For directors and officers liability insurers facing a potential influx of claims arising from lawsuits that banking regulators are filing against their insureds, a key question is whether regulatory exclusions in their policies will hold up.
Such exclusions were pretty heavily litigated during the Savings & Loan crisis, according to Kevin LaCroix, a broker with OakBridge Insurance Services in Beachwood, Ohio, who also reported that the coverage cases were ultimately concluded in favor of insurers.
On the basis of the case law coming out of that period, “the regulatory exclusion is enforceable and does preclude coverage” for claims brought by Federal Deposit Insurance Corporation, said Mr. LaCroix, who is also a lawyer and the author of the D&O diary blog.
He reported, however, that some of the banks that failed in recent years were insured under three-year D&O programs that were in place before insurers started to routinely put regulatory exclusions on the policies. “Often the regulators, when they close the banks, get their notice of potential claim in [quickly] so they can set their anchor on a policy that doesn’t have a regulatory exclusion,” he said, pointing to the FDIC’s well-developed knowledge of insurance matters—a byproduct of the litigation wars of the S&L crisis.
“They are very sophisticated in reviewing the insurance in place, understanding how it operates and what they need to do to lay their stake on the D&O policy proceeds as a way to offset losses to the [FDIC] insurance fund. I think that’s going to be a major factor in how they are proceeding,” he said.
Moving forward in time, the prospect of insurers getting tagged on three-year policies without regulatory exclusions will dwindle out, Mr. LaCroix noted, speaking on a webinar presented by New York-based Advisen last month. Policies getting renewed for troubled banks are likelier to have the regulatory exclusions, he said.
Agreeing with Mr. LaCroix about the FDIC’s sophistication on coverage issues, Kevin Mattessich, managing partner in the New York office of Kaufman Dolowich Voluck & Gonzo, suggested that the FDIC could engage in some forum shopping. “There are definitely some competing decisions out there on what was timely notice—whether something is a claim made in the period or not, whether something is a loss discovered during the policy period, etc.,” he said.
Speaking at the D&O Seminar of the Professional Liability Underwriting Society early this month, Brian McCormally, a partner at Arnold & Porter in Washington, cautioned insurers about their use of regulatory exclusions. “I have run into a lot of cases recently where banks and bank holding companies have the ability to purchase a tail on their existing policies,” he reported, suggesting that carriers need to be careful if they present renewal policies with regulatory exclusions on them.
“Then you’re sending a message to a bank that it needs to go evaluate whether it has current facts from which it could cobble together a notice of a claim to get a hook into the preexisting policy for which it is purchasing tail,” he said.
Mr. McCormally also said that while insurers may have won the last round of coverage decisions, the FDIC can be expected to launch the same arguments they did 20 years ago—challenging the permissibility of regulatory exclusion clauses under certain state laws, alleging that they are “void as against public policy.”
Mimicking the typical argument from the FDIC, he said it goes something like this: “Judge, we’re here to recover funds on the behalf of the American taxpayer, because of what these bad banks and directors and officer did. You should rule in our favor because we’re on the right side of God and they’re not.”
Sometimes, that argument is a winner, he said, noting that in the last round of coverage litigation the FDIC was successful in lower courts. Insurers ultimately won at an appellate court level, where the public policy argument does not play as well, he reported.
Still, the use of the exclusion is something an insurer should consider very carefully, especially when “there is an existing policy for which you are attempting to change coverage to include a regulatory exclusion clause after the bullet is already in the body,” he said.
“In other words, the investments have already been made and the loans [losses] have already been incurred. It’s just that the regulators haven’t gotten around to criticizing the bank yet.”