Banks have been in the news for all the wrong reasons lately.
Some of us are old enough to remember the financial crisis of 2009 (and even the collapse of Barings bank in 1995!) I’m not going to analyse why banks are struggling – there is a glut of material out there on that. What are some of the policy issues likely to arise when a bank collapses or is taken over unexpectedly? Here’s a handy summary on the main products below.
D&O
Everyone leaps for their policy. For US traded banks US securities class actions will be commenced as soon as the share price plummets on the release of unexpectedly worrying news. This is before developments play out and we know whether the bank will trade through, be taken over or goes insolvent. It’s important at this point to notify the policy promptly of any claims or circumstances likely to give rise to a claim.
If the bank trades through …
There are no immediate policy consequences, but the next scheduled renewal could be a challenge.
Avoid insolvency exclusions where possible as if the bank subsequently goes insolvent there will be no company indemnification and the policy becomes the directors’ only hope. Insurers could face an accusation of “illusory cover”. Underwrite (or decline) the risk and price accordingly.
The prior notified matters exclusion on the renewed policy ought to ensure that anything related to the issues that caused the problem notified stays in the expiring year. If there has to be a specific matters exclusion make sure it takes out the matter specifically.
If the bank is taken over (Credit Suisse being a recent example) …
The policy will go into run-off for the remainder of the policy period and serious thought will need to be given to purchasing a run-off policy (in practice an extension of the current policy, as amended) for at least six years from the transaction to pick up claims that relate to the problematic pre-transaction period.
Clarify who pays for it and to whom matters are notified on it – if the bank is absorbed and effectively ceases to exist someone in the acquiring entity will need to be authorised to notify and manage the claims on behalf of the former directors.
Any claims after the takeover that relate to matters after the takeover will be for the acquiring entity’s D&O insurers. On that subject, a large acquisition would need to be advised to the acquiring entity’s D&O insurers beforehand because under the terms of its D&O policy it’s unlikely the coverage would be extended automatically. Also, it’s the right thing to do to ensure everyone is on side.
If the bank goes into insolvency …
Under some D&O policies this will put the policy into run-off much the same as in a takeover. If this is the case care needs to be taken over notifications before and after the insolvency as these may capture much of the D&O claim activity that follows after the policy period expires (there’s unlikely to be any run-off policy for obvious reasons).
The Policy should not be cancellable – otherwise a liquidator might try and recover a pro rata return premium and cancel the policy leaving the directors naked.
If insolvency isn’t a run-off event then the policy will continue to operate as normal until it expires. It will pick up ongoing acts of the directors post insolvency assuming they are retained in that capacity but will not cover the insolvency practitioners (administrators, trustees in bankruptcy and liquidators etc) as these people are almost always excluded from being Insured Persons. Like in the run-off scenario though, the expiry of the policy will be a hard stop and so care will be needed over notifications in the run up to expiry. It’s unlikely an insolvency practitioner will pay to trigger the discovery period but if the terms of triggering discovery are met then this is a consideration for the directors who are able to fund it themselves.
Crime
Mercifully this is less complicated, unless of course the bank’s predicament was connected to a fraud. It has happened
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Proprietary trading by a “rogue trader” is probably the most likely crime scenario to threaten a bank (Barings, England’s oldest bank, collapsed in 1995 after a futures trader in Singapore built up huge losses which he hid until eventually the balloon went up).
There is broad coverage for employee fraud and so unless excluded the Crime will be a relevant source of coverage and might just help prevent the bank from going under.
Otherwise, where there’s no connected crime, it’s just a question of what happens to the policy if the company is taken over or goes insolvent. Strangely Crime policies can be quite coy about this, particularly insolvency. Some barely mention it or simply say the cover is “terminated” without stating what that means in practice. Crime has a “loss discovered” trigger and so realistically the options are either that:
No discoveries after the date of takeover or insolvency can be notified no matter whether the crimes were committed prior to those events or not; or
The policy goes into run-off until expiry of the policy period so that new discoveries relating to crimes committed prior to the takeover or insolvency can still be notified. This might be modified to provide a specified period for notifying discoveries after the termination but not the entire remainder of the policy period.
So, if there’s a chance to clarify what happens on an imminent renewal this could be a good idea. And if an insolvency or takeover seems likely the termination provisions ought to be checked – do not assume they are the same as in a D&O policy!
Professional Liability
Professional liability is a very broad church, and the policies vary wildly depending on the professional sector insured. What follows is solely from an FI perspective.
If the insolvency / takeover is linked to a large PI loss(es) this will complicate matters. This has happened – remember the collapse of Arthur Andersen after the Enron, Worldcom and Waste Management accounting scandals?
Similar considerations to the D&O will apply to the notification of claims. However, in the case of PI it’s important to check whether there is a mandatory notice of circumstances provision. This is likely to be less onerous in terms of the quality and amount of information required to be notified but a failure to notify promptly could have more serious consequences.
Insolvency and takeovers may or may not be treated the same, like in the D&O. They may put the policy into run-off, so the same considerations apply (see above). From experience though the PI is less likely to say explicitly what happens than the D&O even though it would make sense for it to do so. If silent:
Arguably the policy continues as normal until policy expiry, and this may be the best option for the Insured in the case of insolvency.
In the case of a takeover, if a run-off policy is going to be needed following policy expiry it would be better to engage on the subject at the point of the transaction and not run the risk of an issue on policy expiry.
In a takeover the acquiring entity’s PI policy may not contain any automatic acquisition coverage and so if the bank is to continue to be covered for ongoing matters post acquisition this will need to be addressed with the acquiror’s existing PI insurers and a run-off policy bought for claims arising out of the bank’s pre-transaction matters.
There is a further consideration on the PI where the bank goes insolvent: the insolvency exclusion.
There is quite likely to be an insolvency exclusion in the policy. This ought to just capture claims caused by the insolvency of the bank, in other words errors and omissions subsequent to the collapse. An insolvency event is very likely to cause huge disruption to the daily business of the bank and so more mistakes will be made, and trading commitments left unhonoured. People may be leaving in droves in an unstructured way mid-transaction or assignment.
This could lead to an avalanche of claims that would otherwise not have been brought and insurers take the understandable position this is a material change in the risk and should be excluded.
What should not be excluded is claims subsequent to the insolvency that arise from matters pre-dating the insolvency, even if they helped cause the demise of the bank. This is where the choice of exclusionary language becomes important so that the distinction is clear. This may be worth checking for any imminent renewal to ensure it does what is intended.
Of course, nothing in the above or in the policy language necessarily prevents the parties from achieving more innovative or nuanced solutions in these situations. Out of risk also comes opportunity. I can think of many occasions when markets have done this, so an open mind should be kept.