Recent liquidity events concerning banks across the US and Europe, together with concerns of wider contagion (opens a new window), have prompted renewed focus on the stability of the banking sector. As the full impact of these events unfolds, litigation has already commenced against some of the banks involved, and claims are expected to be filed against at least some other organisations which have suffered indirect impacts.
Potential exposures for the failed banks include regulatory investigations, creditor claims and securities fraud class actions, although some comfort may be gleaned from well-structured professional indemnity and directors’ and officers’ (D&O) liability policies. While the breadth of such policies varies, they are likely to provide some level of financial protection for the banks themselves and key personnel, typically covering not only defence costs and liability payments but investigation costs too.
Will entities and their key individuals have insurance protection?
In terms of the wider financial services sector, significant losses have been suffered by funds with meaningful exposure to the affected banks and to the banking sector more generally. The impact of recent events has been felt particularly by those in the technology, crypto and life sciences sectors, with account holders and investors left with uncertainty.
Despite interventions from central and private banks and governments, concerns remain that there could be more issues to follow. With confidence in the banking system having been rocked, many organisations will be reviewing potential exposures. Claims may be seen from investors and regulators in relation to matters such as investment strategy and whether fund directors have executed their duties correctly.
While the consequences may be many and far reaching, insurance cover may give some comfort to other banks which may be concerned at their own potential to suffer issues, and to account holders and investment managers who may potentially be impacted. The below are aspects well negotiated professional indemnity and D&O liability programmes can be expected to respond to, subject to policy terms and conditions, and depending on whether claims are formulated as breach of professional services claims (professional indemnity) or claims regarding the running of the business at a managerial and supervisory level (D&O):
Failed banks will be the subject of litigation by their clients alleging negligence giving rise to the collapses. Further litigation may be brought by shareholders, whose shares have diminished in value, claiming that the directors and officers have misled investors and possibly also breached fiduciary duties. Regulators will no doubt also be considering the extent to which actions of the directors and officers in the run up to the collapses were in accordance with their duties and whether decisions were in line with regulatory expectations.
Firms using failed or struggling banks for banking, payroll, and loans could suffer disruption, including a reduction in investor confidence, if they are unable to maintain or replace their banking relationships. This is particularly so for firms operating in sectors, where there may be limited appetite on the part of other banks. Allegations could ensue, including that firms have not undertaken appropriate due diligence in respect of their banking relationships, misled shareholders regarding exposure to a risky interest rate environment or not sufficiently diversified funding and liquidity sources.
Private equity firms and asset managers that may have invested into failed bank stocks may face claims alleging negligence by investors, for example, for failure to undertake appropriate due diligence or for misrepresentation of the position to investors. Legal and regulatory proceedings may be commenced against the manager and/or the fund board of directors, for example alleging inappropriate oversight.
The greater trading activity which occurs during periods of market volatility can lead to an increase in trade errors. In volatile periods, the errors encountered can be more significant, as the market is more likely to have moved a material amount by the time the error is identified, and the position closed out. Mitigation cover is key here, enabling firms to seek reimbursement under the policy for amounts incurred in dealing with errors which would otherwise result in a covered claim under the insurance policy.
In addition to professional indemnity and D&O cover, cyber insurance will likely have a part to play as we can expect that cyber criminals will be opportunistic and seek to use the recent collapses to their advantage. An uptick in social engineering claims is likely, with cyber criminals seeking to replace bank details with incorrect ones or perhaps glean personal details from firms, positioning themselves as assisting impacted firms. Employment practices liability policies may also be triggered, for example in respect of redundancies by distressed companies.
How are insurers reacting?
While it may be too early to comment on insurers’ response to the events, it is to be expected that underwriters will ask a lot more probing questions to better understand a company’s risk profile and exposure.
For banks, there will certainly be more focus around the following:
Liquidity management or financial agility — in other words, having the assets available to act quickly; industry concentration risk;
Interest rate risk management;
Asset/liability matching — matching future asset sales and income streams against the timing of expected future expenses; and
Investment portfolio makeup — maturity, unrealised losses, hedging techniques, and other factors.
For non-banks, we can expect to see more focus around banking relationships, concentration risk to any one bank, diversification of funding and liquidity sources. We are already seeing queries from underwriters as to how insureds may be exposed to affected banks, and to broader uncertainty within the banking system. This is likely to continue, and insureds should be ready to set out the processes they have in place to minimise the likelihood of being impacted by similar events should further issues arise. Managing social media risk is another potential area regarding which underwriters may seek comfort. Social media has been widely suggested to have compounded the speed with which recent banking events unfolded and, as a result, has been described as a new key risk in the financial services sector.
No doubt giving thought to diversification of banking arrangements will also be key. Hindsight is a wonderful thing, but the important thing now is to enhance processes and procedures to minimise the likelihood of any impact where possible.
Are your insurance protections adequate and is a notification warranted?
The situation which has unfolded is also a timely reminder of the need to periodically undertake a thorough review of professional indemnity and D&O covers, to ensure that insureds benefit from the best protections available. It is also prudent to review claims notifications provisions, considering the extent to which a notification may be warranted, even on a precautionary basis, particularly where renewal is approaching. Even the broadest of cover can be rendered potentially ineffective where insureds do not comply with the policy reporting requirements.
A good dialogue with your broker, wherever you are in the policy period, will enable consideration to be given to whether any action is required, either in terms of notification of circumstances or perhaps adjustments to the policy mid-term, if enhancements to cover or additional limits are required or desirable.
Finally, it is worth mentioning that new developments in this space may change the risk perception significantly. Lockton will monitor this risk area closely and issue new updates as appropriate.
For further information, please contact:
Laura Skaanild, Senior Vice President Global Professional & Financial Risks
T: +44 (0)207 933 1677