What’s Changing in Bank D&O Insurance

To quote Shakespeare, “What’s past is prologue.” By looking back at Federal Deposit Insurance Corp. (FDIC) actions in 2015 and beyond, I believe it provides a good template for what we can expect for insurance in 2016. For purposes of this article, there are two areas we will look at: FDIC settlements and regulators’ civil money penalties (CMPs).

The Impact of the Wave of Failed Banks
Here are the trends with regards to the impact that failed banks have had on FDIC suits and then on FDIC settlements:

Year Failed Banks # of FDIC Suits # of FDIC Settlements Settlement $ (total)
2008 25      
2009 140      
2010 157 2    
2011 92 16 1 $700,000
2012 51 26 7 $186,345,000
2013 24 40 9 $49,466,093
2014 18 21 23 $90,800,500
2015 8 3 45 $347,947,183
Totals 515 108 85 $675,258,776

We see an interesting chain reaction that begins with failed banks. Since 2008, there have been 515 total failed banks, with a peak of 157 in 2010. We see a similar trend with the number of FDIC suits against banks, albeit with a three-year lag, which is consistent with the statute of limitations. This trend continues with FDIC settlements, which generally have a two-year delay following the lawsuit. For example, a bank that failed in 2010 will typically be sued in 2013 and settle in 2015. And a vast majority of those settlements are represented as directors and officers’ (D&O) claims payments associated with the D&O insurance policy that existed at the time the bank failed.

A majority of the claims are being paid by the same insurance carriers that currently represent today’s community and regional banks. This implies that healthy banks will continue to pay for the sins of their ancestors. The good news is that it is fair to say that settlements against bank directors and officers peaked in 2015. So while we can expect slightly higher D&O rates at least until the time when these claims amortize off the carrier’s books, fewer settlements in 2016 should begin to put downward pressure on prices for D&O insurance.

The best way to mitigate against these increases is to make sure your bank is seen for its strengths. We recommend hosting an underwriting meeting/call approximately six weeks prior to the renewal, which should include both the incumbent D&O underwriter and one or two of the  alternative underwriters who typically will offer terms for similar banks.

FDIC Civil Money Penalties (CMP)
Since 1996, the FDIC has forbidden banks from insuring against CMP payments for their officers and directors. However, we regularly saw civil money penalty endorsements on D&O policies up until 2013. On October 10th of 2013, the FDIC sent out the letter FIL-47-2013 which explicitly reinforced that civil money penalties (CMPs) can neither be indemnified by the banking institution or covered under the bank’s D&O policy. Once that letter came out, most insurance carriers refused to offer the CMP endorsement(s) previously provided, thus creating a significant gap in coverage for all bank directors and officers.

Since then, we have seen several new insurance products created to address this gap and we continue to get inquiries about them. Remember, since the bank cannot cover the CMP, the individual must complete the application and pay for the coverage themselves. And it will be the individual’s name as the only named insured listed on the policy.

Here is the 2014 vs. 2015 data with regards to the CMP trends against individual D&Os:

  • The average CMP amount increased from $67,646 to $74,980
  • The median CMP amount increased from $15,000 to $50,000
  • The maximum individual CMP in 2014 was $500,000 and in 2015, $545,000
  • In the past two years, approximately 29 percent of CMPs were for failed institutions
CMP Fine Size 2014 2015
<= $50K 71% 64%
$51K – $100K 10% 12%
$101K – $150K 10% 12%
$151K – $250K 2% 8%

Since a vast majority of banks cited are solvent, it behooves D&Os of even the healthiest institutions to consider this coverage. Factors that go into eligibility are the regulatory status of the bank and any past regulatory history of the individuals. So if you are interested, it is better to inquire prior to any type of regulatory restriction, although that would not disqualify you for the coverage.

Negotiate the Best Directors & Officers Liability Contract for Your Board

11-26-14-AHT.jpgThe bank’s directors & officers (D&O) policy is there to protect the personal assets of the individual directors and officers. In dire cases, it very well could be the last line of defense to ensure that individuals do not have to pay out of pocket after a lawsuit or regulatory fine. With that context, having an organized renewal process can ensure the best results. Here is our recommended step-by-step timeline to ensure the most comprehensive placement.

90 – 120 Days in Advance of the D&O Renewal: Renewal Strategy
Typically, the chief financial officer or in-house attorney would be responsible for the renewal discussions. The renewal strategy discussion with a broker could:

  • Review any recent successes or challenges at the bank that may have arisen since the last renewal and discuss what impact those may have on the renewal.
  • Analyze any recent claims and litigation trends that are impacting other bank boards as well as any changes in carrier appetite, any new carriers in the market, new language grants and pricing trends.
  • Update the limits benchmarking analysis and review the current limits sharing structure to ensure it is appropriate for a bank based on the asset size and risk analysis.
  • Determine a marketing strategy. Our advice is to market the D&O insurance at least every other renewal cycle and if you are on a three-year policy term, every cycle.

60 – 90 Days in Advance of the D&O Renewal: Insurance Application

  • If you are not sure of an answer to a specific question, it is always better to leave it blank rather than guess.
  • If a question can be answered by a document that is publicly available, simply answer, “see public filings.” This way, when you are completing the same renewal application the following year, that field can remain as is.
  • Likewise, if the answer to a question requires more than a handful of words, it is always OK to respond, “see attached.” This way, at the following renewal, all you need do is update the attachment.

45 – 60 Days in Advance of the D&O Renewal: D&O Underwriter Meeting
The next step is to give the underwriters an opportunity to learn more about the bank other than from the insurance applications and the public filings. This is accomplished via the D&O underwriter meeting/call. The call leader is usually the chief executive officer or chief financial officer, but could include counsel or the chairman of the board as well. The process for this meeting is to collect all of the underwriters (including the incumbent) into either one location or one call. Having the incumbents on the call with competitors will let the incumbents know they are going to have to sharpen their pencils to keep the business. There are other benefits as well:

  • You can allow underwriters to hear from the bank executive(s) directly, the best advocates of the bank.
  • The call gives executives the chance to answer verbally instead of in writing.
  • You can express the importance of everyone’s time on the call, so underwriters should get the message that they should speak now or forever hold their peace. We typically find that this really streamlines the process from call to quote to bind.

Note that the process includes collecting all underwriter questions in advance of the call and providing these to the executive team several days prior to the call, so they have an understanding of what types of questions may get asked.

20-30 Days Prior to Renewal: Taking Bids
After the meeting, all that is left is to do is collect, compare and summarize the different quotations. Note that most underwriters will typically not offer a quote more than a month in advance of the renewal, so expect 20-30 days prior to renewal to start hearing about the different coverage improvements and recommendations. Because of all of the ground work already done, this part is typically the easiest, as the whole process normally has come to a positive end. Of course, the audit committee, or in most cases, the full board will want to hear the recommendations and make a final decision.

FDIC Lawsuits Trending Upward

4-8_Cornerstone.pngIf the current pace of Federal Deposit Insurance Corp. (FDIC) lawsuits against directors and officers of failed institutions continues, 39 lawsuits will be filed in 2013—more than any year since the financial crisis began. As the number of filed lawsuits increase, the number of new failures has decreased. The most commonly named defendant in an FDIC lawsuit continues to be the chief executive officer.

These are some of the Cornerstone Research authors’ findings in their fifth in a series of reports that analyze the characteristics of FDIC professional liability lawsuits filed against directors and officers (D&O) of failed financial institutions.

In brief:

  • At least 12 FDIC D&O lawsuits have been filed in 2013, 10 in the first quarter and at least two in the first three weeks of April. The pace of filings in the first quarter of 2013 slowed slightly in comparison with the 12 filed lawsuits in the fourth quarter of 2012, but is higher than any previous quarter in 2010, 2011, or 2012. If the filing of new lawsuits continues in 2013 at the pace observed through the third week of April, 39 lawsuits will be filed this year—more than any year since the financial crisis began.
  • FDIC seizures of financial institutions continued to decline so far in 2013 compared with 2012. Eight institutions have been seized as of April 22, 2013. Since 2007, 476 financial institutions have failed.
  • Institutions that are subject to D&O litigation have historically been larger (in terms of assets) and have had higher estimated costs of failure than the average failed financial institution. While this was not true in the second half of 2012, the FDIC’s recently filed D&O lawsuits have again, on average, targeted larger failed institutions.
  • Chief executive officers continue to be the most commonly named defendants. They have been named in 88 percent of all filed complaints and 10 of the 12 lawsuits in 2013. Chief financial officers, chief credit officers, chief loan officers, chief operating officers, and chief banking officers are other commonly named defendants. Outside directors have been named, frequently along with inside directors, in 75 percent of all filed complaints and nine of the 12 lawsuits filed in 2013.
  • The FDIC has recently begun to publish settlement agreements related to its professional liability cases. Based on the settlement agreements we have reviewed, the FDIC has obtained aggregate settlements of $601 million—$115 million attributable to filed D&O lawsuits, $216 million attributable to claims involving D&Os that did not result in a filed complaint, and $270 million attributable to claims against professional firms and non-D&O individuals associated with failed financial institutions.
  • Since the December 7, 2012, trial verdict of three former officers of IndyMac’s Homebuilder Division resulting in a $169 million award, the parties have filed post-trial briefs on the applicability of pre- and post-judgment interest. The court has ordered that both are appropriate. A mediation to address remaining issues is scheduled for May. The D&O insurance carrier will participate in the mediation. 

Fewer Directors and Officers Get Sued; Pace of Bank Failures has Slowed

cornerstone-0912-wp.pngThis is the third in a series of reports that examines statistics and offers commentary on the characteristics of professional liability lawsuits filed to date by the Federal Deposit Insurance Corporation against directors and officers of failed financial institutions.

  • In our May 2012 report, we had observed a decline in the seizures of banks and thrifts by the FDIC in 2012 relative to 2011 and 2010 levels. This decline has continued during the past four months. In the past four months, the FDIC seized 19 financial institutions. The pace of seizures in May through August is slightly less than the first four months of 2012, when the FDIC seized 22 institutions.
  • FDIC seizures in 2012 continue to be concentrated in the Southeast. Nine of the 41 institutions that failed this year were in Georgia. Since 2007, 84 institutions in Georgia have been seized, representing 18 percent of all failures. Florida has the second highest financial institution failure rate, with five failures in 2012 and 63 failures since 2007. Illinois and California follow, with 53 and 39 failures, respectively, since 2007.
  • Based on the FDIC’s estimates at the time of seizure, California—where financial institution failures have cost $21 billion since 2007—has the highest total estimated failure cost. Florida and Georgia each have more than $10 billion in estimated failure costs, followed by Illinois, Puerto Rico, and Texas.
  • While the pace of D&O lawsuits has increased in 2012 relative to previous years, the FDIC has filed new lawsuits in the past four months at a significantly slower rate than in the first four months of the year. Only three lawsuits were filed in the last four months compared with 11 in the first four months of the year.
  • To date, 7 percent of financial institutions that have failed since 2007 have been the subject of FDIC lawsuits. These lawsuits generally have targeted larger failed institutions and those with a higher estimated cost of failure. The 31 financial institutions targeted in lawsuits had median total assets of $836 million, more than 3.5 times the median size of all failed institutions and more than five times the median size of institutions active at mid-year 2012.
  • Defendants named in the 32 lawsuits the FDIC has filed since 2007 included 266 former officers and directors.

For a full copy of the latest report, click here.