Banking Sector update: Mitigate Against the Hardening D&O Market

What can banks do?

The banking sector has been met with significant challenges in recent years, from COVID adversely impacting commercial lending portfolios to recent bank failures impacting D&O loss ratios and increasing interest rates impacting bank’s earnings, all of which have been cause for concern in the Directors and Officers (D&O) market.

Even with all that activity, prior to most recent renewal cycles, we were pleasantly surprised to have seen relatively flat renewals with multi-year options still available for our community/regional banking clients. However, in 2024, we have begun to see meaningfully more scrutiny by the bank D&O underwriters, which can lead to more restrictive coverages, fewer multi-year options, higher retentions/ deductibles, and increased premiums.

Key areas of concern D&O underwriters are focused on:

• Weaker earnings due to rising rates and deposit costs

• Increasing levels of non-performing assets

• Increasing occurrences of memorandums of understanding (MOUs)
  Several of the MOUs that we have seen have a common theme of involvement with atypical banking services, such as fintech operations. The MOUs typically center around a lack of compliance and the need for the bank to improve their overall BSA/AML compliance.
• High commercial real estate (CRE)/office lending concentration, which can result in impacted earnings from higher loan loss provisions and additional regulatory scrutiny

• Increasing investor activist behavior

• DOJ activity with respect to fair practices in lending and consumer related activity

• Increased regulatory focus coming out of the events of spring 2023 have posed challenges between underwriters and banks

These characteristics can increase the perceived risk profile of banks in general and the likelihood of some form of D&O and/or Professional Liability claims. They are beginning to contribute to an overall hardening of the bank D&O market.

With all of that said, there are steps bank executives can take to demonstrate to the underwriters how they are working to avoid these pitfalls and thus separate themselves from those banking institutions that may be perceived as riskier. One key part of our process with all our banking clients is the hosting of the D&O underwriter meeting/call, which can help the insured get ahead of these concerns and improve their profile for underwriters.

What that process looks like:

1. Based on the size of the bank and whether they are publicly listed or privately held, we would approach between 15 – 25 different D&O insurers that work with us on our community and regional bank clients. Typically, we will end up with between 10 – 20 D&O underwriters (including the incumbent underwriters – which is part of the value proposition detailed below) who will dial in to listen to the executive team of the bank.
2. In order to make the call as productive as possible, we ask all underwriters to share, in advance, any specific questions they may have of the executive team prior to the call. We share these with our insured and develop an approach to addressing particular topics and concerns.
   Subset of the common questions and topics we’ve recently been receiving:
   • Can the bank provide expectations regarding their NIM if rates stay stable or reduce over the next 6-12 months?
   • Can the bank provide information about the stability of their deposit base?
     • Has there been any significant deposit outflow since rates have increased?
     • What percentage of the bank’s deposit base is FDIC insured?
   • Are there any lending concentrations in one specific area or industry?
   • How much of their office lending is in urban areas/central business districts?
   • Can the bank provide information on CRE/office LTV’s and vacancy rates?
   • Does the bank discuss their liquidity positions in their public statements? For most public banks this information is readily available on earnings releases or within investor presentations. For private banks or mutuals they will need to be able to provide information.
   • If there is a high level of uninsured deposits, there could be a question about how much borrowing capacity the bank has to cover uninsured deposits.
     • Related, there are some banks which uninsured deposit amounts are overstated on their call reports because the call reports do not consider collateralized municipal deposits. A bank will need to be able to explain their uninsured deposit levels to underwriters.
   • To try to vet out risks associated with activist behaviors, particularly for publicly listed institutions, there could be a question about the relationships the bank has with their largest shareholders.
3. On the call itself, after brief introductions, the executive team provides a general overview of the bank’s operations, highlighting the past 12 -36 months (based on if there was a multi-year term). Note, we never look for the team to read the questions provided and provide an answer to each one. Instead, we seek a more casual discussion, where they will often hit on many of the questions asked, naturally. We would estimate that half of the time, the team will have some form of presentation (often an investor slide deck) that we will use as a template for the overview. The other half of the time, the team will simply have a conversation.
4. After the overview, we open it up for questions from the underwriters, whether it be a topic that was not addressed or where they would like additional, more detailed, information about something that was brought up in the overview.
5. We then close with timing expectations for the quotes.

Benefits of hosting such a call can include, but are not limited to:

• Leveraging the competitive influences of the D&O market, by specifically including the incumbent underwriter who is sitting ‘across the table’ from their competitors, which will almost always generate the best results from a coverage and pricing standpoint.
  This does not mean there is an intent to move the coverage from the current insurer. It simply makes them aware of the competitors’ interest.
• Generating a personal connection with the underwriting community encourages underwriting beyond the black and white of applications and public filings. Thus, we convert from underwriters assuming the worst to providing the benefit of the doubt.
• Limiting the underwriter’s ability to ask for additional information post call, thus streamlining the binding process.

By following this process, the bank helps to separate itself from its peers, highlights their strengths, and controls the narrative of potential challenges, which will better enable them to mitigate the potential impacts of the hardening market.