The Federal Reserve wants bank directors and senior executives to know that while their D&O insurance policies are “an important risk mitigation tool,” their policies could contain exclusions that could “potentially limit coverage” and leave them without insurance in the event of a claim. In a July 23, 2019 letter (here), the Fed informed banks and other financial institutions of the risks associated with exclusionary provisions in D&O insurance policies and urged board members and senior executives to “understand fully the protections and limitations” that the D&O insurance policies provide. As discussed below, the Fed’s guidance is good advice for directors and senior executives of any organization, not just for banks. An August 3, 2019 post on the Willis Towers Watson blog about the Fed letter can be found here.
The Fed’s July 23 letter is addressed to the “officer in charge of supervision at each federal reserve bank and to financial institutions supervised by the federal reserve.” The purpose of the letter is to make “covered financial institutions” (state member banks, bank holding companies, and savings and loan holding companies) aware that their D&O insurance policies “may include exclusionary provisions that potentially limit coverage” that could leave directors and officers “liable for excluded claims.”
The Fed letter notes that under FDIC regulations, a bank’s D&O insurance policy “must exclude from coverage a prohibited indemnification payment.” (About this reference to FDIC regulations, see more below.) The timing of the letter seems to be related to a perception on the part of Fed officials that “an increase in the terms or provisions contained in these policies that exclude from coverage a wide range of other types of director and officer liabilities.” These “expansive exclusionary terms” could “adversely affect the recruitment and retention of well-qualified individuals.”
When exclusions apply, a bank’s directors and officers “may not have insurance coverage and may be personally liable for damages” arising out of civil suits. The Fed is concerned that in some cases, bank directors and officers “may not be fully aware of the addition or significance of such exclusionary language.”
The Fed suggests that a bank’s choice of a D&O insurance policy “should be based on a well-informed analysis of costs and benefits,” with important consideration of the potential impact of policy exclusions. The Fed “urges each board member and executive officer” to understand the answers to certain key questions about the D&O insurance policy’s coverage, particularly “when considering renewals and amendments to existing policies”;
- What protections do I want from my institution’s D&O policy?
- What exclusions exist in my institution’s D&O policy?
- Are any of the exclusions new and, if so, how do they change my coverage?
- What is my potential personal financial exposure arising from each policy exclusion?
The Fed’s letter concludes by noting that D&O policies are “an important risk mitigation tool for financial institutions,” and therefore it is “vital” for directors and officers to “understand fully the protections and limitations provided by such policies.”
The Fed’s recent letter expressly refers to a similar, prior letter from the FDIC. On October 13, 2013, the FDIC sent a letter about both D&O insurance policies generally (and their exclusionary provisions) and the FDIC’s stance with respect to the insurability of civil money penalties. (The earlier FDIC letter explains the later Fed’s letter’s reference to the prohibition of insurance for non-indemnifiable matters; the FDIC’s letter expressly states that insured institutions may not purchase insurance protection for civil money penalties.) I discussed the FDIC’s letter in a blog post at the time, here.
The Fed letter is in many respects an almost verbatim recapitulation of the earlier FDIC letter. The stated purpose of both letters to inform bank directors and officers of the risks associated with exclusionary provisions in directors and officers insurance policies. Both letters note that the letters were motivated in part by “an increase” in bank D&O insurance policy exclusions. Interestingly, in neither letter does the banking regulator issuing the letter identify the specific exclusionary provisions about which the agency was concerned, nor does it identify the exclusions that the agency things “increasingly” are being added.
The FDIC’s 2013 letter arguably was more timely than the recent Fed letter. In 2013, as the economy was still feeling the after effects of the recent financial crisis, many banks were seeing (or had recently seen) exclusions that had become relatively rare being added back to their D&O insurance policies. Specifically, prior to the financial crisis, it had become relatively rare for D&O insurance policies to contain so-called regulatory exclusions (that is, exclusions precluding coverage for claims brought against insured persons by banking and other regulators). In the midst of and following the financial crisis, the regulatory exclusion once again became a fairly common feature for bank D&O insurance policies. You can certainly see why the re-appearance of the regulatory exclusion during and in the aftermath of the financial crisis was a matter of concern for the FDIC, since it was the claims the FDIC and other banking regulators might want to bring for which the exclusions precluded coverage.
The timing of the Fed’s letter is a little curious. Because the Fed letter largely echoes the earlier FDIC letter, the Fed letter may not be the result of a separate or independent consideration of the contemporary risks associated with exclusions in bank D&O insurance policies. In any event, it is less clear now to what the Fed might have been referring about exclusions that “increasingly” are being added to bank D&O insurance policies. It could be (and indeed likely was) that, because the text of the two letters is very similar, that the Fed was simply repeating the same warning for the same reason that the FDIC issued its letter. Just the same, it isn’t entirely clear why the Fed would be issuing its letter now, unless it was a general sense that the FDIC’s 2013 letter had an important message that the Fed thought was worth repeating.
In any event, both the Fed’s letter and the FDIC’s earlier letter have the same advice for bank directors and offices, which is that the bank officials should fully understand what their D&O insurance policies cover. The four bullet-pointed questions that the Fed recommended in its recent letter are the same as the identical list of questions in the earlier FDIC letter.
The agency’s warnings about the need for banking directors and officers to be fully informed about the institution’s D&O insurance is good advice. Indeed, the warnings represent worth counsel for officials at any corporate entity, not just banking institutions. All corporate officials should be attentive to their D&O insurance, and the questions that the Fed and the FDIC suggest are good questions for directors and officers of any institution.
There is a particular aspect of the Fed’s (and before the Fed, the FDIC’s) four questions that is particularly important. All too often, officials at corporate institutions of all types (not just banks), when asking about their D&O insurance, focus almost exclusively on basic considerations such as price, limits, and retentions. These basic considerations are of course important. But inquiring about these considerations alone is not sufficient. In the event of a serious claim, differences in policy wording could be critical in determining whether or not the claim will be covered. The Fed’s overall message, that corporate officials should be informed about the key coverage provisions of their D&O insurance (and not just about the premium, limits, and retentions) is an important one. Indeed, all corporate executives have a keen interest in making sure that their D&O insurance provides the maximum available coverage.
Because the Fed’s letter went to all “covered financial institutions,” insurance professionals that work with these financial institutions should expect that their banking clients will be presenting them with the recommended questions and should be prepared to answer the questions when they arise.
For their part, banking officials should consider whether their advisers are adequately answering their questions. Although it is true in every corporate context, it is particularly true in the context of banking institutions that the firms and their directors and officers should be sure that their insurance advisor is knowledgeable and experienced. In looking for answers to the FDIC’s suggested questions, bank officials will want to assess whether their advisors’ answers show that their advisor is sufficiently knowledgeable and experienced to counsel them with regard to these important insurance matters.