Myths, misconceptions, and misunderstandings pervade the area of director and officer insurance and protection

 

In the Mel Brooks’ film, History of the World, Part I, the comedian plays Comicus, a “standup philosopher” who plays Caesar’s Palace—the real one. The unfortunate Comicus flubs his jokes, and finds himself trying to battle his way out of the palace. As a Roman warrior’s blade easily slices through his sword and shield, Comicus realizes that he mistakenly grabbed a set of prop weapons and armor.

 

“I’m fighting with cardboard!” he wails.

How’s your armor?
Unfortunately, uninformed directors and officers of banks may themselves be relying on “cardboard” for their defense from potential public or private lawsuits. Sometimes directors and officers think they have coverage that they don’t. And sometimes the coverage they have doesn’t do what they think it does, or, in other cases, it simply doesn’t provide enough coverage for all the parties using the policy to protect themselves. And some practice just don’t make any sense at all.

This is no academic matter, when defense attorneys’ fees are “absolutely skyrocketing,” according to Michael C. Read, business relationship manager, Progressive Insurance ABA Program, Mayfield Heights, Ohio. Read says that defense fees are running to $500 per hour and more in small and medium-sized cities, and $800-$900 per hour in larger cities. Read was one of the legal and insurance experts who spoke about insurance issues in December during an ABA Community Bankers Council telephone briefing called Director Protection Issues: Boldly Going Forward—In Full Armor. (See below)

A myth is as off as a myle
Quick quiz for those of you who need D&O protection. Which of the following gives you the better armor from liabilities that develop from service with your bank or your bank board?
• A personal “umbrella” policy?
• A homeowner’s policy?
• Asset protection trusts?
• Skipping a board meeting you’re not comfortable with?

Time’s up. The answer is: “None of the above.”

As regards personal insurances, it doesn’t do anything at all for a director who is sued in his or her capacity as a bank board member, according to bank insurance expert Ronald C. Summerville, president, RCS Consulting Group, Chevy Chase, Md.

“Those personal coverages provide protection for bodily injury and property damage claims,” says Summerville.

 

“They don’t provide protection from errors and omissions and professional liability generated by your work. And, in fact, they universally contain an exclusion for business endeavors.”

Regarding the third and fourth choices, speaker Thomas B. Chandler, partner at the Hawley Troxell Ennis & Hawley LLP, law firm, of Boise, Idaho, advised against them. Chandler, himself a community bank director, says that setting up asset protection trusts, transferring assets to family members, or sending funds to offshore havens isn’t worthwhile.

“If you’re worrying at that level,” says Chandler, “there are other things going on in your life that are more important. You can run, but you can’t hide.” And, almost chuckling, Chandler says that not going to an uncomfortable board meeting doesn’t provide any insulation against liability.

“But the bank made me do it”
The flip-side misconception involves activities that a director or executive may think their bank D&O policy protects them in, but which may not be so. Summerville pointed out that some banks encourage, or even require, certain officers and directors to serve on boards of community nonprofit organizations, such as the local hospital.

“Your bank’s D&O policy may or may not protect you in your participation on these boards,” says Summerville. Some policies automatically provide coverage, some don’t, and some will provide it if the coverage is explicitly requested and the request is documented, such as in board minutes. However, Summerville adds, “be aware that coverage is only available for your service on nonprofit boards.”

No standard policies
Another misconception to get over, especially if your bank hasn’t been shopping for D&O coverage in some time, is that this kind of insurance follows a standard blueprint. It doesn’t.

“A D&O insurance policy is a legal contract,” says Summerville. “It’s made up of a number of sections, including one or more insuring agreements, exclusions, definitions, and a number of policy terms and conditions. While certain forms of insurance such as workers’ compensation and commercial auto policies are standardized, and don’t vary from one carrier to another, D&O isn’t that kind of insurance.”

One important matter to know about, when deciding which carrier to go with, is the policy provision for advancing defense costs. Read points out that not all D&O policies pay attorneys fees and other legal costs as they are billed, even though they will pay in the end.

“You want those costs to be advanced along the way,” advises Read.

“The bank’s covered…isn’t it?”
Many bankers think that D&O also covers the bank automatically. They may think that because most D&O cases involve the “corporate entity,” in insurance parlance.

“Plaintiff’s attorneys view the entity as the deep pocket,” says Mike Read of Progressive, “and they’re going to go after the deep pocket every time.”

Consultant Ron Summerville notes that currently, 15% of claims specifically name only directors and officers, while 85% of the claims name the entity. While that is somewhat favorable news for the individuals, it is not as good as it appears at first blush. Summerville points out that one-third of the entity claims also name director and officers. Thus, directors and officers find themselves involved in 45% of claims, overall.

But here’s the kicker: “There’s no automatic coverage for your bank in a D&O policy if it’s named in conjunction with a director or officer in a suit,” says Progressive’s Read.

When a bank does have entity coverage, it comes in one of two forms.

The first is “Bankers Professional Liability” coverage, or BPL.

BPL, which Read calls the “original entity coverage,” carries surprises.

“BPL is generally restricted for fee-based professional services,” says Read. “That means that professional services you offer customers are only covered if they are specifically named on your BPL policy. …If you offer a product or service that is not specifically named, you don’t have coverage. You also don’t have coverage if you fail to charge a fee for that service. … So this can leave you with a big potential exposure to suits that are brought by third parties, depositors, and business partners.”

The second is “Broad Form Company Liability” coverage, or BFCL.

“This is really the contemporary version of entity coverage, and is a relatively new response to company liability,” says Read. “Broad Form is not restricted to fee-based professional services or specific products. So that means that your activities are covered as long as they are not specifically excluded.”

The sources of the claims underscore the importance of having broad form coverage, according to Read. Figures cited by Read and Summerville indicate that 72% of claims come from customer suits; 21% from third parties; 3% from employees; 3% from shareholders; and, surprising to some, only 1% from regulators.

The causes of the claims are equally interesting: 40% lender liability; 30% depositor relationships; 10% from brokerage/investment advisory services; 7% from the bank’s own securities or regulatory issues; and 13% from other sources.

“Broad form provides better protection,” says Read, “because it protects the entity against exposure from suits brought by depositors, business partners, and third parties.” Third parties can include beneficiaries, spouses, and customers of customers.

“That’s covered by our D&O”
Ron Summerville warns that some don’t clearly understand that policies have limits, even when the affair at hand is clearly covered.

 

“Your D&O policy doesn’t provide unlimited insurance protection,” says Summerville. “It has a per-occurrence limit and an aggregate limit of liability built into the policy. The aggregate is the maximum amount of insurance available for the entire policy period.”

And there’s an important difference between D&O, Summerville says, and general liability policies. Under the latter, defense costs are paid in addition to the policy limit. But in D&O policies, he continues, defense costs are included within the limits of the policy.

“So, any defense costs that are paid erode the limits that are available for making settlements,” says Summerville, perhaps leaving little, if any, coverage.” BJ

 

Training also protects directors, and is as close as a phone

This article is based on an ABA Community Bankers Council telephone briefing for bank directors that concerned director protection issues. The briefing was one of a series of four-times-a-year briefings, produced in cooperation with ABA Bank Directors Briefing newsletter, www.bdbonline.biz. The 2007 series is set for April 11, June 20, Sept. 19, and mid-November, topics to be announced. E-mail This e-mail address is being protected from spam bots, you need JavaScript enabled to view it for more information. To order the CD of this briefing—$255 for ABA members, $385 for nonmembers—call 1-800-775-7654, and ask for CD 11201.

 

The electronic version of this article available at: http://www.nxtbook.com/nxtbooks/sb/ababj0107/index.php?startid=38

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