Bank Insurance – Directors’ and Officers’ Insurance

There are no standard D&O insurance policies. Coverage provided varies widely by insurer. Each policy and proposal of coverage must be reviewed and analyzed carefully to determine the best offering based upon the needs of the financial institution.

Summary of Coverage

Bank directors’ and officers’ have a fiduciary responsibility to customers, shareholders, and the general public in all dealings. There are also regulatory issues. The purpose of Directors’ and Officers’ Insurance is to protect the personal assets of the directors, officers, and employees of a financial institution from losses arising from, “Wrongful Acts.”

Each insurer has a unique definition for “wrongful act.” The term generally means: any actual or alleged act or omission, error, misstatement, misleading statement, neglect, or breach of duty by an “Insured Person” in the discharge of his/her duties with the financial institution.

“Insured Persons” are (generally) any past, present, or future director, officer or employee, or honorary director or trustee of the financial institution.

Losses include any amount that the Insured Persons are legally obligated to pay, including judgments, settlements, defense costs, pre- and post-judgment interest, and punitive damages (where insurable by law).

The primary purpose of D&O coverage is the protection of the directors’ and officers’ of the bank. Most banks indemnify the directors’ and officers’. However, litigation without insurance can put a severe dent in the financial statements. Legal expenses can be substantial.

Unendorsed D&O policies do not provide protection for the “Entity;” the bank itself. Many lawsuits name one or more “Insured Person” and the bank. In such a case, without Entity protection, judgments, settlements, and costs of defense will be allocated by the insurer between the financial institution and the individual Insured Persons. If the allocation determines that sixty percent of the action was attributable to an Insured Person, the D&O policy (without Entity coverage) would pay only 60% of the judgment. The balance would not be covered. In general, courts impose a greater duty on financial institutions than they impose on individuals. This places the majority of any loss involving the Entity and an Insured Person on the Bank. There is no formula to determine the allocation of costs and awards between bank and individual. Disputes between the insurance carrier and the bank can lead to frustration and higher attorney fees.

Entity protection is available through most D&O insurance companies. Carriers provide coverage by an endorsement to the D&O policy. Many carriers include extra coverage relative to entity acts, making the D&O policy a broad “Errors & Omissions” type of contract. Protection can be provided for:

  • Securities-related suits.
  • Shareholder suits.
  • Lending-related suits brought by borrowers or guarantors.
  • Suits brought by depositors alleging negligence with regard to any kind of forgery, unauthorized withdrawals, or any employee dishonesty.
  • Suits related to electronic banking activities.
  • Suits related to IRA or Keogh plan administration.
  • Suits alleging breach of fiduciary duty or employee benefit plan liability.
  • Suits alleging notary errors and omissions.
  • Suits alleging negligence regarding investment advice.
  • Suits related to data processing operations performed by the financial institution
  • Suits brought by business partners.
  • Suits served against the bank by third parties wronged by business partners or scam artists, who allege that the bank is negligent simply by virtue of being the perpetrator’s depository.
  • Nuisance suits initiated by those who go after the “deep pockets” of the financial institution.

D&O policies can also include protection for “employment related practices” such as discrimination, wrongful discharge, sexual harassment, and the like.

Coverage Considerations
As there are no standard D&O policies. Each policy and proposal must be evaluated on its own merits. Here are some issues that should be considered:

Claims-Made Policy
See the separate article describing claims-made policy issues.

Policy Limit
What amount of coverage is provided? What is the total amount of protection offered for the total of all claims during the covered timeframe (also known as an aggregate limit)? D&O policies are “claims-made contracts.” Coverage applies to any claim brought during the policy period. Multiple claims can, in effect, use up the limit of coverage.

Many factors must be considered when deciding what policy limits your institution should carry: price, terms of the policy, regulatory requirements, and capital levels. Peer data has been accumulated by a variety of insurance companies and bank organizations. Discuss limits with your insurance advisor or your state bank association.

Entity Coverage Included in Policy Limit
Entity coverage makes sense for most banks. However, it can dilute the limits of coverage available for true D&O claims. The bank could run out of insurance, as each claim reduces the coverage available for future claims.

Having entity claims outside the basic policy limit or as a separate limit protects the bank from using up the coverage. Alternately, the bank can purchase higher limits of coverage.

Positions Covered
All policies define “Insured Persons.” The contract may indicate Directors, Officers, and Employees or some variation. Most contracts extend coverage to, “past, present and future” directors, officers, and employees.

Defense Within Limit
It is common for D&O policies to include the cost of defending a claim (attorney’s fees, etc.) within the policy limit of liability. That means that the amount of coverage purchased must be enough to cover the awards and the defense costs of all claims. This can also be an issue to consider relative to occurrence limits.

Failure to Provide Insurance Exclusion
This exclusion currently exists in very few policies. In the past, insurance companies would not provide D&O coverage for claims brought by, for example, a stockholder, for a loss due to the failure of the bank to buy enough or the right kind of insurance.
Hammer Clause
A policy provision that limits the insurer’s liability should the insured refuse to accept a settlement offer from the plaintiff. In many cases the insurance policy limits the insurer’s obligation to the amount of the settlement offered. Some also restrict defense costs when the insured wishes to continue the fight.

Marital Estates Extension
This coverage provides protection for the spouse of an “Insured Person” when suit is brought against the spouse for community property or property held jointly. Coverage only applies when it is the actions of the “Insured Person” that causes the claim. For example, an officer is sued over issues surrounding a loan application. The officer’s spouse is also brought into the suit, as she owns the family home. The Marital Estates Extension provides the spouse with coverage.

Non-Cancellation Endorsement
Who can cancel the policy? Can the insurance company decide they no longer want to provide coverage? Some policies allow only the insured to cancel the policy — other than for nonpayment of premium. Note: Most policies do not guarantee premiums. An insurer may not be able cancel your policy but may be able to triple your premiums!

Non-Profit Service
Provides protection for actions by an “Insured Person” arising out of his work as a board member for a nonprofit when it is considered part of his bank duties to perform such a public service.

Civil Money Penalties
Provides coverage for penalties assessed by regulatory agencies against directors’ and officers’.

Employment Related Practices Coverage
Employment practices liability coverage can be a part of the D&O insurance or a separate policy. The protection provided includes such issues as: wrongful discharge, harassment, discrimination, etc. Check the policy’s definition of “wrongful employment act.” Does it include only certain acts, such as sexual harassment? Or is the coverage broad, including workplace harassment, for example? Are discrimination suits brought by third parties covered? Remember that including employment practices claims in your organization’s D&O policy could affect the limit of liability available for other claims.

Fiduciary Liability
Coverage for errors and omissions in the duties prescribed by the federal law ERISA for the administration of the bank’s own employee benefit plan. This may also be a separate policy.

IRA/Keogh Liability
Covers the bank against liability caused by errors or omissions while acting as administrator or trustee of IRA or HR10 / Keogh plans.

Lender Liability
Protects the financial institution against lawsuits alleging improper procedures, extension of credit, refusal to lend, or improper servicing of loans.

Remember that every director and officer
liability policy is unique. Read your policy!

Securities Liability
Protection for the entity against lawsuits resulting from the purchase or sale of or the offer to purchase or sell any securities issued by the insured.

Trust Errors & Omissions
Protects the bank from liability arising out of wrongful acts in the administration of trust accounts. The coverage may be an endorsement to the D&O policy or a separate, stand alone policy. In any event, make sure that coverage for this protection does not erode the aggregate limit of coverage on the D&O.