For nearly two decades, banks were comfortable procuring insurance policies that would cover civil money penalties for officers and directors-provided that the individuals paid for that part of the coverage themselves.
But all of that changed last summer, when examiners cited two Louisiana banks for violations of Part 359 of the Federal Deposit Insurance Act, which prohibits banks from paying or reimbursing officers or directors for insurance covering civil money penalties assessed by a federal banking agency. The examiners asserted that the prohibition applies to securing that specific insurance coverage even if it is paid for by the banks' officers or directors themselves.
The American Association of Bank Directors disputes this interpretation of the rule by the Federal Deposit Insurance Corp. In a Feb. 3 letter to FDIC General Counsel Michael Krimminger, the trade group argued that as long as the coverage is not paid for by the bank, there is no violation of Part 359.
The AABD warns that if the FDIC holds fast to its position, banks across the country would be forced to cancel existing insurance contracts. Premiums for the coverage would rise if policies could no longer be pooled together. And as the AABD noted in a posting about the issue on its website, "It's hard enough to find good bank directors willing to serve."
David Baris, the AABD's executive director, says the FDIC's recent reading of the rule demands public scrutiny.
"We don't think the regulation should be interpreted this way, and if they want to address it as a public policy issue, then they ought to reopen the rulemaking process and allow for public comment," Baris says.
Krimminger maintains that the FDIC has not changed its position on Part 359. What changed, he says, is that in the last few years, insurance companies began issuing policies to banks with binders for civil money penalties on officers and directors, with the officers and directors themselves potentially paying for that specific piece of the coverage.
"The argument that this is permitted ignores the fact that simply having the coverage in a policy obtained by the bank is itself barred by Part 359," Krimminger says. "Insurance coverage for civil money penalties is certainly not good public policy. It's designed to encourage behavior that is not in the best interest of the bank, and we shouldn't be encouraging people to take actions that could put them at risk of civil money penalties."
The insurance industry started addressing civil money penalties in policies in the early 1990s, after the 1989 passage of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), which significantly expanded the scope of civil money penalties in response to the savings and loan crisis.
Justin Psaki, a vice president in the executive assurance division of Arch Insurance Group in New York, says the first response by the insurance industry was to offer civil monetary penalties coverage via a standard directors and officers contract in the name of the bank or bank holding company. The coverage typically provided limits of $100,000 per director or officer, with no more than $1 million in the aggregate, and often applied to civil monetary penalties regardless of whether the company indemnified losses on behalf of directors and officers.
It was later feared that the FDIC would prohibit this kind of coverage because the insurance policy would be in the name of the bank, and the premium for the civil money penalty protection was paid for by the bank, Psaki says. So for the past two years or so, insurance companies began adding an endorsement to these policies with the same terms, but it applied only to non-indemnifiable coverage for directors and officers, and the premium for the coverage was paid for individually.
Based on the recent FDIC objections to this coverage for two failed Louisiana banks last summer, the insurance industry is now considering offering stand-alone, non-indemnifiable coverage solely for bank directors and officers, with premiums paid for by the individuals.
Most D&O policies actually exclude coverage for fines or penalties, Psaki says. And policies covering civil money penalties typically have fraud exclusions in them, so claims won't be paid if the director or officer is shown to have purposely defrauded the bank.
Mike Hogan, executive vice president of U.S. Risk Financial Services, a Nashville, Tenn., insurance agency, says any policy that names an individual officer or director and doesn't have the name of the bank anywhere on the policy falls outside the FDIC's jurisdiction.
But Krimminger isn't so sure. Noting that the FDIC would need to study the issue, he suggests that while Part 359 focuses on prohibited payments, insurance and indemnification by a bank, the same public policy concerns would seem to exist when officers and directors separately procure coverage for civil money penalties, even if the bank has no role in the matter. "My personal view...is that a bank should not be providing insurance to their officers and directors for acts that would give rise to civil money penalties," Krimminger says. "People should bear the risk for their conduct."