The vise is tightening around banking companies seeking to insure their directors and officers against liability.
With federal and state prosecutors turning their attention to financial fraud, directors and officers insurance is becoming all the more critical — and all the harder and more expensive to obtain.
Depending on the coverage, premiums for the insurance rose 15% to 40% last year, and observers expect rates to double when it comes time for policy renewals this year.
In addition to higher premiums, bankers are facing more restrictive terms and conditions, lower coverage limits and higher deductibles. In some extreme instances, weak institutions are being denied coverage, observers say.
The timing is unfortunate for an industry that has struggled to retain and attract talented directors as corporate governance standards have tightened under the Sarbanes-Oxley Act of 2002. With significant headwinds continuing from the financial crisis, strong board leadership is in demand, and bankers are finding they need to pay up to insure the directors against liability.
The issue is likely to come to the fore — and the floor — during next month's shareholder meetings, when investors will get a chance to vent at the individuals they hold responsible for sinking share prices and struggles with profitability. D&O premiums are a meaningful expense line, ranging from several thousands of dollars for small institutions to $5 million or more for big ones.
Wilson Stewart, a vice president and the insurance risk manager at Fifth Third Bancorp, said the $120 billion-asset Cincinnati company expects a "significant" increase in its premiums when it renews its policy in July. "It is a difficult market with difficult circumstances. We have over the last year seen pricing pressure, but we also feel that maintaining coverage is critical to the corporate governance structure of our company."
Observers say both healthy and struggling institutions face rising costs and will find D&O insurance harder to find.
Many companies are reluctant to discuss the topic at great length, because of the tricky back-and-forth that comes with negotiating with carriers; a key renewal date for many policies is July 1.
"There is a crisis of coverage," said David Bradford, an executive vice president at insurance-industry research firm Advisen Ltd.
Premiums have been steadily climbing since 2004 and are now "about as high as I have ever seen them," he said. "There is simply more risk perceived, so the price goes up, and the breadth of that coverage narrows considerably."
Steve Fitzsimmons, the managing director of the professional liability group at Arthur J. Gallagher & Co.'s risk management services unit, says he knows how difficult it is for some of his clients to get coverage. "The usual underwriters are stepping back and questioning if they want to renew. It's a hard pill to swallow, particularly for the smaller banks. It's tough to tell a client you have gone to 22 providers and they keep getting rejected."
The Treasury Department's Capital Purchase Program has infused billions of dollars into the banking system, but it also has raised concerns among insurers that the government could make it harder for companies to indemnify directors and officers against litigation. Observers said those concerns create more demand for D&O insurance at a time where underwriters are paring back capacity.
Bradford said the biggest premium increases have been for all-inclusive coverage that protects directors and the company from lawsuits; premiums for such policies on average rose 37% last year and could double this year.
Observers said the biggest reason for the increase is the subprime mortgage implosion and the resulting flood of securities litigation. Last year lawsuits against financial services companies made up half of all securities litigation, according to Advisen.
In addition, state attorneys general are stepping up efforts to indict firms for financial fraud; many of the cases involve allegations of mortgage origination misdeeds. And many observers say the Securities and Exchange Commission could step up its pursuit of cases against financial firms.
Prosecutors have been willing to indict officers in many instances, making the insurance even more critical while driving up the costs of coverage. Observers say important board members, including lead independent directors and those chairing compensation, audit and corporate governance committees, could be pulled into court.
Brian Benjamin, the president of the financial institutions group for American International Group Inc.'s AIG Commercial Insurance, said in an interview that underwriters are adding exclusions to all-inclusive policies to protect against possible bank failures. For instance, there could be exclusions for claims brought by the Federal Deposit Insurance Corp. or other government agencies. "Those typically apply to the more troubled institutions."
Failure concerns are also driving up the costs of A-side insurance, which provides direct coverage to directors and officers and covers defense costs that could result from legal claims. It applies where the company does not indemnify directors and officers, often because of corporate bylaws or regulations. Observers said it could also apply when regulators close a financial institution.
Premiums for A-side coverage rose 15% on average last year, but Bradford said rates could "skyrocket" as more firms suffer.
Nevertheless, Fitzsimmons says insiders want bankers to obtain as much coverage as possible. "Maybe 5% of all banks may not buy up to their limits. That's rare, because their board members won't let them take lesser insurance."
Observers say a growing number of Troubled Asset Relief Program recipients are increasing their A-side coverage to address concerns that Congress will eventually limit or restrict how much they can indemnify directors and officers.
"I think the way the market views A-coverage is going to change," and much higher premiums are on the horizon, Benjamin said.
Another issue has been the focused nature of the D&O underwriting business. Bradford said AIG, Lloyd's of London and XL Capital handle about half of all financial D&O policies, and 10 insurers write about 80% of industry policies. Those firms are also lowering the maximum amount of liability they are willing to insure by 60%, to $10 million.
"Some of the smaller carriers are actually withdrawing from the market, because they are worried about their own liability," said Aaron M. Kaslow, a partner in the Washington office of Kilpatrick Stockton LLP. The reluctance to issue policies could grow as more shareholder and employee suits are filed and "banking companies get into more difficulties" as a result of the operating environment.
That would force financial institutions that need a hefty amount of protection — sometimes $100 million or more — to turn to numerous providers to get the coverage they need. As a result, observers say, premiums could continue to rise even beyond this year.
"We're being told there might be another two or three years of increases in store for our clients," Fitzsimmons said.