D & O Insurance Coverage Vs Cost, A Real Juggling Act
The Financial Institution Directors and Officers Liability policy is probably the most misunderstood and essential insurance policy in any community bank’s insurance program. It is also one of the (if not THE) most expensive policies it has. Discovering the best balance of coverage and cost is the real trick here. In order to establish this balance, it is essential to have a basic understanding of the policy itself.
The Financial Institution Directors and Officers liability policy was designed to cover the Directors and Officers of a bank for their liability from managerial errors or omissions. Note, it was not designed to cover the Financial Institution itself, that coverage came later. It is a “claims made” policy meaning that a claim must occur and be made in the policy year. It wasn’t too long ago that coverage was expanded to include the institution itself through the Bankers Professional Liability policy or Entity Liability coverage. Now the Directors and Officers AND the Institution could be covered. With the possible exception of one insurance company, these coverages had separate limits or were separate policies. As you can imagine lawsuits had a tendency to overlap and it was sometimes difficult to tell which policy provided coverage. To compound the problem, many times these two areas have different Policy limits.
There are many other coverages available, but for our purposes I will limit this discussion to two other areas, Employment Practices Liability and Fiduciary Liability. Employment Practices Liability covers the Directors and Officers (and hopefully the Bank itself) for lawsuits alleging discrimination, harassment, etc of an employee. Fiduciary Liability protects the bank for liability resulting from the mishandling of funds in an employee pension fund of some type.
There are a couple of other things a banker needs to be aware of in this area. First, there is very little standardization in insurance policy forms between insurance companies, and second, the forms are in a constant state of change. Also, pay careful attention to HOW the limits of the D&O policy are applied.
Some limits are “inclusive” meaning that they are included in the limit of other coverages or the policy as a whole. Other limits are “stand alone” and may or may not, be part of the policy as a whole. Are you confused yet? Let me give you some examples:
Bank A has a D&O policy with a D&O liability limit of $2,000,000. It has a Bankers Professional Liability inclusive limit of 1,000,000 with a Lenders Liability sub-limit of $1,000,000. It has an Employers Liability inclusive limit of $1,000,000 and a Fiduciary liability inclusive limit of $1,000,000. (Forget the deductibles for now, this is confusing enough!)
Bank B has a D&O policy with a maximum policy limit of $3,000,000 and the same other coverage limits as A except B’s limits are all “stand alone”.
Bank C has the same limits of A and the stand alone limits of B but no maximum limit.
The annual premium for A is about 1/3 less than the premium for B, and ½ the premium for C.
With Bank A, a $2,000,000 D&O loss finishes the policy. All the other coverages are included in the D&O limit and a major loss here negates the coverage for the other areas.
Bank B could suffer a Bankers Professional liability loss of $1,000,000 and an Employers Liability loss of $1,000, 000 and still have $1,000,000 left for the possible D&O loss. (Remember the policy has a maximum limit) Bank C could suffer a total loss in all areas of coverage for a total loss of $5,000,000 because a loss in each area does not affect the other areas or the total for the policy.
The standalone limit option allows the bank to choose individual limits for each exposure with lower limits in some areas and higher in others.
In conclusion, it is extremely important to be familiar with the coverages you are buying, what limits you need, how these limits will be applied in a loss, and how the coverages and limits relate to your bank’s particular exposures. As complicated as this article may seem, believe me, I have simplified the real process in the extreme. Be careful! You may be spending a lot of money on the wrong type of coverage.