Understanding Banker’s Liability Exposures:
Bankers’ Directors & Officers Liability
Bankers’ Professional Liability

No business organization has a more complicated liability exposure profile than a Bank or Thrift. This exposure profile makes these institutions some of the hardest to insure. The first step in securing the appropriate coverage for your bank or thrift is to understand the exposures.

Sources of Exposures

Banking Operations and Management
The process of operating a bank brings with it the traditional exposures of any brick and mortar professional business. These include general liability exposures arising out of the premises of the business; directors and officers liability for management errors and omissions that any business operation might face and errors and omissions in providing banking services (Bankers’ Professional Liability).

The Regulatory System
The dual regulatory system of state and federal statutes and agencies creates a tangled web of regulation. Key statues regulating banks and thrifts include the National Bank Act; the Bank Holding Company Act; the Federal Depository Insurance Act, the Financial Institutions Reform, Recovery, and Enforcement Acts (“FIRREA”); the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and Gramm-Leach-Bliley Act of 1999 all govern and regulate the actions of banks and thrifts. These acts also expand the role of regulatory agencies and their enforcement powers. Officers and Directors are expected to assure the compliance of their organizations to these rules and their interpretations.

Mergers & Acquisitions
“Of the 200 largest financial institutions at the beginning of 1985, less than 100 remain in existence 18 years later: although some of those institutions failed, most were acquired by other financial institutions.”1 Most mergers and acquisitions are driven by competitive market conditions but some are the result of a need to upgrade technologies or enter new product lines. Directors and Officers have the responsibility of deciding on how to deal with or make offers for mergers and acquisitions. These decisions typically need to show that they had the best interest of the shareholder in mind. Still, any shareholder unhappy with a decision is a potential claimant for management malpractice.

Expansion into New Activities
Gramm-Leach-Bliley opened the door for Banks and Thrifts to become involved in other types of financial services. The decision to enter these services can be costly. Not entering these services, could result in business lost to other institutions that do offer these services. If the directors and officers choices have a negative impact on earnings or stock prices, stockholder actions could follow.

Coverages
Section 1

Directors and Officers Liability (D&O)
This provides cover for directors and officers collectively and individually. It can include entity protection for lender liability claims, private placement security claims, and IRA/Keogh account coverage. It can be expanded with additional options for Trust E&O and Fiduciary Liability.

Fiduciary Liability
Protects the bank and the Insured Persons in the management of the financial institution's employee pension and/or profit sharing plans. Coverage is provided for liability losses and defense costs arising from a "Breach of Fiduciary Duty" in the financial institution or Insured Person's capacity as fiduciary of these plans, under the Employee Retirement Income Security Act of 1974 (ERISA). A "Breach of Fiduciary Duty" may arise when an employee fails to perform his/her duties in a manner that a "reasonable person" would.

Securities Liability
Endorsement protects the financial institution from lawsuits resulting from "Wrongful Securities Acts." A “Wrongful Securities Act" is any actual or alleged act, error, omission, misstatement, misleading statement, neglect or breach of duty by the financial institution or any person or entity for which the financial institution is legally responsible, which in whole or in part is based upon, arises from, or is a consequence of the purchase or sale of, or the offer to purchase or sell, any securities issued by the Company, and shall include any appeal from such proceeding.

"Entity"(the bank) Errors and Omissions (E&O)
While most financial institutions purchase D&O coverage to protect the directors and officers, D&O policies do not provide protection for the financial institution itself. In addition, if a suit names an Insured Person and the financial institution, judgments, settlements and costs of defense will be allocated between the financial institution and the individual Insured Persons.

Since the law often imputes a greater duty to the corporate entity, financial institutions often bear the lion's share of any loss. Further, the settlement of allocation issues between the financial institution and the D&O carrier increases both attorneys' fees and the frustration level of all parties involved. Entity endorsements available under the D&O Policy are intended to extend coverage to the entity.

Lender Liability Endorsement
The Lender Liability Endorsement protects the financial institution against suits brought by borrowers or guarantors, related to extensions of credit, agreements or refusals to extend credit, or the servicing, collection or restructuring of any extension of credit. Although lender liability coverage for the individual directors, officers and employees is provided under the basic D&O Policy, many financial institutions find this endorsement valuable, as mounting costs of defense from frivolous foreclosure-related and bankruptcy-inspired suits impact the bank's bottom line.

IRA/Keogh
Coverage is available in one of two ways:
1) as an endorsement to the D&O Policy
2) as part of the Entity E&O Endorsement. The endorsement limit of liability is included within, the aggregate limit of liability on the D&O Policy.

Employment Practices Liability (EPL) Insurance
The EPL Policy provides coverage for the financial institution and the Insured Persons for losses arising from "Wrongful Employment Acts." A "Wrongful Employment Act" is any actual or alleged wrongful termination, discrimination, or sexual harassment. In addition, the financial institution may be held liable for the acts of its directors, officers and employees.

Employment Practices Liability protection is offered both as an endorsement to the D&O Policy and as a separate policy. We encourage the purchase of coverage as a separate policy to minimize potential erosion of the D&O limit of liability. By purchasing Employment Practices Liability Insurance as a separate policy, limits will be available exclusively for claims arising from "Wrongful Employment Acts," enabling the financial institution to maintain the D&O Policy for the protection of the directors' and officers' personal assets.

Bankers Professional Liability
Coverage highlights includes:
• Covered professional services (sometimes where the bank gets paid a" fee" for its service),
• Insureds include the bank and its past, present and future directors, officers and employees

Trust Errors & Omissions (E&O)
Trust Errors & Omissions (E&O) insurance protects the financial institution and Insured Persons from liability resulting from "Wrongful Acts" while acting in the capacity of administrator, conservator, guardian, custodian or trustee. "Wrongful Acts" are any actual or alleged act, error, omission, misstatement, misleading statement, neglect or breach of duty.

Section II.

Financial Institution Bond
Agreement A - Employee Dishonesty: As employee dishonesty (dishonest or fraudulent acts committed by employees acting alone or in collusion with others) represents the greatest threat to a financial institution, Agreement A is the most important part of a financial institution's Bond coverage.

Agreement B covers losses that occur on premises. Losses must be a direct result of burglary, robbery, misplacement, or unexplained disappearance of property located on the financial institution's premises. Theft, false pretenses, and larceny are also covered if committed by a person on the premises. Damage to furniture or fixtures resulting from the above listed acts are also covered under this Insuring Agreement (unless caused by fire).

Agreement C covers losses of certain property while in transit. Losses must be a direct result of robbery, larceny, theft, misplacement, mysterious disappearance, damage or destruction to the property. Under this Insuring Agreement, financial institution employees are authorized to carry cash. If a transportation company is carrying cash, it must be transported via an armored vehicle. If the transportation company does not utilize an armored vehicle, only records, certificated securities in registered form and not endorsed (or with restrictive endorsements), and negotiable instruments not payable to the bearer, are covered.

Agreement D provides coverage for losses resulting from forgery or alteration of negotiable instruments (except Evidence of Debt.) Written, telegraphic, cable, or Teletype instructions that are forged or altered are also covered. Excluded are transmissions of electronic funds transfer systems. Facsimile signatures are treated as handwritten signatures.

Agreement E: This agreement covers losses resulting directly from extending credit on the faith of Stock Certificates, Documents of Title, Deeds or like instruments, Certificates of Origin or Title, Corporate or Personal Guarantees, Evidences of Debt and Security Agreements, which are forged, altered, lost, or stolen. Counterfeit coverage is also supplied for certain of these enumerated documents. The financial institution must have acted in good faith on an original instrument (photocopies are not considered originals).

Additional coverage under the Financial Institution Bond may include:

Electronic/Computer Systems
The Electronic/Computer Systems Rider provides protection against loss resulting directly from the fraudulent transfer of funds initiated through the financial institution's computer systems. The source of this fraud may be a dishonest employee, a customer or a third party. Access to the system may be obtained directly, through an Internet banking, PC or home banking program. Reconstruction costs due to the destruction of data or programs caused by virus or hacker activity can also be covered.

ATM
The Financial Institution Bond covers loss resulting from robbery, burglary, theft, or damage involving automated teller machines (ATMs) located both on and off the financial institution's premises. The ATM rider is not intended to cover the financial institution for ATM losses caused by vandalism, malicious mischief, failure of the machine to function properly, or improper withdrawals through the use of debit or credit cards.

Transit Cash Letter
Cash letters are generally covered under Insuring Agreement C - In Transit. The Transit Cash Letter Rider extends this coverage by reducing the deductible. As a condition of coverage, the front and back of each item placed in the cash letter must be photographed.

Trading Loss
The Financial Institution Bond specifically excludes employee dishonesty losses due to trading. The Trading Loss Rider amends the exclusion to provide coverage for such acts of employee dishonesty. This rider does not provide coverage for losses incurred through bad investment decisions or for losses in the form of normal fees or commissions. The employee must intend to cause the financial institution a loss and must intend to obtain a financial benefit for himself/herself or another.

Stop Payment
The Stop Payment Rider provides coverage for loss due to:
-Failure to comply with a customer's request to stop payment on a check, note, or draft (excluding Travelers Checks)
-Wrongfully refusing to pay a check
-Failure to give proper notice of dishonor.

Servicing Contractor
Coverage is provided for losses resulting from dishonest or fraudulent acts committed by a (Real Estate) servicing contractor, provided the contractor acted with the manifest intent to cause a loss to the financial institution and to obtain a financial benefit for themselves or another person or entity. Coverage is also provided for a contractor's failure to forward funds collected on behalf of the financial institution, where the contractor is legally obligated to do so. This rider does not provide coverage for losses resulting from a contractor's failing to collect funds, a contractor's insolvency.

Fraudulent Mortgages
Covers losses resulting directly from the financial institution accepting or acting upon mortgages, deeds of trust, and like instruments conveying title on which a signature is legitimate but defective because it was through fraud, trick, or under false pretenses.

Extortion
This provides protection in the event that an extortionist threatens the financial institution's employees or property. This extends coverage for the loss of property surrendered as a result of threats to cause bodily harm or hold captive one or more of the following individuals: directors, trustees, employees, or partners of the financial institution. This also covers property surrendered as a result of a threat to do damage to property.

ERISA
The ERISA rider extends the definition of employee to the directors and/or trustees while managing funds (or other property) of the bank's employee, welfare, and/or pension plan(s). The limit associated with ERISA coverage is equal to that of Insuring Agreement A, however, there is no deductible associated with the ERISA rider.

Safe Depository
Coverage is comprised of two components, Insuring Agreement A and Insuring Agreement B. The financial institution may purchase the agreements separately or jointly.
A. Liability of the bank
This agreement covers a loss that the financial institution becomes legally obligated to pay by reason of liability for loss of customers' property.
B. Customers' Property / Premises Damage

Section III

Property & Casualty
Property and Casualty coverage provides significant protection for the bank’s assets.
Property
General liability
Auto liability
Umbrella liability
Trusts Foreclosed properties
Mail
Computer
Workers' Compensation…

Force Placed / Real Estate owned
Banks have the need to "force place" property coverage whenever a mortgagor fails in documenting the insurance required in the mortgage agreement. In addition, when a bank takes back a property (forecloses) the bank is exposed to both the property and the liability claims that are usual to a property owner.

This program may offer rates and coverage for the dual interests of the bank and the borrower even if the property is vacant. Liability coverage on the foreclosed property can also be included.

Mortgage Protection Plan (MIP)
Covers against "all risk" of physical loss to the property on a contingent bases. That is; if the property insurance required of the borrower in the mortgage agreement is not evident, and a loss such as a fire causes damages to the property. The MIP insurance company will pay the bank for the damages.

Lenders Single Interest Property
The Lenders Single Interest Property Policy will reimburse an insured against loss arising out of damage or destruction to scheduled property caused by an insured peril. The property must be in the foreclosure process, acquired through foreclosure, repossession, as mortgagee in possession, through abandonment, deed-in-lieu, or used as security for an active loan or lease that is uninsured by a borrower.

What Next?
Sign up for Jorgensen & Company’s e-mail loss prevention newsletter for Banks and other Financial Intuitions here. Then call Tom Dattoli at 201-345-2442 to discuss your program and needs.