Publication Date: 04/30/2008
Source: Community Banker
 
HEADNOTE

Evaluate your D&O insurance needs at all stages in your institutions development.

Organizing a de novo bank is a daunting task, even for the most experienced banker. In addition to writing and refining business plans, recruiting qualified directors and management, and performing due diligence on prospective service providers, countless hours are spent working with various regulatory bodies to gain approval of your new bank's charter and meeting with investors to raise capital.

An important responsibility that tends to get overlooked during these busy times is the placement of your Directors & Officers (D&O) Liability policy and related insurance coverage. De novo banks face liability risk from day one, and it is important to have a properly structured insurance program in place that responds to the unique risks faced in all three stages of a new bank's development: formation, offering, and opening. It is also important to reassess insurance coverage once your bank reaches profitability and you consider expanding or offering additional products and services to your customer base.

Formation

Many organizers are unaware that they face personal liability as soon as formation begins, well before any money changes hands during the offering or the bank opens for business. The single biggest exposure during the formation stage involves "investor solicitation" efforts. Even though the offering may be months away, organizers are actively soliciting potential investors and presenting the conceptual framework of the offering. The organizers may face significant liability if the actual offering is different from what was presented to investors because the investors may sue the organizers and allege misrepresentation. Other sources of potential claims during the formation stage include lawsuits arising from organizer meeting disputes, lawsuits involving employee non-compete agreements, regulatory lawsuits, and lawsuits involving real estate leases or purchases.

Prudent risk managers will recommend that a de novo bank have a basic Directors & Officers policy in place from the first day of formation. Subject to certain terms and conditions, D&O policies are designed to protect the personal assets of the Insured Persons against Losses resulting from Wrongful Acts. There are a few special considerations for de novo banks to evaluate. First and foremost, pay close attention to your carrier's definition of Insured Persons because many base D&O contracts do not cover organizers. As a de novo bank, it is imperative that your insurance carrier considers an organizer to be an Insured Person. It is also important to find a contract that includes broad definitions. The definition of "Loss" should include judgments, settlements and defense costs, and the definition of "Wrongful Acts" should include any actual or alleged omission, error, misstatement, misleading statement, neglect or breach of duty by an Insured Person in the discharge of his/her duties. Policies with more restrictive definitions should be avoided.

Offering

The offering stage of a de novo bank's development presents an entirely new set of exposures. The most obvious concern is the offering itself. There is significant risk in making representations to potential investors. Whether an offering is a private placement or public stock offering, the organizers, directors and the corporate entity can be held liable for mistakes or inaccuracies in the offering documents or any Wrongful Act arising from them. A common allegation against financial institutions during this stage is failure to provide accurate information about the company's business plans or its potential future performance in a prospectus, private placement memorandum or offering circular.

Securities Liability coverage should be in place at the time of your offering to cover Wrongful Acts against the Insured Persons and the Company (the corporate entity) which arise from, or are a consequence of the purchase or sale of, or the offer to purchase or sell, any securities issued by the financial institution. seek coverage that applies to all state and federal securities laws (not just the securities and Exchange Act of 1933) and to public offerings, private offerings, going public or private transactions and initial and subsequent stock offerings. securities Liability is normally purchased as an endorsement to your D&O policy.

You will begin to collect confidential investor information such as Social security numbers, dates of birth and financial statements once your offering commences. A relatively new concern in today's business environment is the protection of such information and the suits that could result from your failure to properly safeguard this material. The insurance industry is beginning to respond to this issue by offering endorsements to the D&O policy, which provide liability coverage for claims of negligent management of confidential information. Insurance carriers generally refer to this coverage as Privacy Protection or Loss of Sensitive Information Protection.

Some markets expand the scope of coverage by offering a liability mitigation expense component, which reimburses the bank for expenses incurred to mitigate a potential lawsuit by notifying investors or customers of a breach, reissuing plastic cards and changing account numbers and providing basic credit monitoring services. The mitigation expense coverage part is especially important to de novo banks, and you should ask your insurance carrier if its Privacy Protection includes this valuable benefit.

Opening

The insurance needs of a de novo bank change significantly upon opening. In addition to the risks faced in the formation and offering stages, you and your bank are now subject to operational exposure from borrowers, depositors, miscellaneous third parties and even your own employees.

The fidelity coverages required by regulators for financial institutions are provided in the Financial Institution Bond. The law requires that a bank have a Bond in place when it opens. Basic Bond forms provide first-party protection for dishonest or fraudulent acts of employees, robbery or burglary, loss of certain items while in-transit and counterfeit currency. Through the years, a number of endorsements have been introduced that expand coverage beyond basic bond to include losses resulting from forged, altered and counterfeit items, unauthorized signatures and computer systems. Many bankers consider the Bond to be the key insurance policy because the overall exposure to loss addressed by a Bond is so extensive. As such, carefully consider coverage recommendations made by your broker or insurance carrier when evaluating various Bond proposals.

Now that your de novo bank is making loans, it is essential that you address the exposure to lending related lawsuits through the addition of a Lender Liability endorsement to your D&O policy. Lender Liability commonly protects the financial institution against losses relating to extensions of credit, agreements or refusals to extend credit, loan servicing or the collection or restructuring of any extension of credit. However, not all Lender Liability policies provide equivalent coverage. Some endorsements limit coverage scope to claims brought only by borrowers or guarantors. Broader language that covers suits brought by borrowers, guarantors, and other third parties (such as other financial institutions or contractors) is critical and is available in the market. Lender suits have always been common, and it is anticipated that their frequency will only increase due to the ongoing problems in todays real estate markets.

It is also important to cover the financial institution for professional services and for suits brought by customers or third parties. Historically, coverage for professional services was provided by Bankers Professional Liability endorsements. Coverage was limited, however, because only specifically listed, fee-based professional services were covered. Moreover, there was no coverage for suits brought by third parties. Some carriers in the industry responded to this significant gap by creating broader coverage known as Broad Form Company Liability, Entity Errors & Omissions or Company Liability Coverage. This more contemporary approach to insuring the financial institution provides the broadest protection available because coverage is not restricted to specifically named, feebased professional services, and lawsuits brought by third parties are covered unless specifically excluded.

Employment Practices Liability (EPL) coverage becomes a critical component of your insurance program as you begin to hire employees. The number of lawsuits filed by employees against their employers has been rising steadily. Unfortunately, banks are not immune to this trend. EPL protects the financial institution and its employees against losses relating from Wrongful Employment Acts such as termination, discrimination, sexual harassment or other violations of statutory or common law relating to employment. Coverage is offered as a D&O endorsement or as a separate policy. To preserve the D&O limit of liability, however, separate policies are recommended.

Future Endeavors

It is important to reassess your insurance program as your bank grows, and most insurance experts recommend a comprehensive review once your de novo bank reaches profitability. Insurance policies are constantly evolving to keep pace with new exposures; analyze your coverage to ensure that your program includes the latest industry enhancements. Premium is always a consideration, and you are now in a better position to take steps to reduce your insurance costs by exploring higher deductibles and multiyear terms with your carrier.

Now is also the time to evaluate future plans. Perhaps your bank plans to acquire an insurance agency or offer investment advisory services or financial planning advice. If so, you should ensure that your existing policies cover these exposures. An Internet Banking Liability policy should be added if the bank has a transactional Web site. Always consult with your insurance broker to verify that any new products and services you offer, such as remote deposit, are covered under your Financial Institution Bond.

Limit adequacy also becomes more important as your bank grows. Consider the general risk profile of your institution when evaluating limits. In addition to total assets, you should take into account your ownership structure, business focus, products and services offered and location. If your bank is publicly traded, you will want to be on the higher end of the limit spectrum. As it relates to business model, banks that pursue a traditional focus have less risk than banks that venture into brokerage, real estate or other activities permitted by Graham-Leach-Bliley. These lower risk banks do not need to purchase as much coverage as their higher risk counterparts.

A bank that focuses on retail products and services (as opposed to an emphasis on commercial clients or construction lending) certainly falls into the lower risk tier as well. Location also makes a difference. Obviously, banks that are located in more litigious areas should purchase higher limits than rural banks or those in less litigious areas of the country. Finally, you may want to use peer group data as a benchmark. There are a number of resources available to bankers that suggest various professional liability and financial institution bond coverage limits based on total assets or other measurable criteria of the bank.

While the insurance needs of any bank are complex, de novo banks face a unique challenge because these needs change quickly in a relatively short period of time as the new bank moves from formation to offering to opening. For this reason, it is important to work with a knowledgeable insurance agent and/or reputable carrier that offers a comprehensive suite of products and the ability to grow with your bank over time.

SIDEBAR

Lender suits have always been common, and it is anticipated that their frequency will only increase due to the ongoing problems in today's real estate markets.

SIDEBAR

The number of lawsuits filed by employees against their employers has been rising steadily. Unfortunately, banks are not immune to this trend.