Helping financial institutions manage their risks

One source of prospects for us is a handbook published annually by Thomson Publications for the Community Bankers Association of Illinois. (Similar publications are available in other states.) It contains such information about its members as the names of board members and senior management, asset size, numbers of branch offices, etc. We refine the data and use it for prospecting and for direct-mail campaigns. For instance, we have an agreement with one of our carriers to jointly market to community banks. Recipients receive a letter from the company discussing relevant issues and the insurer's capabilities. A letter from us accompanies it.

Centers of influence play a role in our business. For instance, we do business with some institutions as a result of their relationships with risk-management consultants. On behalf of their clients, they typically approach several brokers to design and offer terms for comprehensive insurance programs. Following such contacts, we have been selected by several institutions to implement our designs and become the agent of record.

Existing relationships also can lead to new business. From time to time, a person who has been part of management at one of our client banks moves to another institution, learns it has insurance problems and contacts us to solve them.

We use the Internet extensively to gather information. It helps us stay abreast of new products, services or operational changes that could have implications for a bank's insurance program. Online banking is one obvious example. The fact that a community bank has begun offering Internet banking may give us something to discuss with the prospect, whose incumbent agent may have overlooked the issue.

Qualifying clients

When talking with prospects, particularly those who contact us for bids, we ask how they usually obtain insurance. If they reply that they seek bids frequently and the main criterion is getting the lowest price, we reply that another agency would be a better choice for them. But when our questioning reveals they are not happy with the service they are receiving, then we lay our cards on the table and discuss the scope of the services we provide, the markets we can make available, and references from other financial institutions we work with. If the prospect then seems receptive, we state that we'd like to become the bank's agent and ask to become their broker of record.

Sometimes we encounter financial institutions in which an agent sits on a bank's board, is related to a key officer or otherwise is in an influential position. In such cases, the insurance buying decision is based on a relationship rather than on competence or service. There's little we can do in these cases, other than present our credentials and references. If the buying decision is political, then only something political can change it; e.g., a board member who, perhaps cognizant of potential personal liability and the potential conflict of interest that exists when an agent is a director, says, "I can't abide this."

Problems, of course, also can precipitate a change of mind. One bank that purchased insurance coverage from a relative of the principal owners ran into a number of problems that led to denied claims and adversely affected its directors and officers liability coverage. The bank turned to a risk-management consultant who introduced us. We subsequently solved the insurance problems and wrote the account.

Where a political situation prevents us from becoming a bank's agent, we sometimes work with it as a consultant. For instance, one rapidly growing institution asks us every two years to analyze its program and prepare a written review presentation to its board, which we do on a fee-for-service basis.

Education and risk management

We feel we have a responsibility to educate our clients. An educated client is much more likely to be a long-term client than one with only a superficial understanding of the bank's insurance program.

The education process starts with our initial interview. It continues in the format of our proposals. They are quite detailed and include explanatory footnotes on most pages. We usually obtain copies of current insurance policies and compare the existing coverages with what we propose, not only in terms of limits and premiums but also in regard to the scope of protection.

We organize the presentation by class of insurance coverages. The first section addresses property-casualty coverages. The second and third sections address financial-institution-oriented coverages and professional coverages, respectively. We may also include other sections that address miscellaneous coverages and employee benefits. We distinguish those elements of a bank's program that are comparable to those of any business (general liability, property, workers comp, etc.) from those that are specific to financial institutions (mortgage interest insurance, financial institution bonds, etc.) and further distinguish those that are professional in nature (D&O, E&O, etc.).

We also discuss the risk management process at length, which helps clients understand what to insure and what to manage by other means. For instance, backing up computer data and moving it offsite usually makes more sense than merely insuring the cost to reconstruct lost data. We explain that sound procedures are integral to a bank's insurance program and its overall risk management effort. When the lending department, for instance, doesn't communicate well with the operations department, an uninsured loss may result. Lending officers, like insurance salespeople, want to get the deal done. In pursuit of that goal, they may skip some steps or fail to document certain information if the operational side of the business does not keep them in check.

When mortgage customers fail to maintain insurance on their properties, we've seen lending officers interfere with the process that is supposed to automatically force-place coverage. A lending officer thinks to himself, "I know Joe; he's a good guy and he'll replace that coverage," but Joe doesn't, and the uninsured house burns down. The bank's mortgage impairment coverage will not respond because the bank should have taken steps to insure the property but didn't.

With regard to risk management, we also stress the importance of accurate valuations for the bank's own property. We recommend that banks obtain independent insurance-value appraisals from competent firms, have procedures for updating those values each year and have procedures for adding and deleting real and business personal property as it is acquired, sold or discarded.

I've seen firsthand how important this process is. There was a major water-damage loss at a building we insured. We also insured the bank that was the building's largest tenant. The same insurer provided coverage for both the landlord and the bank under separate programs. I attended the adjuster's meeting with the building owner and the bank's president and senior vice president.

"The first thing we have to do is establish that the insured values are adequate," the adjuster said. "We have an appraisal done by Industrial Appraisal, which is the basis for the insurance values that we have," I replied, "and we have agreed-amount endorsements on the building, the contents, and the improvements and betterments."

The adjuster flipped a page and said, "All right, the next thing we need is a complete inventory reflecting current replacement values and identifying those items that were damaged." "Here's the report from the appraisal company that has all of the values as of the date of the loss," said the bank's senior vice president, "and we've indicated by check marks which items were damaged."

The adjuster turned another page on the clipboard and said, "It's really nice to work on a claim where everything is done correctly."

It's "nice" not only for an adjuster but, more important, also for our client, whose valuable time is at risk following a loss, along with the bank's physical assets. The quicker the loss can be adjusted, the quicker the client can return to operating the institution. For all our clients-not just banks-we do what we can to "pre-adjust" losses in the manner just described to minimize their time spent in the adjustment process.

Coverages

Financial institutions require an array of coverages, some of which may be provided in package products created for banks and others as stand-alone policies. Among the major products we secure for our clients are the following:

?Directors and officers liability insurance. D&O traditionally has been written to provide direct coverage for directors and officers, as well as corporation indemnification coverage for businesses. Because lawsuits increasingly name the bank itself as a defendant, we have sought to also include "entity" coverage in D&O policies. Especially for publicly traded financial institutions, it's crucial to at least have entity SEC liability coverage.

There has been much debate, however, about whether a D&O policy written for a financial institution should provide entity coverage. Depending on how the policy is designed, entity-coverage losses may erode the limits available for directors and officers. At least with regard to D&O insurance for community banks, however, we are usually able to secure entity coverage that does not reduce protection for directors and officers.

One important decision for banks is how much D&O coverage to buy. The American Bankers Association publishes a biannual survey of the insurance limits their members purchase. We purchase the survey and reference its findings in our proposals and annual reviews. The survey results cannot establish the "correct" amount of insurance to buy, because selection of coverage limits rests upon the business judgment of the bank's senior management and its directors. However, the reports show our clients the coverages and limits similarly sized institutions have chosen.

?Financial institution bonds. Financial institution bonds historically have been written subject to aggregate limits. It is often possible, however, to obtain multiple per-claim aggregates (usually double or sometimes triple). In fact, in the current marketplace, one can obtain terms for non-aggregate bonds, which is our preference.

Financial institution bonds address employee dishonesty exposures and also provide many other coverages that may be appropriate for a bank, depending on its scope of services. For instance, financial institution bonds provide coverage for cash letters in transit. A cash letter consists of checks deposited into banks that are drawn against accounts from other banks, plus a cover memorandum. The cash letter is usually transported by an armored car to a Federal Reserve Bank, a correspondent bank or an exchange such as the Chicago Clearing House Association, where the paper checks are "presented" for payment.

Banks with multiple locations typically consolidate these checks at one of their facilities, then send them to their destination in one shipment. While the checks are in transit between the insured bank's facilities, they technically are referred to as "work in process" rather than as "cash letters." A loss of a work in process may not be covered by the cash letter transit section of the financial institution bond, depending on how broadly the underwriter interprets its "cash letter" coverage. Consequently, we have requested that underwriters amend the definition of "cash letter" to include these check shipments (work in process) between a bank's facilities.

?Kidnap/ransom insurance. Financial institution bonds can provide kidnap, ransom and extortion insurance. The coverage is usually narrow in scope. Therefore, we often remove it from the bond (thereby reducing the bond's cost) and purchase separate kidnap/ransom coverage. Stand-alone coverage typically has a broader definition of extortion, often covers a broader range of persons and responds to a broader range of injuries than does the extortion provision in financial institution bonds. (Similarly, we take the safe-deposit box insurance out of the financial institution bond and write it separately to secure broader coverage.)

When a bank receives an extortion threat, or a kidnapping actually takes place, law enforcement authorities focus on solving the crime and may spend little time informing and advising the institution. With a separate kidnap/ransom policy, a financial institution can opt to retain an emergency response team that will function as the institution's advocate and adviser. It is possible to familiarize the emergency response firm with the bank's management in advance, so the response team will be able to react more quickly and effectively should a crisis arise.

?Time element insurance. Banks don't generally buy standard business income insurance as part of their property programs, because by law they can't be closed for more than three consecutive days. But another time element coverage, extra expense insurance, is something to which they should pay a great deal of attention. A bank with multiple locations can fairly easily shift operations from a damaged location to one of its other sites. A bank operating from a single location, however, often must resort to more intensive and more costly measures. They can include installing temporary trailers in the parking lot to handle deposits and make disbursements, renting temporary office space, and finding a way to reestablish computer connections to off-site data processors.

Regardless of how many offices they have, we ask our clients to share with us their plans for handling the loss of a facility, or help them develop such plans if they don't have them. We also urge them to purchase adequate extra expense insurance, reminding them of a bank that had a marvelous response plan but failed to realize how expensive it would be to implement. When arson at an adjacent property also destroyed their main bank building, they put their plan into action-but ran out of extra expense money in a week.

?Mortgage interest insurance. This is a two-part product. The first is mortgage impairment insurance, which covers a bank's mortgage interest in property for which a borrower is required to provide insurance but fails or ceases to do so without the bank's knowledge. The second part is mortgage E&O, which responds to liability losses arising from the bank's failure or alleged failure to obtain or maintain coverage on a mortgaged property for which it has a responsibility to insure for the interest of the owner.

Particularly with regard to mortgage impairment insurance, coverage can vary considerably from one market to another. Some policies respond only to the perils for which the bank requires its borrowers to obtain coverage. Other insurers will provide coverage for a much wider range of perils ("balance of perils").

Even if a bank has the more narrow form of mortgage impairment insurance, it may be possible to effectively expand coverage by revising its insurance requirements for borrowers. If a bank's loan agreement merely requires residential mortgage customers to carry fire and extended perils coverage, we recommend that it revise its loan forms to require borrowers to insure the broader range of perils covered by the HO-3, since most of the bank's customers probably have such coverage anyway.

Internet banking liability insurance. As banks broaden their services to include Internet banking, they may incur exposures not contemplated by, nor insurable under, financial institution bonds or other existing coverages. A number of insurers have developed Internet liability insurance forms that address these exposures.

These policies provide broad-form liability coverage for banks and their directors, officers and employees for losses arising from "wrongful Internet/electronic banking acts": allegations of personal-injury-type claims (libel, slander and defamation, etc.); loss or damage to a customer's electronic data; denial, impairment or interruption of service; loss of business opportunity; unauthorized access to a customer account; infringement of copyright, misappropriation of ideas or plagiarism; and infringement of trademark, trade name or service mark.

Coverage also can be extended to include indemnification to the bank for loss of property surrendered as a direct result of a threat to damage the bank's computer system through the use of or access to an Internet Web site or private computer; to interrupt the bank's Internet banking services; to publish, use or disclose any confidential information obtained from the bank's computer system or from an Internet Web site; or to steal money or other property for which a bank is legally responsible. Associated public relations and business interruption expenses can be covered too. We discuss these issues with our banks each year and give them proposals to consider when they begin offering customers Internet banking services.

Markets

In 1985, following the collapse of the S&L industry and the onset of a hard market, the D&O market for financial institutions suffered a meltdown. (For instance, we had a London D&O contract covering a multitude of banks that was cancelled midterm after the program's reinsurance underwriters withdrew.) In response to the crisis, the American Bankers Association created a captive providing D&O insurance and engaged Progressive Insurance Co. to be its underwriting manager. As the marketplace has changed, the ABA program has remained a consistent and successful source of coverage for D&O, financial institution bonds, EPLI, safe deposit insurance and recently Internet banking coverage. It remains one of the markets we frequently work with today. One consequence of the 1985 turmoil is that bankers with long memories still have concerns about insurers' reliability. A carrier's ratings and financial condition are of great interest to our clients.

Among the principal financial institution markets we represent are Chubb, Zurich and St. Paul Travelers. St. Paul has been a major player for us in the past, and we're waiting to see what direction it will take in its new incarnation as St. Paul Travelers.

Chubb is a long-time writer of financial institution insurance and maintains separate departments to underwrite this business. We have worked with Chubb to insure many financial institution accounts for a broad array of financial institution coverages from the time we first began placing coverages for banks.

Zurich also focuses on financial institutions and is an important source for these coverages. Our relationship with this market dates from when we represented the Fidelity and Deposit Insurance Co., a company Zurich acquired a number of years ago.

We also use a wholesaler, U.S. Risk, to gain access to other markets in certain circumstances, particularly with regard to professional liability, and to address unusual or difficult risks. Mike Hogan, who runs the wholesaler's Tennessee office, has been a great mentor, a valuable and experienced resource, and a friend.

Submissions

Thanks to the Internet and the extraordinary amount of information now available online, we don't have to gather nearly as much information directly from bankers for submissions as we once did. Primarily, we need to give an underwriter a properly completed application. Markets generally will accept a competitor's application for purposes of providing an indication, although most carriers insist on having their own forms completed before they will bind coverage.

Carriers sometimes ask us for a bank's financial statements, but generally underwriters can obtain the necessary information by accessing the bank's call reports and other financial data available at the Federal Deposit Insurance Corp.'s Web site. They may also subscribe to databases of private firms that analyze financial institutions.

If the FDIC, Office of the Comptroller of the Currency or a state banking regulator has taken a critical regulatory action against a bank, the underwriter will want information about it. This can be a sensitive matter, because some information in these reports may not be released, and banks can be censured and fined if they disclose it without regulatory approval. However, regulators will allow the release of information on a case-by-case basis about memoranda of understanding and cease-and-desist orders because they realize underwriters will not provide coverage without it. With such data, an underwriter can assess the seriousness of any criticisms leveled against a bank, decide whether or to what to degree to offer insurance, and, if it issues coverage, monitor the steps the bank takes to address the regulatory criticisms and requirements.

Annual reviews

Banks have ongoing service needs. They establish new locations, change vehicles, acquire and sell foreclosed properties, etc., so we constantly interact with them to keep their programs up to date. We also conduct a formal annual face-to-face survey meeting with senior management at each bank we insure. In addition to the usual fact-finding questions, I ask a number of open-ended questions intended to shed light on changing exposures, e.g.: "What are you doing that you didn't do in the past? What services have you discontinued? Is there anything about your operations that we have not discussed that could create or eliminate the need for insurance?"

We prepare annual insurance reviews for our clients. They include a schedule of insurance coverages, prices, expiration dates, etc. They also include narratives explaining how their exposures have changed in the past year, along with our recommendations for covering them. We give the reviews to senior management in time to be included in their directors' board packets. In most cases we are invited to attend the board meetings, present the reports and take questions from directors. Typically, questions focus on the principal insurance coverages, the insurance marketplace, and alternative retentions and limits for D&O coverages. "How do we and our insurance program compare with others?" is one frequently asked question.

Such questions indicate good corporate governance and awareness that a financial institution's board of directors is required to annually review the bank's insurance program. The review must be reflected in the board's minutes. We've been told that our review is the first thing regulators ask for when they conduct their bank examinations. It provides comprehensive, yet accessible, documentation of the bank's insurance program.

The bottom line

As I'm sure you have surmised from this article, banks can be challenging accounts. Agents catering to financial institutions not only must be able to provide the numerous products and services they require but also have a sound understanding of the banking business itself. We recognize that financial institutions' selection of agents is sometimes political. But whether attempting to gain new accounts or retain existing ones, we stress that professionals like bankers should turn to other professionals for their insurance needs. As long as most do so, we're confident that we'll continue to design and place insurance programs for banks and other financial institutions.