Executive summary
We are pleased to present FINEX GB’s Banking Market Update looking ahead into 2021. In this issue, we explore the current state of the Financial Institutions Financial Lines1 insurance market and identify new and emerging issues within the banking industry and discuss what impact those issues may have on Financial Lines policies.
2020 saw all of us, banks and lenders included, settling in to the “new normal” driven by the COVID-19 pandemic. Unprecedented in its scope, the virus itself, along with the financial market volatility that followed, has had tremendous consequences for all industries, including the insurance sector, across the globe. It has undoubtedly been, and continues to be, a significant issue affecting both banks and the Financial Lines insurance market and will likely continue to do so for the foreseeable future.
Though the full extent of the virus’ impact on Financial Lines insurance for banks is not yet known, we do know that the pandemic has added a new layer of volatility on top of an already challenged insurance market. The continued low interest rate environment remains a long-standing cause for concern regarding profitability and the potential for a successful shift to revenue generating activities. With continued uncertainty surrounding Brexit trades deals and potential new regulation, the banking sector remains as challenging as ever to operate and compete within.
COVID-19 aside, we have not lost sight of the fact that other new and emerging issues are also affecting the banking industry. Noteworthy items addressed within this edition include cybersecurity, Environmental, Social and Governance (ESG) and the projected wind-down of LIBOR. We discuss these issues in detail and identify the potential implications they may have on a bank’s risk profile, as well as their Financial Lines insurance policies. Banks have faced a challenging year, much of which is expected to extend into 2021. We hope this publication offers valuable insights to help you successfully navigate through these turbulent times.
Should you have any questions or wish to discuss any of these issues in greater detail, please engage with myself or a member of your Willis Towers Watson team.
Financial Lines market update
Premium Rates: Premiums are expected to follow 2020’s volatile market, trending higher with more double-digit increases, particularly with the on-going uncertainty that COVID-19 has had on credit and loan portfolios. On average, premiums are increasing by +20% to +35% for large banks and +15% to +30% for mid-market and challenger banks.
Excess Rates: Increased limit factors (ILFs) (the discount applied to excess layers) underwent significant rate rises in 2020 owing to insurers correcting for sizeable excess layer discounting during soft market conditions. Catastrophe coverage was available at highly competitive rates in the past, but as insurers look to protect balance sheets and reduce total exposures, this has driven pricing accordingly. Excess layer insurers have applied premium increases of as high as +80% to correct layer pricing, but it is important to look at the value of the underlying premium rate charged per million of indemnity provided, as a true mark of value.
It is worth noting that renewals from Q2 2020 onwards saw a higher correction in ILFs than those in Q1 2020 and as such, renewals in Q1 2021 may experience further increased rate corrections compared to Q2 and onwards into 2021 as markets seek to balance portfolios that renewed before the full onset of the pandemic.
Retentions: More than ever, insurers are insisting that banks assume a higher self-insured retention and are incentivising insureds through lower premium increases for higher retentions. Most of the largest banks have sizeable retentions and therefore this particular aspect has impacted mid to large sized banks with low retentions compared to their peer groups.
- Since the release of our Global FI Market Conditions, we have seen Axa XL’s UK Branch, XL Catlin Insurance Company, a lead FI market, put their FI book into run-off.
- At the same time, Aviva Insurance Limited London, HDI Global Specialty SE, and Convex Insurance UK Limited are three insurers that have entered the FI market in recent times.
- New capacity is starting to gather momentum with the announcements of Ki Syndicate 1618 now active as of 1/1/2021; Ki Syndicate is the first ever algorithm-based Syndicate that aims to provide clients with security, sustainability and scalability. In addition, Mosaic Insurance Company, Arcadian Risk Capital and Faraday Underwriting Limited plan to launch and actively underwrite in 2021.
- Breaking relationships with long-term primary and/or excess insurance partners may be required to mitigate premium increases.
- Stable to narrowing coverage: Broad coverage is generally still available, though some insurers are reassessing their portfolio and making minor adjustments to the scope of coverage to focus on the core intent of cover. Notable coverage developments include:
- Silent Cyber Exclusions: Some insurers are beginning to add cyber exclusions to Professional Indemnity insurance. As insurers continue to assess their silent cyber exposures, we may potentially see similar exclusions added to other types of policies. In a letter from the PRA2 to all insurers dated 30 January 2019, the PRA made it clear that it expected all insurers should have action plans to reduce unintended exposure, which can be caused by non-affirmative cyber cover. Lloyd’s of London is now mandating3 that all policies provide clarity regarding cyber coverage by either excluding or providing affirmative coverage.
- Crypto currency exclusions: A select few primary insurers are now applying blanket exclusions for crypto currency related losses within Crime policies.
- Tightening capacity: Large line sizes continue to be temporarily unavailable where previously insurers may have deployed £15m in capacity per insured, such lines are typically restricted to £10m or £5m. The largest insurers may deploy more than £15m of capacity but require capacity to be spread “ventilated” throughout a tower to mitigate against small to medium sized claims and losses. Insurers are closely managing aggregate liability across all Financial Lines.
- New Business: Insurers have continued a trend to deploy capacity to incumbent risks and limit new business opportunities, particularly in the third and fourth quarters of 2020, and gross Written Premium targets were close to or already met. As we enter a new underwriting year in 2021, there may be scope for an increase in desire for new business.
Given that current market conditions are expected to remain for 2021, it goes without saying that early and thorough engagement with insurers is critical in the current environment. Financial Lines insurance renewals will be challenging, so beginning the process sooner allows for early engagement with key stakeholders, provides more time to gather renewal information and gives your broker a longer window to market and negotiate terms. Early planning should not just focus on data gathering and quoting, but also on undertaking a thorough review of coverage, the policy limits required, engagement with internal stakeholders and to ensure that insurance risk transfer evolves and remains aligned to the bank’s changing requirements and remits.
Banking Industry Trends - Key issues to watch
As the pandemic works its way through the global economy, the near-term outlook is bleak: the risk of bankruptcy for some firms is almost certain, investors are nervous, key person succession plans are being questioned, portfolio valuation and liquidation are being scrutinised and Business Continuity Plans are being tested and challenged in unprecedented ways.
The insurance market was already in a challenged state going into 2020 and a recent UK Supreme Court ruling4 has paved the way for small businesses to seek insurance pay-outs caused by COVID-19 lockdowns. It is estimated that 370,000 policyholders across 60 insurers could see £1.2 billion ($1.6 billion) in claims in the UK. If similar rulings are mirrored in other jurisdictions, insurers could see far higher losses than originally anticipated. The global pandemic now adds a new layer of uncertainty to the renewal process, with insurers applying greater scrutiny to all aspects of an insured’s business and the underwriting process is expected to be far more invasive than in recent years past.
Beginning the renewal process well in advance of the renewal date, approximately 4-6 months in advance (depending on scale of programmes), is highly recommended. For larger firms, conducting underwriter meetings is critical and engaging the appropriate individuals within the organisation to speak thoroughly to each of the insurer’s concerns will be imperative in order to mitigate the ‘hardening market’s’ impact on renewal terms. Being able to demonstrate top of peer group performance and statistics is advantageous in differentiating risk profiles and leveraging this to achieve better than ‘market norm’ terms.
Digital transformation within the banking industry has been a slow burn lasting more than a decade as a shift from traditional branch banking to digital distribution platforms gathers momentum. Digitalisation initially focused on how to replicate in-branch banking in a user friendly and regulatory compliant way so that the customer could easily understand the products they were purchasing and the terms on which they were engaging into, without another human advising them. Digitalisation is now focused on enhancing the customer experience and ensuring that the bank can develop and maintain a connection to the customer in the absence of in-branch personnel.
“Banks will need to compete with the likes of Amazon on customer experience, while also offering something deeper, be it through relationships and service, boosting businesses and communities, or taking a stand on global issues to engender trust. This is how they will transition from offering financial services to enabling financial betterment.” - Mark Sullivan, Global Business Leader, Banking and Capital Markets, Genpact5.
Unfortunately, in the face of Open Banking and the future threat of technology firms being able to offer banking solutions in a simpler, more cost effective and often more user-friendly way, leaves many banks at a cross-road. Banks are at a clear disadvantage to their expected future rivals; they face significant regulatory burdens and have to spend vast sums to modernise technological capabilities, whilst implementing significant cost cutting programmes, to remain competitive. If banks fail to adapt or invest correctly then they may lose market share to rivals, and if they under-invest in systems and controls then they could fall foul to significant regulatory fines and penalties.
- Review Financial Lines insurances in line with digital risk profiles to ensure that both activities and exposures are covered as broadly as possible and are in line with risk appetite.
- Our Operational Risk Solutions team can assist with reviewing insurance programme optimisation; taking into account risk appetite in order to determine both aggregated insurable risk appetite and per event insurable risk appetite. Current and potential insurability of risks is computed to ultimately determine an ‘aggregated insurable risk profile’. These measures then set the boundaries to enable selection of the most appropriate policy limits and deductibles.
- Consider the purchase of a Cyber insurance policy if Cyber insurance is not already part of the risk transfer strategy.
The focus on cybersecurity for all industries, is now stronger than ever, with scrutiny coming from regulators, business counterparties and investors.
Global regulators are focussed on creating new regulations to address cybersecurity. Further cybersecurity scrutiny by the FCA is expected to increase going forward, particularly in light of the increased exposures arising out of the COVID-19 pandemic.
The vulnerability of the COVID-19 work-from-home network, with the rise of new malware, presents increased risk.
As mentioned earlier, insurers are also assessing their exposure to “Silent Cyber Coverage” under traditional insurance policies going forward, with a view to ensuring cover is either affirmed or not accordingly.
- Regulators continue to voice their concerns about cybersecurity and resiliency. The common theme is that regulators expect all financial institutions to be resilient upfront rather than thinking about it as an afterthought when reviewing existing technology or introducing new technology when managing cyber risks. The rise in digital banking and use of biometrics in fraud prevention and Anti-Money Laundering requires tailored cyber solutions.
- Existing Financial Lines insurance should be reviewed, including the scope and limitations of such cover and how it interacts with other insurances. If little exists, explore stand-alone options or potential cyber extensions to the PI and D&O policies.
As digitalisation gathers momentum, banks are exposed more than ever to increasingly sophisticated methods of theft, fraud and financial crime6. Everyday acts of crime such as identify theft, card fraud, money laundering and social engineering schemes defraud banks and their customers of funds; Ernst & Young puts the estimated annual cost of money laundering and associated crimes at between US$1.4 trillion to US$3.5 trillion7). Tackling financial crime requires vast resources and evolution of methods to control losses; with such significant profits to be made globally, financial crime is expected to be an ever present item on banking board agendas.
Financial Crime has been and will continue to be a prominent risk for banks and other Financial Institutions that hold significant financial deposits. Some of the biggest threats remain sophisticated social engineering schemes including phishing, vishing, malware, tailgating and water holing that dupe victims into providing confidential information and access to bank accounts. Technology and a difficult to police dark web allow fraudsters to evolve schemes as banking controls improve in reaction to losses. Control and prevention costs continue to rise which diverts capital from other banking initiatives.
- Consider the level of Social Engineering coverage within the Crime policy. This is an area that Crime insurers have been watching closely over recent years given the emergence of social engineering frauds, but with the current increase in home working, they have sought additional information about how banks manage it. As a result, the extent of coverage available under crime policies, both breadth of coverage and limits available, are under closer scrutiny.
- Review the definition of Electronic Computer Fraud within the Crime policy to ensure that the definition and types of fraudulent activities are captured as widely as possible.
In 2019 Fitch Ratings released its report on banks and ESG8, finding that ESG considerations in lending decisions have become mainstream. Banks with assets over $100 billion were much more likely to apply ESG policies to their lending decisions, or screen their lending against ESG policies, than banks with assets under $100 billion. Regionally, African, W. European and Latin American banks were more likely to apply ESG polices than North American and APAC regions.
Although ESG is an evolving area of risk, initiatives such as the Task Force on Climate-related Financial Disclosures (TCFD)9 seek to develop standardised climate-related disclosures to inform (amongst other considerations), insurance underwriting decisions on climate-related risks. TCFD’s goals seek to span investment, credit and other key financial decisions in categorising a Financial Institution’s climate risks. Complexity of due diligence for ESG related activities and reporting could result in increased regulatory investigations and/or client questions. As ESG activities and reporting gain momentum it is important to monitor any corresponding impact on Financial Lines insurances to ensure that coverage continues to respond.
- Underwriters will expect banks to be focused on ESG and banks should be prepared to identify ESG strategy and risk assessments. Litigation and public appetite to hold banks accountable will result in increased defence costs, if not indemnity costs.
- ESG related exposures such as TCFD should be mapped against existing coverages, definitions, extension and exclusions periodically, to ensure that such claims do not fall outside of cover.
- Our Financial Institutions practice is resourced with contract advisory specialists who have extensive experience across the team dedicated to Financial Institutions contract reviews, new product development and on-going coverage negotiations across all Financial Lines insurances. This depth of resource puts our broking practice at the forefront of product development and coverage reviews on topical issues. For more information on our coverage reviews and capabilities, please reach out to us.
The regulatory environment globally has given rise to multiple accountability regimes, including the Senior Managers & Certification Regime (SM&CR) in the UK, the Manager-in-Charge regime in Hong Kong and similar proposed regimes in Ireland and Singapore. The focus on accountability will continue throughout 2021 and beyond.
Increased regulatory requirements and the potential for follow-on civil litigation, creates a heightened exposure for banks.
Investigations coverage, definition of “Insured Person”, consideration of a Willis Towers Watson Legal Expenses Additional Protection (LEAP) policy10 (available for UK entities only) and overseas local insurance requirements should be reviewed accordingly.
In July 2017, the FCA announced the discontinuation of LIBOR after irregularities in banking interest rate figures did not reflect the true rate at which they could borrow. This manipulation of data led to the distrust in LIBOR and consequently a lack of confidence in LIBOR as an indicator for the true health of the global economy. LIBOR will be discontinued on 31st December 2021 and thereafter different jurisdictions will need to use alternatives to LIBOR. Possible alternatives include; the Sterling Overnight Index Average (SONIA) for the UK, the Secured Overnight Financing Rate (SOFR) for the US and the Tokyo Overnight Average Rate (TONA) for Japan.
A key issue is how banks and lenders handle “legacy” contracts which reference LIBOR. Currently the Bank of England put $300 trillion of existing mortgages, loans, bonds and derivatives that use LIBOR within their contracts11. Banks are grappling with adopting either amendment or hardwire approaches in order to deal with these contracts, which increases compliance risk and uncertainty. Furthermore, inconsistent guidance from regulators and market participants adds complexity and may lead to a lack of borrower understanding.
Risk to reputation and litigation may also result where counterparties perceive changes to the terms of contracts disadvantage them relative to the bank.
The discontinuation presents potential additional exposures under Financial Lines insurances. Insurers have not yet expressed significant interest in LIBOR but expect uptick in questioning through the 2021 renewal cycle.
Disclaimer
Willis Towers Watson offers insurance-related services through its appropriately licensed and authorised companies in each country in which Willis Towers Watson operates, for example:
- In the United Kingdom, Willis Limited, registered number: 181116 England and Wales. Registered address: 51 Lime Street, London, EC3M 7DQ. A Lloyd’s Broker. Authorised and regulated by the Financial Conduct Authority for its general insurance mediation activities only; and
- Willis Towers Watson SA/NV, Quai des Vennes, 4020, Liège, Belgium (0415.981.986 RPM Liège) (registered as a branch in the UK at 51 Lime Street, London, EC3M 7DQ UK Branch Number BR021056) in relation to all EEA-regulated business. Authorised by the Financial Services and Markets Authority (FSMA) Belgium, and authorised and subject to limited regulation by the Financial Conduct Authority. Details about the extent of our authorisation and regulation by the Financial Conduct Authority are available from us on request
For further authorisation and regulatory details about our Willis Towers Watson legal entities, operating in your country, please refer to our Willis Towers Watson website.
It is a regulatory requirement for us to consider our local licensing requirements prior to establishing any contractual agreement with our clients.
This market update offers a general overview of its subject matter. It does not necessarily address every aspect of its subject or every product available in the market. It is not intended to be, and should not be, used to replace specific advice relating to individual situations and we do not offer, and this should not be seen as, legal, accounting or tax advice. If you intend to take any action or make any decision on the basis of the content of this publication you should first seek specific advice from an appropriate professional. Some of the information in this publication may be compiled from third party sources we consider to be reliable, however we do not guarantee and are not responsible for the accuracy of such.
The views expressed are not necessarily those of Willis Towers Watson. Copyright Willis Limited 2021. All rights reserved.
Willis Towers Watson is a trading name of Willis Limited, Registered number: 181116 England and Wales. Registered address: 51 Lime Street, London, EC3M 7DQ. A Lloyd’s Broker. Authorised and regulated by the Financial Conduct Authority for its general insurance mediation activities only.
Footnotes
1 Financial Lines incorporates Directors’ and Officers’ Liability, Professional Indemnity and Crime insurances.
3 https://www.lloyds.com/~/media/files/the-market/communications/market-bulletins/2019/07/y5258.pdf
5 https://www.genpact.com/uploads/files/genpact-banking-in-the-age-of-instinct-report.pdf
6 See our recent webinar with Themis on Financial Crime in 2020: A relentless game of cat & mouse – video link here.
7 https://www.ey.com/en_uk/disrupting-financial-crime
10 https://www.willistowerswatson.com/en-GB/Solutions/products/legal-expenses-additional-protection
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