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Digital Assets – An evolving insurance landscape

All Eyes on FIs Podcast: Season 1 – Episode 2

July 24, 2023

Digital Assets, the ever-changing insurance landscape and how the market is responding to client needs.
Financial, Executive and Professional Risks (FINEX)
Directors and Officers risk insights

In our second episode of All Eyes on FIs we discuss digital assets and how the insurance market is responding to client needs. Caroline Sawyer, Director in our Financial Institutions (FI) team asks our speakers Craig Glendinning (also in our FI team in GB) and Miguel Cano, our digital assets lead in our US FI practice to give examples of the requests that the financial institutions team have seen from clients, the current state of the insurance market and how the insurance market is adapting and providing solutions in this evolving space.

Also in this episode we offer both a UK market perspective from Craig and a US perspective from Miguel.

So get comfy, grab a cup of tea and join us for a chat.

Episode 2: Digital Assets – An evolving insurance landscape

Transcript for this episode:

All Eyes on FIs — Episode 2: Digital assets

CRAIG GLENDINNING: The situation is indeed dynamic, and the market really is evolving to embrace digital risks increasingly so, I mean, there are some interesting solutions now being created by insurers.

SPEAKER 2: Welcome to All Eyes on FIs, a podcast series from the WTW financial institutions team. Our experts have their eyes on risk management, regulatory changes, and coverage challenges faced by financial institutions of all kinds and sizes from professional liability to crime and everything in between.

CAROLINE SAWYER: Hi, I'm Caroline Sawyer from our financial institutions team at WTW in London. I'm joined by my colleagues, Craig Glendinning also from our London office and Miguel Cano from our New York office. We're going to discuss digital assets and how the insurance market is responding to client needs.

Miguel, and then Craig, could I ask you to introduce yourselves?

MIGUEL CANO: Yeah, sure. Thanks, Caroline. So as Caroline mentioned, my name is Miguel Cano. I'm based out of our New York City office. I currently work on the financial institutions management liability team, and I'm also part of the digital asset solutions team at WTW. I've been with the firm for just over three years and prior to that, I spent three years at Goldman Sachs, where I started off my career.

Craig, over to you.

CRAIG GLENDINNING: Thank you. I'm Craig Glendinning also based in the London office and part of the financial institutions practice there. 30 years in the industry, mainly working on crime risks.

CAROLINE SAWYER: Thanks. So we're going to address, firstly, what kind of requests we've been seeing from clients? Secondly, where the insurance market is at the moment? And then, finally, how the insurance market is adapting and providing new solutions in this evolving space?

I think it is important to emphasize that this is a dynamic situation. And as the industry around digital assets is developing, so too is the availability and scope of insurance products evolving. So Craig will share his perspective from the UK insurance market, and Miguel will share his thoughts from the US insurance market perspective.

Miguel, if we could start with you. We are seeing increasing enquiries from clients and new clients about insurance cover for digital assets. Where are we seeing this demand?

MIGUEL CANO: Yes, so I would say the demand for insurance products from Web3 companies is really twofold. So one, it's really from emerging Web3 companies, so sort of these start-ups that are growing, that are trying to be more risk conscious. Maybe they're creating board of directors or getting new board members on who are asking about the insurance products that they have. So that's one side of it.

The other side of it is inquiries from established institutions, who are exploring the space. So it's really maybe just a small subset of what their actual business is, but they think that there are some actual solutions with the Web3 technology that could enhance their technology or their business. So that's the other side of really where the demand is coming from.

CAROLINE SAWYER: OK, so potentially, a range of parties for whom this is either core or perhaps more peripheral business, who want to understand how the insurance market can provide them with risk transfer solutions.

Craig, very broadly, could you explain what approach insurers have been taking with regard to digital assets?

CRAIG GLENDINNING: Yes, certainly, Caroline. And as you mentioned earlier, the situation is indeed dynamic and the market really is evolving to embrace digital risks increasingly so

I mean, there are some interesting solutions now being created by insurers and brokers in the crime space and D&O space, especially and I think as market conditions soften, where it's becoming easier to remove some of the exclusions from traditional programs, that we saw being attached during tougher conditions. Whilst those exclusions did breed a push towards more focused policies, we certainly welcome those exclusions being removed from main programs, too, because it does give some of our larger clients more flexibility.

That said, though, a few large players are still sitting on the side-lines and really waiting for regulatory clarity and I think we're now starting to see that, for instance, in Europe, the EU appears to be taking the lead with its proposed markets in crypto assets regulation. MiCA, it's a regulatory framework expected to come into force next year and frankly, it will govern any person or entity providing crypto asset services.

So that's pretty much anyone in the financial institution space and essentially, it's seeking to harmonize regulation across member states. Again, here in the UK, the HM Treasury's just published a consultation paper last month with a very similar approach. So we're starting to see some real progress towards regulation and the certainty that that will provide.

CAROLINE SAWYER: Thanks, Craig. I mean, you've led us into the, perhaps, somewhat complex topic of regulation, and you've indicated that this is one of the reasons for some of the cautiousness from the insurance industry.

Miguel, could you perhaps provide a bit of detail on the regulatory framework in the US and also whether you see lack of regulation or, perhaps, lack of clarity around regulation as one of the headwinds in the development of the insurance market for this industry?

MIGUEL CANO: Yeah, certainly. So I would say it's-- regulation is definitely a headwind for digital assets in the US. Digital assets and crypto overall is suffering from a reputational problem, and it's leading to regulators taking a really close look into this industry.

Some examples of that is the SEC bulletin, SAB 121, that came out essentially saying that anybody that's custodying assets essentially has to hold those assets on their balance sheet from an accounting perspective. That has very large capital requirement implications and it's almost a way of regulators telling banks or any sort of anybody that's looking to custody, take a step back, be careful, look at this closely.

We've also seen the OCC, the FDIC, and the Federal Reserve come out with joint statements. They came out with a joint statement in January, where they essentially listed out every single risk as it relates to digital assets that they perceive, and essentially, came out and said that the way that digital assets are currently handled from a custody perspective do not meet banking regulatory standards as is. So, they didn't actually really say, don't do this. They just said that, as it is right now, does not meet banking regulatory standards.

So that really is an indication that going forward in the future, it's a pretty good chance that we're going to see some regulation here that might make it a bit more difficult to participate in this space. Really, more recently too, we've seen the Wells Notices that were sent to Coinbase from the FCC with related to their staking products and whether those are securities. There's a sort of internal battle between the SEC and the CFTC, where they're fighting for jurisdiction in this space.

So, I think there's definitely a lot of uncertainty. I think, there's some clarity to some extent, but not enough, particularly in the custody of digital assets. And now, even with just figuring out whether state assets should be considered securities or not.

CAROLINE SAWYER: I mean, I think that's really helpful in providing that context for how insurers are approaching what is still a relatively new industry. Now, I'd like to delve into the insurance market on a more granular basis and focus on the extent to which the exposures posed by digital assets can be covered by insurance.

So, let's begin by considering what cover is available via the traditional financial lines policies. So, if we break that down into the core financial lines covers, directors’ and officers’ liability insurance, cyber insurance, and crime and professional indemnity or errors in omission cover.

Miguel, perhaps you could start us off and then perhaps we could pass over, Craig, to you to cover off crime and professional indemnity.

MIGUEL CANO: Yeah, that sounds good. So with regards to D&O, I would say it's certainly available, but it's still very much case by case and what I mean by that is if you are an established large institution who is looking to expand into this space and you're looking to have coverage for your digital asset exposure, it's going to be a lot easier for us to negotiate and get that coverage because we have a lot of leverage. Because you're buying all these other lines of business that are not related to the digital assets. It's not your core business.

So, we have a lot of leverage because there's a lot of premium being allocated to non-crypto side of the risk. If you're a smaller Web3 company where digital assets is your core competency, it's more difficult. We have to go to more nuanced markets. We're focusing on the space a bit more. There's a bit more concern with regards to the exposure, mostly because directors’ and officers’ policies cover regulatory investigations

and as we just mentioned, there is a lot of regulatory uncertainty and certainly, we've seen regulators in the United States start to take action on some of these larger exchanges and digital asset companies. So very much case by case. Certainly available, we can certainly place it, but does require usually a deeper underlying underwriting dive from the underwriters.

With regards to cyber, I would say the cyber marketplace is pretty difficult. It's difficult if you're not in digital asset space, and it's even more so if you are in it.

So, I actually had a conversation with a cyber underwriter because I was curious, and I asked what, very blankly, what's the difference between cyber risk of a digital asset company versus one that isn't digital assets and she really couldn't give me a great answer. She said there really isn't any, but this is still a new business that's sort of coming into play, and we're not delving into it yet

and I think part of the reason for that is because the cyber market over the last two to three years has been very, very tough market with very high rates. We're starting to see that flatten a little bit now. But there really hasn't been a need for these insurers to push into this new type of business because they've been getting so much premium from just their current business that they have on hand.

So I think now, as we start to see the market, hopefully, soften a bit more, there will be sort of a need for these underwriters to get some more premium and we'll be able to see them look to provide some solutions in the digital asset space, on Cyber and D&O and all the other lines of business where the rate per million is a little bit juicier from that perspective.

CAROLINE SAWYER: Thanks. Over to you, Craig.

CRAIG GLENDINNING: Thank you. I think really the story for E&O or PI, as we call it over here, is pretty much the same as we've just heard for D&O and cyber. Very hard to get coverage, unless you are a large financial institution, and it is part of your offering. We can argue that it is just-- it is delivered in the usual course of the bank delivering professional services to its customers. If we're looking for specific insurance for crypto native or specialist sort of monoline type covers, very, very much more difficult.

The crime story, though, is far more compelling. There are a number of offerings out there. I mean, they broadly break down into an offering from the specie market which, I think was the first to evolve, evolved from sort of vault insurance, this idea of covering physical loss. That was very easy in the days of cold storage, where you had basically a hard drive stored in a vault but those policies are in that market to its credit is looking to step up and take on as best it can, the more relevant exposures now that are sought.

At the same time, though, the traditional liability market through crime insurance, although typically more expensive, is offering far broader coverage. We've seen some very good manuscript covers created for clients who are after a specific solution. That cover goes very much further. It's not restricted by whether if you like the dishonest act took part, and it covers far more sort of social engineering-type exposures as well. So basically, a far more comprehensive type of coverage for the risk.

It is worth saying, though, that paid losses are yet to test the true efficacy of some of these approaches. Under real-world conditions, brokers and clients are increasingly stress-testing the covers themselves and I think that's a great thing and we're seeing clients become more aware. There's less focus on just buying a lot of limit and more focus on are we getting a product here that actually works for the risks we're looking to transfer.

Back to you, Caroline.

CAROLINE SAWYER: Thanks. We've mentioned this is a developing market in insurance, and now, we've just covered how this is playing out in those traditional financial lines policies. Are there new products or solutions coming onto the market?

Miguel, again, perhaps I could start with you and then Craig. I don't know if either of you could perhaps give us an example, if there are.

MIGUEL CANO: Yeah, sure thing. So I totally agree. This is very much a developing marketplace and because of that, we have to have new innovative insurance solutions as well.

I think one of the ones that comes to mind to me right away where we've been getting a lot of queries is related to slashing, and it's called slashing insurance. This is insurance for proof-of-stake networks there's proof of work, and there's proof of stake

Ethereum is moving from proof of work to proof of stake. It's insurance for validators in proof-of-stake networks to the extent that they are slashed. Getting slashed is essentially when you are securing the network if you do some type of action that the blockchain or that particular blockchain views as an incorrect action, you can get slashed, which means part of the assets that you're holding essentially just disappear or get taken from you. This insurance provides coverage for validators to reimburse themselves for any of those slashed assets for the actions that they might have occurred.

But you can also see it from the investor side if I'm an investor. If I delegate my assets to a particular validator, that validator gets slashed, and they lose those funds. It's insurance for me as an investor to get reimbursed for my funds to the extent that my validator does not have insurance or does not have enough insurance to cover me fully for my losses.

Just one other one that quickly comes to mind is smart contract insurance. Again, it's insurance for the actual failure or malfunction of the actual smart contract that's created. Two quick ones that kind of come to mind.

CAROLINE SAWYER: Thanks. Over to you Craig.

CRAIG GLENDINNING: So I think my one observation here would be that as we're seeing the sort of traditional financial sector engage with digital offerings, they're bringing a very positive and demanding approach, which can only be welcomed. I mean, it's just-- lots of positive informed interest from clients will help the market deliver solutions. I think we really need engaged clients here, educating insurers and being very clear about what covers they're looking for and the traditional large players from the financial sector will help the market evolve.

CAROLINE SAWYER: Absolutely, agree, Craig and I think that leads us quite neatly to wrapping up here.

As the industry around digital assets develops, so too do the insurance offerings, which can protect from some of those risks associated with that type of business. Traditional financial lines insurance policies can provide protection, but there is some cautiousness from insurers and these policies can be difficult to procure.

Insurer appetite will depend on the nature of the business. As Miguel alluded to, it's very much on a case-by-case basis, and of course, there is an overlay of the market conditions for that class of insurance more generally. There are also new innovative products which are entering the insurance market to address particular solutions.

And then, finally, as ever, do speak to your insurance broker if you want to discuss this topic further. Or please do reach out to Craig, Miguel, or me, and we'd be really happy to discuss this with you.


MIGUEL CANO: Thanks, everyone.


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