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Does Bankers Professional Liability (BPL) insurance still hold value for the banking sector?

Financial, Executive and Professional Risks (FINEX)

May 7, 2021

Assessing the value of BPL insurance can prove challenging for banks.

This article explores the challenges and proposes that BPL insurance is viewed as an investment decision, with a reasoned and quantified cost benefits analysis.

As banks across the world are grappling with the challenges of a COVID-19 driven economic turbulence, coupled with a hardened insurance market, the benefit of insurance has come under scrutiny. Bankers Professional Liability insurance has seen price increases, together with a decrease in market capacity, that has led some banks to challenge whether the benefits provided by insurance outweigh the cost.

The banking industry has for a long time had a more varied outlook on the use of risk transfer mechanisms than other financial institutions and large corporates, with marked differences in the methods and scales of insurance purchased. Whilst some banks are looking to external insurance markets to cover medium severity events between 1in10 to 1in100 year, others have greater risk appetite and only seek to transfer risk for the highest severity risks, up to 1in1000 year. However, there becomes a point at the extreme where the traditional insurance market cannot price competitively, and the bank must choose between self-retention and non-traditional methods. How the bank does this depends on the maturity of its risk framework and ability to quantify the benefit of each option.

The challenging insurance market

Insurance intermediaries have been warning of a hardening market for over two years, with capacity to underwrite risk likely to decrease along with rising prices.

Over the past year Bankers Professional Liability primary rates for banks have increased by an average of 10-50%1 in the London market, with many companies experiencing significant increases in premium coupled with underwriters looking to reduce their exposure.

Over the past year Bankers Professional Liability primary rates for banks have increased by an average of 10-50%1 in the London market

Deductible increases are being used by some banks, and more generally by financial services firms, as an attempt to manage insurance rate increases. However, while this may in the short-term mitigate or offset premium increases, there is concern over the long-term financial impact of higher risk retentions. For those banks with excess capacity within their captives they have been able to use this ring-fenced capital to shoulder some of the burden and manage the risk retained by individual business units.

Other banks have looked at combining their Crime and Bankers Professional Liability policies (with a shared aggregate limit) as a way of encouraging underwriter participation and potentially decreasing the extent of rate increase. However, as with deductible increases, the short-term costs savings could have long term affects especially if there are inadequate limits or reinstatements that could see a large claim exhaust the full insurance limit.

The challenge for banks becomes whether Bankers Professional Liability insurance is a worthwhile investment within a hard market and how can the value be measured.

Has insurance proven its worth?

Just like any form of investment, the efficiency of risk transfer through insurance is challenged at board level. Where a bank has not experienced a loss or made a claim on their policy, the annual premium spend can be seen by some directors as a poor investment. For others, the premium paid is seen as a necessary cost of business. However, we would argue that neither are truly considering the efficiency of their strategy. How can you determine the success of a long-term investment through a short-term lens? Is there anything that can be learnt from the wider industry experience?

Willis Towers Watson’s proprietary claim database2 has over 1,500 Bankers Professional Liability claims from banking institutions

Willis Towers Watson’s proprietary claim database2 has over 1,500 Bankers Professional Liability claims from banking institutions, collected over the past decade, with losses totalling over $19billion. Given the breadth of information held, it evidences the small and frequent losses, the large and infrequent, and uninsurable losses. It can also demonstrate the types of events which typically fall below deductibles and the scenarios that can breach the limit.

However, it also raises questions around the efficiency of policy structures, with 33%3 of insurable losses being paid by the insured due to insufficient policy limit.

The data paints a positive light on effectiveness of Bankers Professional Liability ability to cover operational risk losses experienced by the banking industry, with 55% of the loss value being covered. However, it also raises questions around the efficiency of policy structures, with 33%3 of insurable losses being paid by the insured due to insufficient policy limit. Given these events reflect the plausible worst-case scenarios banks are considering within their scenario stress testing they highlight the importance of understanding the limit to which insurance is bought and how it links to the bank’s risk appetite.

While past events can help drive risk awareness, forward looking scenarios can be used to drive insurance buying strategies. Just as banks factor controls into their risk framework to look at inherent and residual risk, so too can insurance be incorporated. How would the contracts in place, be they insurance contracts or with outsourced service providers, respond to the scenario? What proportion of risk is transferred and how much is retained?

A loss event is typically made up of a number of different impacts. Insurance will respond differently to each and affect the overall insurability; from compensation with high levels of historic recovery to uninsurable fines and penalties. As shown process errors and suitability, disclosure and fiduciary events typically have higher insurability. However, some risk types such as money laundering and market abuse have few insurable components especially where regulatory fines make up a significant part of the total loss.

This bar chart illustrates the percentage of insurability between key Basel subcategories; process errors, suitability, disclosure and fiduciary, and improper business practices.
BPL Insurability of key Basel subcategories

Source: Willis Towers Watson Proprietary Claims Database

The graph shows that process errors are the most insurable closely followed by 'Suitability, disclosure and fiduciary'. Improper business practices is the least insurable with a 40-50% gap behind the other two.

Where a bank understands the extent of cover provided by Bankers Professional Liability insurance and links this to the its own operational risk scenarios, it improves their understanding of their total risk exposure and allows for cost benefit analysis of the different mitigation strategies.

Banks which have incorporated insurance into their economic capital models have been able to compare the investment made to the predicted return at difference confidence levels and in relation to their risk appetite; determining, through their own quantitative lens the value insurance holds for them. During this challenging insurance market period the ability to perform that analysis has enabled them to make tough financial decisions with greater levels of certainty.

An eye on the future

The early losses from the COVID-19 pandemic have centred on external fraud, including increases in cyber security threats and phishing attacks, many of which are insurable under Crime and Cyber policies. What will come next as the global economy attempts to regain lost ground?

Following the 2008 Financial Crisis there was an upsurge in the number of claims made against financial services firms for negligence and improper behaviour triggering a steep rise in the number of Bankers Professional Liability claims made to insurers. While the cause of the economic downturn lies far from the industry this time around it is likely that we will again see an uptick in action taken by investors and businesses to recover losses. Therefore, it is important that as banks find themselves increasingly exposed once more that they have adequate protection in place.

A call to action

Against a backdrop of economic uncertainty, budgetary constraints and a challenging Bankers Professional Liability insurance market how should a bank best position itself to determine the value Bankers Professional Liability insurance holds and navigate the challenges ahead? Bank risk management and insurance teams should consider;

  • Making use of the internal risk information available – ensure there is a good understanding as to how insurance maps to each key risk scenario; which impacts would be covered and which would be retained;
  • Undertaking a cost benefit analysis of purchasing insurance against the cost of retaining risk;
  • Using external market data to support decision making;
  • And once a strategy is agreed, review the process regularly, particularly following a change in risk scenarios or business model.

Willis Towers Watson Operational Risk Solutions Team

Our Operational Risk Solutions team works with clients to link their insurance buying strategy to their risk profile, considering the insurability of their risks, their risk appetite and the cost of insurance. Not all operational risks are insurable, and it is therefore important that the insurance limits are maximized where possible to cover the insurable aspects of a firm’s risk. This process includes clearly outlining how insurance would be expected to respond and where changes to wordings or new policies would increase coverage.

Footnotes

1 Source: Willis Towers Watson FINEX FINMAR Client Placements – as at 25th March 2021

2 Willis Towers Watson’s proprietary claims database is comprised of 12,000 insurance notifications made by financial institution clients. Our claims analysis, whilst maintaining confidentiality, illustrates important details about the nature, trends, causes and cost breakdown of loss events impacting financial institutions globally.

3 Excludes the single largest loss in Willis Towers Watson’s proprietary database.

Contacts

Lead Associate – Operational Risk Solutions, FINEX

Associate Director - Operational Risk Solutions, FINEX

Banking Industry Leader, FINEX

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