Managing Exposure [Credit Union Management]

Review insurance coverage carefully in an era when any disaster seems possible.

Murphy's law-anything that can go wrong will-seems to have been unleashed in the financial services industry over the last few years. Add to the deep recession and mortgage crisis the proliferation of Internet and credit card fraud, to name just a few challenges, and there's little wonder that risk management has come to the forefront of board and executive responsibilities.

In an atmosphere where disasters- from floods and wildfires to record foreclosureshave apparently stopped waiting and are just happening, directors maybe spending extra time scrutinizing the credit union's insurance coverage to ensure the organization- and themselves personally- are adequately protected. CUNA Mutual Groups description of its management and professional liability program, which covers both the credit union and the personal assets of directors and officers, offers all-too-real examples of loss scenarios:

* A regulatory agency sues a board for breach of due diligence after the CU is put into conservatorship following huge investment losses related to mortgage-backed securities.

* A former branch manager dismissed for poor performance alleges age discrimination and wrongful termination.

* A member sues the credit union for wrongful repossession of a car.

* A member files suit after erroneously supplying an incorrect account number for a wire transfer that ends up in a stranger s account and disappears.

* The credit union is negotiating with an employee who signed up for but was never properly enrolled in the health care insurance program, a mistake which came to light following her hospitalization, resulting in $50,000 in medical bills.

* Members include the CU in a lawsuit alleging that security breaches resulting in identity theft were preventable.

The list goes on, exacerbated by a still-sour economy. In fact, increased claims related to management and professional liability coverage seem intertwined with economic trends such as staff layoffs and increased foreclosures and repossessions.

Economic Impacts

Employment practices claims were up 35 percent in 2011 over the previous year, reports Jay Isaacson, director of product management for CU protection for CUES Supplier member CUNA Mutual Group (www.cunamutual.com), Madison, Wis. About 64 percent of all claims paid through management and professional liability policies are related to employment practices, "so you need to make sure you're comfortable with your exposures in that area," he advises.

The other area where there's been an uptick in legal action is in foreclosures and repossessions, with an 18 percent jump in claims for lender liability coverage, most commonly alleging defective notice of intent to sell repossessed vehicles, Isaacson says. Overall, claims payments on lender liability coverage increased 30 percent from 2010 to 2011.

Directors and officers can be sued for their actions related to managing and overseeing the CU Such suits have the potential to put the personal assets of directors and officers at risk. Insurance, such as CUNA Mutual's management and professional liability policy, can provide protection.

"The biggest piece of the puzzle is to understand whether the credit union has an indemnification agreement in place to protect its directors and officers," Isaacson says. Indemnification agreements outline the CU's obligation to protect its officials; ultimately, indemnification is officials' main source of protection. Management liability policies can be purchased by the CU to help pay for this obligation. Indemnification agreements can be quite complex and can vary by state, so the CU needs to consult with qualified legal counsel on these agreements, he adds.

The CU may not indemnify directors' actions that involve breach of loyalty, bad faith, fraud, or personal gain, explains Scott Simmonds, CPCU, ARM, CMC, of Insurance Assurance Consulting (www. CUInsuranceConsultant.com). In addition, he notes that the quality of indemnification agreements "varies depending on how long it's been since the bylaws have been reviewed, and much depends on the state laws and court cases in the credit union's jurisdiction."

Ferreting out new Threats

There's nothing like a $100 million lawsuit to get directors wondering about personal liability, notes CUES Director member George Barto, chairman of $850 millionUS Alliance Federal Credit Union (www.usalliancefcu.org), Rye, N.Y., with 50,000 members. Barto admits his wife had a few sleepless nights wondering if they were going to lose their house over the breach of contract allegations lodged against the CU by a former business partner in the late 1990s.

After several years in court, the plaintiff lost its suit, and the CU won a major judgment in countersuit, but was never able to recover any damages. That experience underscored for USAlliance FCU's directors the need to have adequate insurance and indemnification that covers legal defense costs as well as claims, Barto says.

Liability coverage is thoroughly explained to all new USAlliance FCU directors, who can also rely on an experienced board member mentor, along with board meeting presentations and sessions at industry conferences, to keep pace with emerging issues.

As just one example of those new challenges, Barto cites the rise in Internet and credit card fraud incidents. To obtain the most affordable coverage, USAlliance FCU has a $3 million policy limit with a $500,000 deductible. "This type of fraud has become so prevalent and so hard to ferret that we have to continually revisit our coverage to ensure that it keeps pace with the increasing threat," he notes.

Coverage for 'Wrongful Acts'

Take a big-picture view of the CU s insurance policies, Isaacson recommends. He suggests the board undertake an annual comprehensive review of limits and coverage, with a focus on the terms, conditions, and exclusions set out in each policy. Exclusions vary by insurance product, but they should be clearly enumerated within policies, so the board should take care with those sections.

"Don't make decisions based solely on price," he advises. "You need to understand coverage, limits and exclusions" in the context of current operations. Growth in assets and numbers of members, expanding fields of membership, increasingly complex services, and new product lines- such as business loans- may necessitate changes in coverage.

In certain circumstances, a CU may not be allowed to indemnify its officials, which is why directors should look for the broadest possible management liability coverage, Isaacson advises. The main vehicle to obtain this protection is through purchasing Side A DIC (for "differences in conditions") coverage as part of the management liability insurance, which pays for claims against directors when the CU is not able to indemnify them.

There is no "standard" directors and officers coverage, so it must be evaluated carefully, Simmonds notes. D&O insurance covers what indemnification does not for what the policy may refer to as "wrongful acts." For example, it would provide coverage for lawsuits involving lending and may cover suits filed by employees or ex-employees alleging harassment, discrimination and wrongful discharge. In a white paper about these policies, he suggests issues directors may want to consider in their annual review (see box).

Different from many other types of insurance, D&O insurance covers lawsuits filed during the time the policy is in effect, even if the alleged wrongful act occurred years earlier, Simmonds explains. As a result, if a board decides to cancel or replace its D&O policy, it might want to talk with the insurer about "extended reporting period" coverage to provide protection for events that took place while the insurance policy was in effect.

Directors may also want to consider whether "excess D&O" or Side A coverage might be in order where the CU is prohibited from indemnifying the board or in case of insolvency. Fines ordered by the National Credit Union Administration are excluded from coverage (both Side A and D&O), and civil money penalties might not be covered either, Simmonds cautions.

Preparation and Prevention

Oint Wood teaches insurance courses at Delta State University, and his family owned an insurance agency, so he brings an informed perspective on these issues to his service on the board of $90 millionStatewide Federal Credit Union (www.statewidefcu.org), Flowood, Miss., with 15,000 members.

In addition to regular insurance reviews, Wood suggests directors take a wider view of risk management. To prepare for natural disasters, CUs should have coverage for the replacement value of their facilities, and must be ready to provide uninterrupted service.

"On Aug. 29, 2005, when Katrina struck, every credit union along the Gulf Coast was damaged, and every surviving credit union hung their sister credit unions' shingles out front alongside theirs" to ensure that members could immediately access their accounts, Wood recalls. "When a credit union suffers damage, members' lives are turned upside down, too - Their homes, their workplaces, their churches may have been destroyed."

To gauge its disaster readiness, Statewide FCU recently underwent a test with Agility Recovery (www2.agilityrecovery.com), Charlotte, N.C., running a branch out of a mobile facility for a few days.

According to Mississippi law, directors are considered fiduciaries for their institutions, which holds them to the highest standard of financial responsibility, Wood says. As a result, board members must stay educated and informed about risk management, and keep communications open.

The Statewide FCU Board adjourns into executive session at the end of every meeting so directors can share any concerns.

Wood's other rule is golden: Treat CU employees and members with the same respect you would expect in their position. To head off employment practices lawsuits, the board should take care in evaluating the CEO and in overseeing hiring and performance evaluation policies throughout the organization. "Providing that level of service, care and consideration is a form of protection," Wood says simply.

Resources

Read related articles. At cumanagement.org/archive, search for "insurance matters."

Check out CUES Enterprise Risk Management, presented by Vital Insight, at cues.org/erm.

Evaluating Your CU's D&O Coverage

Insurance consultant Scott Simmonds recommends questions like these in the board's annual review of its directors and officers insurance:

* How much coverage do we have? What are the limits of liability?

* Are legal defense costs included in the limit of liability?

* Do we have coverage fbr employment practices?

* Do we have coverage for ERISA imposed liabilities (associated with the administration of employee benefit plans)?

* Do we have coverage for lender liability issues?

* Do we have coverage for prioracts?

* Is there excess Side A coverage?

* Is there an exclusion for securities or insurance sales?

* What professional services are excluded?

* Is there an exclusion for suits brought by regulators?

* Whatare the policyexclusions?

* Is there an insolvency or bankruptcy exclusion?

* Are the directors and officers covered for civil money penalties assessed by regulators?

* Canthe insurance companycancel our policy during the policy term?

* Does the insurance company have to renewour insurance atthe end of the policy term?

Excerpted from Simmonds' white paper, "What Board Members Need to Know About Credit Union Directors' and Officers' Insurance," available arwww.CUInsuranceConsultant.com.

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, based in Stoughton, Wis.