Answering Bank Directors' D&O Insurance Questions (2024)

Bank directors often have many questions about their D&O insurance coverage, and rightly so. Ifsignificant reversals at the bank result in liability claims against the company’s senior officials, the bank’s D&O insurance could be the directors’ last line of defense. In this post, I address two issues that bank directors often ask about: first, does the bank’s D&O insurance cover civil money penalties? And, second, as the credit crisis retreats further into the past, when is the D&O insurance marketplace for banks going to “return to normal”?

The concern about insurance coverage for civil money penalties is, of course, not new. For many years, the leading carriers that provided D&O insurance for banks would specially endorse their policies to provide coverage for civil money penalties. However, as discussed here, in an October 10, 2013 Financial Institutions Letter (here), which included an “Advisory Statement on Director and Officer Liability Insurance Policies, Exclusions and Indemnification for Civil Money Penalties,” the FDIC “reminded” bank officials that under the agency’s regulations, the bank’s purchase of insurance indemnifying against civil money penalties is prohibited. After the agency released the letter, the leading financial institution D&O insurance carriers largely declined to provide the civil money penalties coverage endorsem*nt on their policies.

The concernfor bank directors is that the civil money penalties problem did not go away. Indeed, as detailed in a February 8, 2016 article on Bank Director.com entitled “What’s Changing in Bank D&O?” (here), by Dennis Gustafson of AHT Insurance, civil money penalties (CMP) levied against individual bank directors and officers have been increasing. According to Gustafson, in 2015, the average CMP increased to $79,980, from $67,646 in 2014, and the median amount increased from $15,000 to $50,000. Interesting, during the two-year period, more than 70 percent of the civil money penalties imposed did not involve failed financial institutions.

As these statistics show, bank officials’ potential exposure to civil money penalties represents a continuing risk. However, with the leading bank D&O insurers now unwilling to include a civil money penalties endorsem*nt on their policies, there arguably is a gap in the liability insurance protection for bank directors. As is now a frequent topic of discussion with bank officials, there are products available in the marketplace that provide individuals with CMP protection. These policies are written in the name of and are paid for by the individuals, for their own benefit. The bank is not an insured under these policies. These policies are available at varying limits of liability and with varying retentions.

However, the availability of the policies is also subject to underwriting. The products often are available only for individuals at banks that meet certain credit and leverage ratios, and usually are not available to individuals at banks that are subject to regulatory orders or agreements, or for individuals that have had civil money penalties previously assessed against them within certain time frames. In addition, these kinds of policies may not be available for individuals serving at publicly traded banks. As a result of these considerations and constraints, while the possible availability of insurance for civil money penalties is a frequent topic of conversation, the conversations in many instances do not actually result in an insurance transaction.

Another frequent topic of conversation with bank directors has to do with the lingering impact of the credit crisis on the D&O insurance marketplace. The bank officials are well aware that during the credit crisis and immediately afterward that the cost of their D&O insurance increased, in some cases significantly, and also that in many cases that the policies included more restrictive terms and conditions. Now that the credit crisis is well in the past, many bank officials want to know when things will “return to normal” with respect to their D&O insurance.

The good news here is that things in the financial institution D&O insurance marketplace already are much calmer than they were during the 2009-2012 time frame, when almost every bank was seeing pricing increases and restrictions in terms and conditions, and when placement of insurance for weaker banks was a serious challenge. As banks’ performances have improved, many banks have enjoyed more uneventful management liability insurance renewals, and even some price decreases. However, because of the lingering effects of the failed bank wave that followed the credit crisis, the marketplace has not returned to pre-credit crisis levels.

It is important to remember that between 2008 and 2015, a total of 515 banks failed. The FDIC, in its capacity as received of these 515 failed banks, has initiated a total of 108 lawsuits against the former directors and officers of the failed banks (or roughly 21% of all of the failed institutions). The bulk of these lawsuits were filed in 2014 and prior; the FDIC initiated only three new lawsuits in 2015, and has not initiated any so far in 2016. Indeed, the FDIC has not initiated any new failed bank lawsuits since July 2015. Because the bulk of the FDIC’s failed bank lawsuits were filed before 2014, many have already made it to the settlement stage.

A total of 85 out of the 108 lawsuits the agency filed have already been settled, representing more than three quarters of all the failed bank lawsuits. The aggregate dollar value of the failed bank lawsuit settlements is over $675 million. The vast majority of these settlement payments were funded by the D&O insurance the banks had in place at the time they failed.

The relevance of all of this is that, as Gustafson points out, “a majority of the claims are being paid by the same insurance carriers that currently represent today’s community and regional banks.” Even though the vast majority of the failed bank lawsuits have been settled, the carriers are still in recovery mode. As a result, today even health banks are continuing “to pay for the sins of their ancestors.” The good news is that it looks as if failed bank settlements peaked in 2015. With relatively few of the failed bank lawsuitsleft to settle, the insurance carriers may just about ready to move past the losses associated with the failed banks. As that happens, downward pressure on pricing for financial institution D&O insurance could increase, particularly for the healthiest banks.

On a final note, another topic that often comes up in discussion with senior bank officials is the question whether the existence of insurance actually attracts claims. Behind this question is a suspicion that, for example, the FDIC in the failed bank context only targets officials at failed banks if there is insurance out of which the agency can extract a monetary recovery. However, as I discussed in a recent post (here), recent academic research examining the recent failed bank litigation suggests that it was the banks’ behavior, not the banks’ insurance, that drew the FDIC’s lawsuits.The academics concluded that the FDIC does not merely target bank executives with insurance to pay claims, but rather seeks to set corporate governance standards by suing the executives at banks that were pursuing riskier strategies. In other words, it would not be a prudent move to omit to purchase D&O insurance on the theory that not buying the insurance would somehow ward of claims.

2015 Insurance Coverage Round-Up: Readers interested in having access to a comprehensive round-up of important management liability and professional liability insurance coverage litigation developments will want to review the Troutman Sanders law firm’s recent publication (here) summarizing insurance coverage case law developments during 2015. This year’s version includes a new “Trending Topics” section that highlights developments in important areas of insurance law – this year, the focus topic is Cyber Liability.

The Development of Shareholders’ Litigation Outside the U.S.: As readers monitoring events following recent scandal revelations at Petrobras, Volkswagen and Tesco are aware, there are a number of efforts underway in a number of different countries outside the U.S. to try to use various procedural mechanisms to secure recoveries for these and other companies’ shareholders. According to a February 19, 2016 Law 360 article entitled “Overseas Securities Litigation is Coming of Age” (here, subscription required) by Tyler Mamone of the Saxena White law firm, these kinds of developments had been anticipated after the U.S. Supreme Court’s 2010 decision in Morrison v. National Australia Bank. As it happened, these developments were slower to arrive than might have been anticipated after Morrison first came down. But while there might have been a delay, these developments are now well underway in a number of jurisdictions.

Why are these developments coming together now? Mamone suggests that it is the result of a number of factors: changes in the securities laws of a number of jurisdictions; the availability of increased amounts of litigation funding; and a spate of high-profile scandals. Mamone also suggests that as a result of these changes, the increased levels of shareholder litigation may be with us to stay, even though many of the procedural frameworks for this type of litigation are still coming together.

More About Volkswagen: As I noted in a recent post (here), there are a number of initiatives underway in a variety of jurisdictions aimed at trying to recoup Volkswagen securityholders’ investment losses, including most recently an effort to try to utilize the class settlement procedures in the Netherlands on the VW investors’ behalf. In a February 19, 2016 post on her On the Case blog (here), Alison Frankel takes an interesting look at these various VW scandal-related efforts on behalf of VW investors, including the most recent initiative to use the Dutch class settlement procedures. As Frankel details, many of the features of the VW situation are without precedent. She concludes that “The VW case is creating a new model for shareholder fraud claims outside of the U.S., informed by U.S. lawyers and U.S. class action history.”