP money—those are perceived as positive signs, and the insurance market has reacted to that,” says Ray Santiago, executive vice-president with the financial institutions group of Chartis. “There’s been a slowdown in rate increases and other punitive measures,” he adds, “so it’s a very competitive market.”

Nonetheless, the odds are daunting. “The failed banks number over 300; there’s a watch list of over 800,” says Santiago. “We’re looking at the prospect of increased activity by the FDIC in 2011 and 2012.” Perhaps the biggest danger facing bank directors is the issue of put-back properties. “Those ultimately could be exposures that impact directors and officers,” he says. “If you’re forced to take back the loan, that requires the bank to set aside additional capital.”

Not all is gloomy. Bankers have the option of dealing with ABA Insurance Services, which operates an insurance company that was created to deal with just such situations. See “An ABA backstop,” at left.

 

Follow the money
Recalling that the FDIC sued the directors of one-fourth of failed institutions between 1985 and 1992, Santiago expects the agency will pursue as many as half of all banks that have failed since 2008. “We expect to continue to address rates and terms and conditions as we anticipate more litigation,” he says. “When you think about the amount of perceived loss, as well as that the deposit fund is at an all-time low, I’m sure the FDIC is going to pursue all means of recovery.”  

Indeed, the agency has a fiduciary duty to collect money, according to Memphis attorney Jeff Gerrish, who in the 1980s headed the FDIC division in charge of suing directors of failed institutions. “They’re not suing for the heck of it or for punishment; the FDIC has to sue to collect money for receivership,” he says. “It will bring a claim where there’s insurance or where the directors have a personal ability to pay.”  

Understandably, that prospect is worrisome for some bank directors. “I know a number of banks that have indicated that their outside directors are inquiring about liability issues and their D&O coverage,” says First State Bank’s Hansen. “Clearly, existing directors are reading what is going on and are uneasy about their own liability.” 

Having both sued bank directors and been a bank director, Gerrish says serving on a board is a manageable risk. “There are three ways you can get sued,” he says. “You can get sued by shareholders; that’s covered under D&O insurance. You can be sued if the bank fails, but the majority aren’t going to.” The third possibility—a civil suit not covered by D&O insurance—is the greatest exposure. 

Gerrish advises directors of troubled banks to stay on the board rather than resign. “There’s no benefit to a current director getting off,” he explained. “Whatever liability he has, he already has. He might as well stick around and try to solve the problems.” Resigning from the board means forfeiting control of the situation, as well as the principal source of information. By taking that route, “you’re putting your net worth in someone else’s hands,” Gerrish says.

While no insurance offers blanket protection, experts point out that most bank directors largely control their own risks. “People who do the right thing generally come out on the right side of the equation, and most banks do that,” Taylor says. “It matters less what coverage they should get and more what they should do.” •

ABA program provides insurance backstop

ABA Insurance Services Inc., formed last year as a successor to the nearly 25-year-old ABA Sponsored Insurance Program, offers directors and officers liability, financial institution bond, internet banking liability, employment practices liability, and other related insurance products to community banks. Approximately 1,700 banks across the nation are insured through the program. 

“We started the program back in the mid ’80s to address an insurance crisis,” explained ABA executive vice-president John Wolff. “ABA member banks that are insured own the mutual company.”

Progressive was the carrier until last spring when American Bankers Mutual Insurance Ltd. purchased the portfolio. Although it hired another carrier, 58 of the 65 Progressive employees were retained, making it a seamless transition for members. The program insures members and non-members alike, but only ABA members are eligible for profit distribution. Since 1990, the program has paid out $75.5 million in profits, says Wolff.

John Wells, president and CEO of Cleveland-based ABA Insurance Services, says news of the FDIC’s planned lawsuits has had almost no effect as of yet on the company’s underwriting practices.

“Our rationale is always to underwrite the individual bank based on their performance,” he says. “The product itself can be fit based on the individual risk presented by the bank. Strong financial institutions are still receiving solid coverage at a good rate.”

For more information about the ABA insurance program, contact Jackie Lucas at ABA ( This e-mail address is being protected from spam bots, you need JavaScript enabled to view it ) or call 1-800-BANKERS. To apply for the program, contact Michael J. Read, at ABA Insurance Services—800-274-5222, or  This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

 

 

“BORING IS GOOD,” & OTHER D&O TIPS

Chris Taylor, president of the financial institutions division of Zurich North America, offers pointers on how to avoid ever filing a claim against your D&O insurance.

• Directors need to know their carriers and have conversations with the underwriter. “The more they tell us about the way they operate, the better we can have an advise-and-counsel session that fits,” says Taylor. 

• Understand the bank’s operation. An uninformed board is a red flag of a potential insurance risk.

• Make sure your bank’s board is a diverse group. “Let’s say every board member is a local developer,” says Taylor. “We would say, ‘No accountants? No attorneys?’ We look for a board with a good balance of talent.” 

• Remain vigilant about conflicts of interest. “That’s huge,” he says. “When you look at the high-profile failures of the ’80s and ’90s, conflicts of interest  seemed to be the first issue.” 

• Be able to demonstrate stability in your bank’s day-to-day operations. “We love banks that are predictable,” says Taylor. ”Boring is good.”

The electronic version of this article available at: http://www.nxtbook.com/nxtbooks/sb/ababj0111/index.php?startid=34

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