How to Combat Bank D&O Headwinds

Banks and their boards are at a crossroads of a hardening director and officers (D&O) insurance market, which is creating some challenging conversations as they approach their D&O renewal.

Prior to Covid-19, banks were seeing rate increase ranging from 3% to 26%, strictly based on an overall hardening of the D&O market. But the pandemic has had several specific impacts to the bank D&O renewal process.

Bank D&O underwriters realized very quickly that they would need substantially more information regarding an institution’s response to Covid-19 before they can comfortably offer terms. These questions cover how the bank reacted to their employee base, their response to their customers, their loan and investment exposure to certain high-risk industries and even the impact to the network with so many employees working remotely. Here is a list of the most common coronavirus-related questions a bank can expect.

The analysis of these additional questions means what used to take weeks to produce a quote can now take months. Everything now is a bit more delayed; banks need to budget more time allowances throughout the renewal process.

The pandemic has made multi-year options a thing of the past. Uncertainty associated with the virus and how quickly it caused fact patterns to change has challenged underwriters in ascertaining what the will look like over the next 12 months. Two-year or three-year options are virtually non-existent except for smaller privately held banks from the incumbent carrier.

D&O underwriters are almost paralyzed with fear of offering competing quotes on a bank they do not already have a relationship with. They worry about taking on a new bank and some unanticipated, unexpected pandemic-related claim happens during that first year for which they would be responsible.

The pandemic has made the insurance marketplace messier than it has ever been. Capacity is down, rates are up and underwriters are scrutinizing all new and existing business. Here’s what AHT has been doing for banking clients as they approach their renewal:

1. Set expectations early. Hold your renewal strategy presentation three to four months in advance and make sure you understand what the recent rate increases have been for your broker’s other banking clients to aid in the budgeting process. It can be a difficult message, but it is much better to understand what the rate environment is for similar banks based on the current data months in advance of the renewal.

2. Differentiate your institutions among your peers. We have been doing this for years in meetings with D&O underwriters, but it is more critical than ever. Because D&O lacks actuarial studies that can somewhat predict the probability of a claim, underwriters use the proxy of what I call ‘perceived quality of management.’ The best way for them to experience this is via hearing executives speak on the bank’s operations, compared to written responses.

We include a host of underwriters dedicated to the bank D&O space, including the incumbent underwriter. We begin with a general overview by the executive team of the bank and then open it up for questions from the underwriters, many of which are requested and shared in advance of the meeting.

These meetings expedite the process, especially the questions portion. We typically go from meeting to quote to bind with fewer delays or subjectivities. That’s because Underwriters get a better understanding of the risk, outside of information strictly available on the application and public filings. Some information included in those documents may not paint as full a picture as one that has the additional color added.

Including incumbents in the meeting allows them to experience the interest from competitors. This does not mean we recommended moving from incumbents; It simply means that they gain an understanding that they may need to ‘sharpen their pencils.’ It also increases the chance of gaining some interest from alternative carriers where there may not have been without the meeting.

3. Where there may be fewer alternative options, also look at options with higher retentions.

4. Look for a summary of renewal options as early as possible, understanding that D&O underwriters usually do not quote more than a month in advance. Two weeks prior is a good time to review options.

5. Lastly, more than ever, I am being asked to summarize the process and the results at the subsequent board meeting.

We are seeing challenging renewals the like that we have not seen for years, but your bank can mitigate the challenges by being as proactive and as transparent as possible.

Building an Effective Bank Liability Insurance Program

liability-11-8-17.pngIn a business environment fraught with lawsuits, regulatory scrutiny and cyberattacks, a strong liability insurance program is an essential risk management tool that can protect the bank’s balance sheet and the personal assets of the bank’s directors and officers. With that in mind, consider these practical tips for building a strong bank liability insurance program.

Retaining a Good Broker
Choose a well-regarded, experienced insurance broker focused on insurance for banks. Selecting the right broker sets the tone for the overall quality of the insurance program, both during the policy negotiation and placement phase, and later in the event of a claim.

Typical bank insurance programs cover a wide variety of both corporate governance and operational risks, often integrated into one master policy. A good broker will advise the bank as to which coverages are needed or recommended to fit the bank’s risk profile.

Knowing Your (Policy) Limits
A common way to determine appropriate limits for the various insurance coverages is through the benchmarking process, in which a broker will generate a suggested range of insurance limits by comparing the limits of peer institutions. Bank-specific factors such as market capitalization, regulatory requirements, the nature of lending activities, geography and amount of deposits, as well as market trends such as recent settlement and judgment data, are typically considered in the analysis. In most policies, defense costs are within the limits of liability, so benchmarking needs to account for those costs in addition to potential judgments and settlement amounts.

Given the various coverages that may be contained in the policy, the bank should consider whether the limits of liability for each coverage section should be separated or be part of one overall aggregate limit. Separate limits in key coverage areas will mean higher premiums, but won’t reduce the limits of coverage available in the others.

Filling the Gaps With Side A DIC Coverage
Banks often consider purchasing Side A DIC (difference-in-condition) coverage for the dedicated benefit of directors and officers, to sit on top of more traditional directors and officers (D&O) insurance coverage. These policies are triggered when all other available insurance and indemnification has been exhausted or becomes unavailable. Side A DIC policies also have fewer policy exclusions and offer broader coverage than the underlying policies, so they can fill the gap when the underlying insurance or indemnification fails to provide coverage.

Picking the Right Insurer
The bank insurance market is generally competitive, and there are a number of reputable insurers competing on the basis of price, retention, coverage enhancements, and other features. Although premiums are an important factor, the bank should also ask its broker and coverage counsel about the insurers’ reputation for handling claims. It is crucial that the insurance comes from well-rated and experienced insurers that are knowledgeable about the financial services industry and willing to partner with the bank in the event of a claim. This is particularly true for the primary insurer, which has responsibility for the approval of the insured’s engagement of defense counsel and the payment of defense costs at the outset of a claim.

Negotiating the Policy
Bank insurance policies are often heavily-negotiated contracts, so starting the negotiation process early is key. Each insurer typically uses its own unique policy form, often modified by various endorsements that can improve the scope of coverage. Proposed policy materials should be carefully reviewed and negotiated by the broker and coverage counsel to ensure that the policy language is market-competitive and that different coverage components work well together.

Re-assessing Coverage
Bank insurance coverages should be carefully re-assessed on a periodic basis, generally in conjunction with the policy renewal cycle, to maintain competitive coverage tailored to the bank’s needs. For example, banks that did not purchase cyber coverage in the past may find that the premium and product offerings have improved. In a year’s time, policy enhancements, insurance markets, and regulatory and litigation climates, as well as the bank’s business, geographic footprint and risk profile, can all change and warrant a fresh evaluation of the bank’s insurance needs.

Reporting Claims
Once the coverage is placed, the bank should be on the lookout for any reportable claim. Bank liability insurance policies are “claims-made” policies, and timely claim reporting within the policy window is usually a precondition for coverage. Late notice is one of the most common ways to jeopardize the bank’s coverage rights.

Building, maintaining and effectively using bank liability insurance requires specialized knowledge and collaboration between the bank and its advisors. In our experience, there is no such thing as a one-size-fits-all policy, and bank liability insurance should be reviewed and tailored to the bank’s needs.

Forming a Game Plan for TruPS

9-5-14-bryan-cave.pngFor the past 15 years, trust preferred securities (TruPS) have constituted a significant percentage of the capital of many financial institutions, mostly bank holding companies. Their ubiquity, both as a source of capital and as a common investment for banks, made them a quiet constant for many financial institutions. Even in the chaos of the Great Recession, standard TruPS terms allowed for the deferral of interest payments for up to five years, easing institutions’ cash-flow burdens during those volatile times. However, with industry observers estimating that approximately $2.6 billion in deferred TruPS obligations will come due in the coming years, many institutions are now considering alternatives to avoid a potential default.

Unfortunately, many of the obstacles that caused institutions to commence the deferral period have not gone away, such as an enforcement action with the Federal Reserve that limits the ability to pay dividends or interest. It is unclear if regulators will relax these restrictions for companies facing a default.

So what happens if a financial institution defaults on its TruPS obligations? It is early in the cycle, but some data points are emerging. In two cases, TruPS interests have exercised the so-called nuclear option, and have moved to push the bank holding company into involuntary bankruptcy. While these cases have not yet been resolved, the bankruptcy process could result in the liquidation or sale of the companies’ subsidiary banks. Should these potential sales result in the realization of substantial value for creditors, it is likely that we will see more bankruptcy filings in the future.

Considering the high stakes of managing a potential TruPS default, directors must be fully engaged in charting a path for their financial institutions. While there may not be any silver bullets, a sound board process incorporates many of these components:

Consider potential conflicts of interest.
In a potential TruPS default scenario, the interests of a bank holding company and its subsidiary bank may diverge, particularly if a holding company bankruptcy looms. Allegations of conflict can undercut a board’s ability to rely on the business judgment rule in the event that decisions are later challenged. Boards should be sensitive to potential conflicts, and may want to consider using committees or other structures to ensure proper independence in decision-making.

Determine who owns your TruPS.
Because of the way in which many TruPS issuances were placed, their ownership structures can range from the very simple to the incredibly arcane, and identifying the decision-making authority among the holders and their interests can be difficult to determine and can vary widely. This can influence or preclude the institution’s ability to reach a negotiated settlement of their TruPS obligations.

Develop a decision tree for addressing the TruPS obligations.
Developing tiers of potential alternatives can lend structure to the process, and the short timeframe involved may require that initiatives be pursued simultaneously, on parallel paths. For example, if a potential capital raise proves unworkable, planning for a sale of the subsidiary bank as part of a voluntary bankruptcy, also known as a 363 sale, may prove to be the best alternative.

If possible, engage with the trustee, collateral manager, or TruPS holders.
While the parties may not be able to come to a resolution, attempting to have the conversation with interested parties, where possible, may head-off an involuntary bankruptcy filing, and in any case helps to build a record of the board’s diligence and proactive efforts to satisfy its creditors.

Review your D&O Insurance Policy.
The possibility of bankruptcy (whether voluntary or involuntary) raises a host of issues with respect to insurance coverage—new potential claimants enter the picture, the board’s ability to renew a policy in bankruptcy may be impaired, and the board’s decisions will be scrutinized. Ensuring upfront that your policy is framed to deal with the unique issues that can arise in bankruptcy (and to actually provide coverage for claims by the most likely claimants), regardless of whether you intend to end up there, is critical.

For directors, developing a proactive process for negotiating or settling the company’s TruPS obligations is far superior to adopting a passive approach in the face of a potential default. Even when attractive alternatives for an institution may be limited, evaluating and prioritizing those alternatives provides a framework within which the board can operate, and also allows directors to establish a record of diligence that is consistent with their duties.

Coverage Options for Civil Money Penalties

The Federal Deposit Insurance Corp. (FDIC) issued guidance saying banks should not offer coverage for civil money penalties under directors and officers (D&O) liability insurance policies. In this video, Dennis Gustafson of AHT Insurance advises how boards can modify their policies in order to stay in compliance and still cover defense costs.

Civil Money Penalties: Figuring Out How Your D&O Policy Responds

Update from the author:
On Thursday, October 10, 2013, many Federal Deposit Insurance Corp. (FDIC)-supervised banks received a Financial Institution Letter regarding directors and officers (D&O) liability insurance. It brings up two distinct points:

First, the FDIC recommends that every director and officer is fully versed in the terms, conditions and exclusions of the D&O policy that is put into place for the bank. It also states that the individuals should be aware of any negative language changes from previous years’ D&O renewal. Second, the FDIC goes on to clearly and specifically prohibit any bank from including, as part of the D&O policy, any coverage grants that would be used to pay or reimburse for any civil money penalties (CMP). This explicit language on such a global scale is new and we are now recommending that banks do not include any CMP endorsements that specifically offer coverage or indemnification for civil money penalties or judgments. With that said, we have reviewed the entire statute, and it states that insurance can be used to cover expenses. It specifically says that insurance “…may pay any legal or professional expenses incurred in connection with such proceeding or action.” This is also consistent with our discussion with an FDIC representative. So we continue to recommend some type of affirmative coverage grant for defense costs associated with a CMP action, understanding that the coverage will not indemnify for the actual penalty or judgment.

The D&O Mess

For the past 20 years, directors and officers (D&O) underwriters have been offering civil money penalty endorsements to the D&O policies of their banking clients. This endorsement traditionally provides coverage for claims arising from civil money penalties against an insured person (director or officer) by a bank regulatory agency. Typically, it is offered with a sub-limit of $100,000 per insured person with a $1 million aggregate limit.

Interestingly enough, the entire time this coverage was being offered, since 1996, Part 359 of the FDIC (Federal Deposit Insurance Corp.) Act has been in effect. This statute basically states that the bank cannot purchase an insurance policy that would be used to pay a director or officer for the cost of any judgment or civil money penalty and that the individual cannot be indemnified by the bank for payment of such penalty or judgment.

The way some banks have addressed this was to charge each director and/or officer some small amount correlating to the cost of this coverage. This would allow the bank to show documentation that the individual paid for this coverage and thus the FDIC would not object.

This is how it progressed until the summer of 2011, when the FDIC issued citations against several banks in Louisiana stating that the civil money penalty endorsement on the D&O policy violated FDIC section 359. So it was the actual endorsement which was intended to protect the directors and officers for civil money penalties that caused the citations.

Impact on the Market

To get a real sense of the level of uncertainty, all you need do is look how the different insurance carriers are handling civil money penalty (CMP) coverage. Some carriers will no longer offer the CMP endorsement. Some offer an endorsement that pays for expenses (such as legal fees) but not the actual penalty and others are offering the same coverage grant they have been for the past 20 years, which is intended to cover the actual penalty and the associated expenses. Brokers are advising their banking clients to have the individual directors and officers pay their pro-rated cost for the endorsement. The cancelled personal checks should be saved as proof of personal payment.

The next logical question is how much is the allocated cost for the endorsement? This is a key piece of information for the CFO/risk manager so that he or she knows what to charge the directors and officers. Some carriers are unable to provide a cost, stating that it would violate their rating plans with the states. Other carriers are willing to provide an estimate, with an understanding that there would not be a reduction to their policy premium if the bank wanted to remove this coverage. As I talk with the underwriting community, I see costs for the CMP endorsement range from as low as $25 per director, to as high as $100 per director per year.

As far as alternative options, there was an initial thought that some carriers would create a standalone civil money penalty policy that can be purchased by the individuals looking for this coverage. In order for this solution to become reality, the carriers would have to go through the arduous process of getting it approved by the states and charge a price that is significantly higher than what the directors are paying now, which would limit the opportunity. Another interesting note is that since the initial citations began roughly 18 months ago, I have not seen any more circumstances where the FDIC issued fines relating to this coverage grants.

This article has been modified from an earlier version.

Five FAQs Boards Ask About D&O Insurance

With more lawsuits expected throughout 2013, many bank boards are re-evaluating the effectiveness of their directors & officers (D&O) insurance policies.  Dennis Gustafson of AH&T Insurance responds to the top five questions he frequently hears about D&O policies.

Highlights Include:

  • Civil Money Penalty Clause
  • How to Protect Personal Assets
  • Policies for M&A Transactions