In recent exam cycles, bankers have generally been no strangers to heightened scrutiny by FDIC examiners on a variety of topics. In the past several months, the insurance policies carried by banks have been added to the list of potential hot-button items.
Specifically, FDIC examiners have begun to scrutinize bank insurance policies to determine whether the policies provide coverage for civil money penalties (“CMPs”) that may be assessed against bank officers or directors. If any bank insurance policies are found on examination to contain an endorsement extending coverage for CMPs to officers or directors, the FDIC is citing such policies as being in violation of Part 359 of the FDIC’s Rules and Regulations.
Part 359, among other things, prohibits banks and affiliated holding companies from making certain “prohibited indemnification payments.” These prohibited payments include any payment or agreement to pay or reimburse bank officers or directors for any CMP or judgment resulting from any administrative or civil action which results in a final order or settlement in which that officer or director is assessed a CMP, removed from office or ordered to cease and desist from certain activities. As a matter of public policy, this provision is designed to prevent banks from bearing the costs of penalties assessed against individuals for actions that could result in harm or potential harm to a bank or to the safety and soundness or integrity of the banking system more generally.
Part 359 explicitly permits reasonable payments by banks to purchase commercial insurance policies, provided that the policy not be used to pay or reimburse an officer or director the cost of any judgment or CMP assessed against him or her. However, Part 359 does permit the insurance paid for by the bank to cover (1) legal or professional expenses incurred in connection with such a proceeding and (2) the amount of any restitution to the bank, its holding company, or its receiver.
For individuals serving as officers or directors of banks, CMP assessments represent a potential risk to personal assets. In addition, CMPs are generally assessed not through the civil litigation process, but rather through an administrative proceeding or enforcement action, where burdens of proof and standards of review generally favor the assessing agency, and intent to violate the rule giving rise to a CMP assessment is not necessarily required in order for the penalty to be assessed. As a result, there has been a long-standing demand for some form of coverage for bank officers and directors to address this risk. A solution used by the insurance industry for decades has been to offer CMP coverage by way of a separate endorsement to the D&O insurance policy purchased by the bank. This endorsement is then invoiced separately, and the individuals covered under the endorsement pay the premium associated with the endorsement out of their own pockets.
However, in recent months, this approach has been criticized by the FDIC, which has cited any policy written in the name of the bank or its holding company that, by endorsement, provides CMP coverage for individual officers or directors, regardless of who actually paid the premium associated with such coverage.
In response, as policies with CMP endorsements begin to expire, insurance carriers are likely to begin pulling the CMP endorsements from these policies on renewal. While Part 359 would not prohibit individual officers and directors from independently purchasing their own policies for CMP coverage, outside of the framework of the bank’s base policy document, insurance professionals have indicated that such stand-alone policies are not generally available at the present time. Given the generally low premiums historically associated with CMP coverage in the community bank space, carriers will not necessarily have strong economic motivation to rush to develop stand-alone CMP products for community bankers. In addition, a stand-alone CMP product, if and when created, may likely carry with it a somewhat elevated premium, as carriers would need to recover the incremental costs of that product’s development.
Even with strong economic motivation, it would likely take time for such products to be developed, resulting in an intermittent period where coverage remains unavailable and this risk to officers and directors remains unmitigated. As a point of comparison, products designed over the past several years to address the shortfalls in the regulatory coverage being offered by primary carriers only began to appear in the community bank space some months after shortfalls in regulatory coverage began to become a widespread phenomenon, notwithstanding that the premiums associated with regulatory coverage products were proportionally much larger than CMP coverage premiums.
A stopgap solution could be for carriers to restrict the definition of losses covered under the CMP endorsement to account for “defense costs” and reimbursement to the institution only — those items specifically carved out by the language of Part 359 – but such an approach, from the perspective of the individual, would not mitigate the risks to personal assets posed by the CMPs themselves.
Exactly how things will develop on this front remains to be seen. However, the likely net result of this trend – at least in the near term – will be increased costs to individuals serving as officers and directors of financial institutions, whether actual or contingent. The general trend of increasing exposure for bank officers and directors continues notwithstanding that salaries and fees for services rendered by officers and directors remain subject to increased scrutiny and, in many cases, are being frozen or cut proactively in the interests of cost savings. In addition, officers and directors continue to face elevated demands on their time as they seek to navigate the challenging economic waters and ensure the safe and sound operation of their institutions. At some point, finding or retaining qualified individuals who are willing to bear the costs associated with service – particularly service as a director – may become a challenge for some financial institutions.
The specific terms and scope of coverage provided by insurance policies vary widely, and bankers with questions about their specific insurance policies should contact their insurance professional or coverage counsel.