It is surprising how little most business people know about the fine points of their insurance coverage, relying on their agent or insurance consultant. In this recession era (I refuse to use the word "post"), banks and bank boards are subjected to Internet scams and fraud, claims of lender liability, angry shareholders actions, regulatory enforcement actions and bank failures with attendant F.D.I.C. claims. Such conditions require that each bank and each bank board of directors take special care to insure that the bank's insurance coverage is adequate, complete in its coverage and understood by those in bank management who must administer claims subject to insurance.
First, before talking about the types of insurance that every bank and bank board needs, some insurance concepts need to be explained. What follows is the "typical" policy treatment and policy provisions that may vary by individual policy.
Most of the key business policies such as Directors and Officers, Lenders Liability, etc. are "claims made" policies. This simply means that insurance coverage is afforded only to those claims which are the subject of notice to the insurance carrier before the inception of the new policy period. If the event occured before the new policy, and the claim is not the subject of a notice to the prior carrier, there may be no coverage. If your bank changes policies, claims which occured before the new policy may not be covered unless they are "noticed". See the discussion of "prior acts" below. Even if the policy does not change, insurance companies can claim that late notice affected the insurer's defense of the case and try to avoid coverage. Bank management should carefully consider procedures to "notice" all claims or potential claims to insure that the insurance company will not attempt to deny coverage on lack of notice grounds. .
"Retention" vs. "Deductible" are similar concepts with very different financial impacts. Most of you are familiar with the deductible on your auto: if your teen wrecks your Porsche, the insurance company pays for the damage caused less a deductible amount of $500 to $1000 or some other sum. Charles Wheeler, of Hub International [[charlie.wheeler@hubinternational.com], one of New Mexico's most experienced bank insurance consultants, has observed in an interview that most bank auto and general liability policies have no deductible. The insurance company pays legal bills from the first dollar and any judgment or settlement within policy limits. Even if a policy has a "deductible", the insurance company bears the legal cost.
Retention is a much more complex concept and can add significantly to the cost of your insurance claims handling. Retention amounts are usually found in Directors & Officers, Lender Liability Coverage and employment coverage. They are rare in most other coverages. An example may make the concept more understandable. Assume your bank has a Lender Liability policy with a $100,000 retention and policy limits of $5 million. Under the retention concept your bank absorbs all legal fees and costs up to $100,000. Only then does the insurance start reimbursing legal fees and costs. To increase the retention financial burden, most policies provide for an apportionment of the retention factors. If the lender liability claim is a counterclaim to a foreclosure, the insurance company will attempt to apportion a significant portion of the legal costs to the foreclosure which in turn has the effect of raising the retention amount which increases the bank's cost of defense and settlement. A typical insurance adjuster's ploy in counterclaims on collection matters is to try to "apportion" the legal costs for the collection to 50% of the total legal cost--an absurd position in most cases--since it assumes that a simple foreclosure costs as a much as defending a lender liability claim.
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The typical D&O policy incorporates three types of coverage: Side A, Side B and Side C. Side A is the most essential coverage for directors and officers. It pays defense costs and any judgment against the directors and officers even though those costs cannot be indemnified. Importantly, retention costs are not owed by the directors and officers. This is critical because any trial lawyer knows that the cost of the defense may be more important than the final outcome--which is usually a settlement. A good example of a case where Side A coverage is essential is where the bank or bank holding company is insolvent. In that case the directors do not pay "retention" legal fees or the final settlement amount within policy limits. A common added provision not part of Side A is an "order of payments" provision under which the insurance company pays claims against directors and officers first before payment of judgment against the bank or company.
Side B coverage is the coverage used in most claims if the company or bank is solvent. It covers cases in which the bank or company can indemnify the directors and officers. A good example of the use of Side B coverage is payment of legal costs and any judgment or settlement in a case involving class action claims of securities law violations (assuming such claims are not excluded).
Side C is company coverage and usually will apply in the same type of case in which Side B coverage is paid. In a securities action example, Side C covers the legal cost and settlement or judgment against the company itself (but not the directors and officers). An often overlooked feature of D&O policies is the extent to which the insurance company may rescind or cancel the policy for undisclosed events or fraud which is known by a limited core of officers. Applications for insurance should be carefully completed and checked and double checked. Such provisions require close legal analysis to minimize the risk of termination when a claim arises.
For most bank officers and directors in the present era, D&O is the most important coverage. However, for the bank, there are important insurance coverages which must be looked at with expert help. They are the lender liability coverage, employment law coverage and coverage for internet fraud. I assume that banks will buy bond, auto and general liability coverage in all cases.
Lenders liability insurance is essential and is almost always included in any bank insurance package. The key to the lenders liability coverage is the retention amount. Since many debtors faced with collection action file lender liability claims the retention becomes important. Employment coverage is also important because generally the retentions are low (assuming low claims history) and the cost of the litigation is high versus potential risk of adverse results and recovery.
Cyber coverage sounds attractive but most cyber policies have so many exclusions that the coverage is marginal. A typical cyber policy (if such exists) covers the damages and costs of a hacker stealing personal IDs. However, such policies may not cover the more serious risk of internet fraud. And there appears to be no "standard" policy. You should consult your insurance consultant on coverage for internet fraud and hacking. Many internet fraud claims may be covered by other liability coverage. Given the increasing volume of high dollar wire transfer and ACH fraud, bank management should consult knowledgeable insurance consultants who have knowledge of the type of scams being perpetrated.
The best insurance is the insurance you never use. However, when you need it, it is invaluable.
Thanks to Charles Wheeler and Stephen Lauer, of Comeau, Maldegen, Templeman & Indall for their assistance. Mr. Lauer has been involved in insurance coverage disputes for most of his law practice and is considered a foremost expert in the field.
Marshall G. Martin
Comeau, Maldegen, Templeman and Indall
505 983 4611
mmartin@cmtisantafe.com
