A Bubble of Protection

Regulatory, business expansions up the ante for D&O coverage.

When members step up to serve as directors, their credit union agrees to protect them from personal liability for carrying out their board responsibilitiesa promise that takes the form of directors and officers insurance as part of the organization's management liability coverage.

But with the incidence and costs of litigation on the rise in the financial services industry, according to a recent survey by the law firm Norton Rose Fulbright (www.nortonrosefulbright. com), how can directors ensure that adequate protections are in place? Specialists recommend regular reviews of the risk exposures facing your credit union with a special focus on regulatory and business expansions to ensure that your liability coverage is up to the task.

Credit unions are immune to the most common type of lawsuit filed against directors-the sort filed by stockholders unhappy with investment returns, notes insurance consultant Scott Simmonds (www.ScottSimmonds.com), Saco, Maine. And credit unions are unlikely to face legal action from regulators, like the Federal Deposit Insurance Corp.'s suits against shuttered savings and loans a quarter-century ago and against big banks rocked by securities losses more recently. A notable exception was the National Credit Union Administration's lawsuit against officers of the failed Western Corporate Federal Credit Union (WesCorp) in 2010; board members were not named in the complaint, and the case was eventually settled before going to trial.

As a director, you should be familiar with the indemnification provisions in your credit union's bylaws and other legal documents, says Jay Isaacson, director of product management with CUNA Mutual Group (www.cunamutual.com), Madison, Wis. These provisions specify under what circumstances the credit union can protect its directors and officers from legal claims associated with fulfilling their responsibilities to the organization.

The D&O or management liability policy provides the mechanism for the credit union to fulfill that promise.

Directors generally seek to "be indemnified to the broadest extent available by law," basing insurance limits in part on the size of the credit union, an assessment of its potential exposure to litigation, and its tolerance for risk and ability/preference to self-insure for some level of risk, Isaacson notes. Adequate coverage is not only important to directors, but useful in recruiting strong board candidates.

Under Rule 750 of the NCUA Rules and Regulations, credit unions may indemnify directors as long as they fulfill their fiduciary responsibilities: the duty of care (e.g., attend meetings regularly, engage in board discussions, assess and understand financial reports, and make the best possible decisions for the organization), the duty of loyalty (consider the credit union's interests and avoid conflicts of interest), and the duty of obedience (comply with laws and regulations in carrying out their board responsibilities), Isaacson explains.

The board's fulfillment of its duties is no guarantee against lawsuits, notes Mike Dandini, president of Berkley FinSecure (www.BerkleyFinSecure.com), Towson, Md. "Just because somebody brings a claim doesn't mean the credit union did anything wrong, but it does mean it could be very expensive to finance the litigation to defend the credit union and its directors."

In reviewing this coverage, your board should have access to guidance from an insurance specialist, either within or outside the credit union, who is well versed on management liability, says Kevin M. LaCroix, attorney and executive vice president with RT ProExec (*www.rtspecialty.com), Beachwood, Ohio.

"This is a field that changes rapidly and requires a great deal of expertise to manage appropriately," LaCroix says. "It is not something you can dabble in or do part time."

Consider Your Options

D&O insurance is typically issued as part of a broader management liability policy for three-year terms. Simmonds recommends that financial institutions consider proposals from other insurers when their policies are due for renewal. "It is how we keep the marketplace sharp, how we are assured we are going to get broad coverage and competitive pricing," he says. "There are instances where because of relationships or claims activity that a credit union might skip a three-year cycle or be less aggressive but, in general, financial institutions should be taking a hard look at their insurance every three years."

Because of their unique structures, credit unions should seek out carriers that can provide solutions tailored to their differences from banks and other for-profit entities, says Barbara Ewing, VP/chief underwriting officer for fidelity and management liability for Berkley FinSecure. As just one example, the D&O policy should address whether coverage applies to volunteers serving on the board or on committees, including any advisory, honorary, or emeritus directors.

Along the same lines, Jon Martin, Berkley FinSecure's AVP/credit union program, cautions that surveys and comparisons on liability coverage between community banks and CUs may be of limited value because of differing risk exposures. Even within the credit union sector, comparisons based primarily on asset size don't account for the differences between, say, a credit union serving employees of a single sponsor and another with a community charter.

"Peer-to-peer comparisons can be helpful, but at the end of the day, a credit union has to look at its own exposures, come up with a worst-case scenario, and then decide whether to insure to that limit or another limit that makes more sense," Martin advises.

Guidance from the FDIC in October 2013http://tinyurl.com/fdicrule) counseled bank directors to scrutinize exclusions in their D&O coverage, and this maybe good advice for credit union boards as well, LaCroix says. In particular, some policies may carry a "regulatory exclusion," which precludes coverage for any claims by a regulatory agency.

"Troubled financial institutions may have no choice but to accept coverage with a regulatory exclusion, but certainly for institutions that are healthy enough that they shouldn't have to accept getting a regulatory exclusion, you want to make sure there isn't one on your policy if you have another alternative," he notes.

Developing their risk analyses may help credit unions identify regional differences, such as state laws that result in potential increased litigation and exposure involving employment practices, Martin advises.

Directors should also ascertain that the limit for D&O coverage is separate from the limits for other coverages in the policy, so, for example, claims against the credit union itself involving lender liability or professional liability should not erode the coverage available to directors and officers for claims made against directors personally, Ewing recommends.

How Much is Enough?

What happens in what Simmonds calls an "end-of-the-world" scenario? What if a credit union fails and is taken over by regulators? The institution is defunct, it has no assets, and its insurance limits have been exhausted to cover other legal claims. Do officers and directors have any protection against lawsuits filed against them at this point, or are their retirement accounts, homes, and other personal assets at risk?

The safeguard against this eventuality is called "Side A coverage," insurance that specifically covers individual directors and officers. How much Side A coverage credit unions should provide for directors is one of the most common questions Simmonds fields, and he says the answer varies, based on each institution's appetite for risk, risk exposure, and cost of coverage. In general, he recommends that even small credit unions provide $1 million in coverage for directors, and that recommendation increases with an organization's size and complexity:

For a $150 million credit union, he recommends $3 million in coverage per director or officer; for a $300 million credit union, $4 million in coverage; for a $500 million credit union, $5 million; for a $1 billion credit union, $7 million; and for a credit union with $1 billion to $3 billion in assets, $10 million per director/officer.

Simmonds acknowledges that his recommendations are on the high side, as many credit unions in the $150 million asset range might currently have $1 million to $2 million in D&O coverage limits. His guidance to boards in this situation is to weigh the cost of increased coverage.

"If the cost to increase the credit union's coverage from $2 million to $3 million is $300, we are going to do it. That's easy. If it's $30,000, we are not going to do it. The risk isn't worth that cost," he notes. "But the reality is that it is going to be somewhere in the middle, and the board will need to make an informed decision."

Ewing recommends that credit unions ask for multiple quotes at different limits for each coverage part, so they can compare the incremental costs and select the most needed and cost-effective amounts for each type of coverage. In some cases, they may find they can get additional coverage for relatively small additional cost.

Insurance carriers and agents should provide clear and concise descriptions of the coverage and the types of losses that are and are not covered. "The insuring agreement should be very specific and very easy to understand so the board knows what is and is not part of the risk transfer so that they know what they are purchasing," Dandini says. "Understanding those differences is important as they think about their risk mitigation and risk management needs."

Lessons Learned From Crises

Even as the economic recovery continues, "I don't think anybody in the circle of constituencies thinks that the effects of the credit crisis are a matter of history at this point," LaCroix says. "Those events continue to have practical consequences in the regulatory environment and the D&O insurance environment."

Even though CUs largely avoided legal challenges in the wake of the 2007-09 financial crisis, some implications from the downturn apply to D&O coverage. In broad strokes: (1) repercussions and second-guessing of board and management decisions are likely when financial performance deteriorates, and (2) it may be more difficult to obtain or maintain management liability coverage in such an environment, Isaacson cautions.

"If I'm a director in a situation where my credit union's financial performance is starting to deteriorate, I probably would want to make sure I've got the best available coverage I possibly can," he notes. "But ultimately that is a challenging point because when you start to see some deterioration in a credit union's financial condition and operations are starting to falter a bit, there may be some challenges in terms of what coverage is available to them in the marketplace as well."

D&O coverage "continues to evolve, and it's important to work with providers who understand the credit union marketplace and the complexities and changes that happen within the directors and officers liability landscape," Isaacson says. "In the credit union arena, there is a heightened responsibility for directors and officers with the new rules the NCUA has put out around indemnification (http://tinyurl.com/ rule7014). And just in general the complexity of credit unions continues to grow, and with it an understanding that there is probably more onus on directors and officers today."

The January 2011 NCUArules clarification regarding director responsibilities raised red flags about the potential for increased liability, but Martin says that liability existed even before this guidance. Insurance companies were already considering the role of governance in the context of the rough economic conditions of that time on CUs' loan portfolios and investments.

"There was a palpable feeling that credit unions were under financial pressure largely because the system that was designed to stabilize and support them had fallen out from underneath them," he notes. "The possibility was always therethat one blip in the system could cause this collapse we saw happen. I don't think there was any knee-jerk reaction, just a very real sense of 'Let's slow down and see what we are looking at and study the risks.'"

New Coverage Options

Changing technology and related regulations may influence liability coverage decisions. Given the potential for claims involving electronic banking breaches or identity theft cases, new forms of insurance are available to cover related costs of notification about potential breaches, credit monitoring, and public information campaigns, for example.

CUs offering mobile access may want to look into this coverage, as these new services could result in claims concerning the soundness of operational controls. Martin cites the example of a potential lawsuit stemming from check fraud perpetrated via remote deposit capture. "As the technology expands and different services evolve, the controls are something we always go back to," he says.

Berkley FinSecure also offers coverage for claims arising from consumer protection laws, such as requirements to make ATMs accessible to people with disabilities or violations of so-called "robo-calling" restrictions in making debt collection calls to the wrong person, both of which could result in statutory damages. "Credit unions need to watch how consumer protection, harassment, and other laws evolve at the federal, state, and local level," Dandini cautions.

A relatively new feature of Side A coverage for directors and officers, called "difference in conditions," provides dedicated coverage to individual directors and officers with fewer exclusions than a traditional D&O policy, Isaacson says. This type of coverage is designed "to potentially pay first dollar on a claim where there is no other coverage available under the traditional policy," he explains. A Side A DIC policy might respond when an insured organization wrongfully refuses to indemnify a director.

Directors also have the option to purchase independent director liability insurance for their own protection in addition to the policy maintained by the CU. While CUNA Mutual doesn't directly offer such a policy, a Google search turns up possible providers, and Isaacson estimates the cost between $3,000 and $13,000 for a $1 million policy.

Ultimately such a policy "will sit over the top of the D&O tower that is purchased for me," Isaacson explains. "This layer of an independent director liability policy protects me in the event that there maybe erosion limits or I just don't feel like I have sufficient coverage."

Even with "greener pastures from an economic perspective," Isaacson says directors need to keep in mind that litigation "happens relatively regularly in our society. There tends to be litigation regardless of the economic cycle we find ourselves in."

Resources

Read a bonus article about how much of what kind of insurance a credit union of a particular asset size might want to buy at cues.org/05T914insurance.

Also read "Insurance Matters: Used Up and Left Out" by Scott Simmonds at cues.org/031611insurancematters.

See p. 31 of "The Insurance Assurance Toolbox" by Simmonds for D&0 coverage fine points. Download it at cues.org/insuranceassurance.

Read "Your Assets, D&0 Insurance, and Regulatory Exclusions," by Scott Simmonds, on the Center for Credit Union Board Excellence. Search for "D&0" on cues.org. Access with your CCUBE members-only password or email cues@ cues.org to sign up for a 30-day free trial.

Karen Bankston is a long-time contributor to Credit Union Management and writes about credit unions, membership growth, marketing, operations and technology. She is the proprietor of Precision Prose, in Stoughton, Wis.