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By Patricia Vowinkel

It's not over yet. Nearly five years after the housing crisis first began making headlines, financial institutions are facing the threat of another wave of litigation tied to the collapse of the residential real estate market. This time the threat stems from allegations of abusive foreclosure practices by the banks and mortgage servicers.

"If you look at most of the names that have been talked about thus far, they tend to be major banks. To a large extent, most of these banks do not purchase what we call corporate reimbursement and entity securities coverage for the directors' and officers' (D&O B&C coverage), nor do they purchase errors and omissions insurance," said Mike O'Connell, managing director of Aon Risk Solution's Financial Institutions practice.

"If you go back 10 years ago, it would have been the inverse," he said. "They would have had more insurance limit potentially available."But after Wall Street was buffeted by the initial public offering laddering scandal, the mutual fund market timing scandal, and the conflicts of interest among stock analysts, that all began to change. Underwriters began to consider the very largest banks to be too complex to underwrite. Outside of the top banks -- Bank of America, JPMorgan Chase, Citibank and Wells Fargo, the next tier, however, often does have errors and omissions coverage, and B-side and C-side insurance coverage for directors and officers, he said.

The superregional and regional banks, of which there are about 100, include PNC, KeyBank, Fifth Third Bank, Regions, SunTrust, Union Bank of California and Zion's. These banks typically hold $10 billion or more in assets.

B-side directors' and officers' coverage reimburses the company for amounts that it pays to a director or officer through indemnification, and C-side coverage is for claims directly against a company.

B-side and C-side coverage stand in contrast to A-side coverage, which indemnifies a director or officer with respect to claims for which the company does not indemnify that director or officer, because the company is not required to do so, or because the company is bankrupt. But even those financial institutions that have errors and omissions insurance may find their coverage in dispute. Insurers may claim that the foreclosure litigation is related to earlier housing crisis litigation and therefore covered under a policy from a prior year. And those limits may already be exhausted.

In the financial institutions sector, underwriters have come to expect a major crisis of one sort or another every few years.

Going back to the late 1980s and early 1990s there was the savings-and-loan crisis. The 1990s had the derivatives crisis that hit Bankers Trust and California's Orange County. In the last decade, the crises have been coming more quickly.

There's been the initial public offering laddering scandal, the mutual fund market timing scandal, and stock analyst scandals. In addition, there's been the litigation associated with corporate bankruptcies, and in the last few years, all the litigation related to the housing crisis.

Now, underwriters are bracing for a new round of trouble emanating from the European debt crisis, the collapse of futures broker MF Global and investigations by the Securities and Exchange Commission into insider trading at hedge funds. Other problems related to so-called "force-placed" insurance also could emerge to create even more trouble for mortgage servicers.

"I've been in the business over 30 years, and every 25 to 30 months there's a new financial institutions blow-up," said Greg Flood, president of IronPro, the professional underwriting unit of insurer Ironshore. "We opened this company in 2007 and in that small space of time, there's been the credit crisis and we're now picking our way through the next train wreck with the European debt crisis and now hedge funds," he said.

In the latest chapter of the housing saga, bank foreclosure practices have been called into question.

After 16 months of negotiations, five of the nation's biggest banks agreed in February to a $25 billion government settlement of allegations of abusive foreclosure practices that included "robosigning" and the use of faulty documents to seize homes. The deal, to be spread out over three years, requires the banks to cut mortgage debt amounts and extend $2,000 payments to borrowers who lost their homes to foreclosure, according to a Reuters report.

It will also release the banks -- Bank of America Corp, Wells Fargo & Co, JPMorgan Chase & Co, Citigroup Inc and Ally Financial Inc. -- from civil government claims over faulty foreclosures and the mishandling of requests for loan modifications.

But the banks still face a host of other potential government enforcement actions and investor lawsuits related to their packaging of home loans into securities and other mortgage-related activities, according to Reuters.

Massachusetts Attorney General Martha Coakley and other state attorneys general still reserved the right to pursue allegations that the banks illegally used a national housing database, the Mortgage Electronic Registration Systems Inc, to initiate foreclosures without holding the actual documents, according to the New York Times.

Major banks also face tens of billions of dollars in claims from investors and companies that bought toxic mortgages from them and are pursuing legal actions of their own, according to the report.

One of the key sticking points during the negotiations had been the question of the scope of immunity from litigation. "If you are going to pay a lot of money, you want comfort that the matter is fully and finally released," said Tom Orrico, who leads the Financial Institutions Center of Excellence within Marsh's FINPRO Practice. "If you are not going to get that kind of comfort, that would be an issue." Without a sweeping immunity agreement, the top banks may not be able to avoid additional foreclosure litigation.

The banks have already set aside large pools of reserves to pay the cost of judgments and settlements, according to the New York Times report. Bank of America has set aside nearly $16 billion to handle potential claims, according to the report.

Ally Financial, one of the lenders involved in the settlement talks, said in late January that it will take a $270 million charge in the fourth quarter for penalties it expects to pay in the pending foreclosure settlement.

"A successful prosecution by the state attorneys general would necessitate some level of loss for the banks?whether it's an insurable loss is another question," said Jim Gray, executive vice president and chief underwriting officer of professional liability at Alterra Bermuda.

Losses arising from the foreclosure litigation typically would be covered under either an errors and omissions policy, or -- if there were shareholder litigation -- under the company's directors' and officers' policy.

Errors and omissions insurance is the coverage that banks would turn to first in connection with the foreclosure litigation issue.

Many of the largest banks, however, are unlikely to have errors and omissions insurance, and the banks that do have it may find that underwriters will argue that this litigation is tied to an earlier policy year and that the limits for that year have already been exhausted.

Errors and omissions coverage "was not a universal across all of these companies," Gray said.

Outside the top handful of banks, the next tier of financial institutions with errors and omissions, as well as the B-side and C-side coverages for directors and officers, may not have enough limits to cover all of their losses from the foreclosure litigation crisis, O'Connell said.

Directors' & officers' coveragewould not come into play until there was shareholder litigation in connection with foreclosures, Gray said.

Even if there were shareholder litigation, there still might not be coverage under a company's directors' and officers' policy, said Kevin LaCroix, author of The D&O Diary blog and an attorney and executive vice president at OakBridge Insurance Services in Beachwood, Ohio.

Some policies might contain exclusions that would limit coverage, he said, and ther institutions might only carry A-side coverage.

A-side provides coverage directly to the directors and officers for loss resulting from claims made against them for their wrongful acts. A-side coverage applies where the corporation does not indemnify its directors and officers.

The good news for institutions buying directors' and officers' coverage is that the price has dropped.

There was a significant uptick in the directors' and officers' rate when the housing crisis first hit in the third quarter of 2007, but now the pricing has been on a downward trend.

Although there is still a significant inventory of litigation, a lot of insurers may have already factored that into their pricing, Orrico said.

"So we expect 2012 to be a flat market," he said.

PATRICIA VOWINKEL has covered the insurance industry for more than 15 years.

March 1, 2012

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