Shifting the Risk Landscape

Despite market fluctuations occasionally drawing deep breaths from investors as global economies endeavour to move on from the global financial crisis, investment managers have generally enjoyed returning stability and significantly improved trading conditions in recent years.

However, new and emerging challenges are shifting the risk landscape for investment managers, notably the growing threat of cyber-attacks — with cyber criminals finding ever more inventive ways to compromise systems — and increasing regulatory investigations. This poses a challenge not only for investment managers but also their insurer partners in finding ways to address the complexities as they arise and to mitigate the associated risks.

From a regulatory perspective, there is now far greater scrutiny of Financial Institutions across the US, UK and Europe. In the United Kingdom there has been an increase in the number of private warnings issued in recent years. These are a low-touch way of addressing less serious issues, as opposed to a full investigation for more serious and obvious regulatory breaches. While these, in effect, serve as a warning, usually with no lasting implications for the firm, any individuals implicated will likely see this recorded on their employment file, which could affect their prospects.

Private warnings can affect people within an organisation who may not be at the most senior levels, such as anti-money laundering officers or compliance managers. The only way they can challenge a private warning after it has been issued is via a judicial review, which is time consuming and costly. While insurance cannot fund the costs of a Judicial Review, it can provide funding to affected individuals to contest a potential action at the point where the regulator declares its intention to issue a private warning by way of a ‘minded to’ letter. This assistance can be extremely valuable for investment manager clients and is one example of how innovative insurance brokers and insurers are developing insurance products capable of meeting their needs in complex situations such as this.

Part of the issue for investment managers with much of modern-day regulation globally is that it is not prescriptive and therefore can often be difficult to interpret – or be confident you have interpreted it correctly. This has prompted many to voice the concern that it is not a question of if they have a regulatory issue but when.

There has also been an increase in more visible regulatory enforcement action, with numerous examples of investigations or fines being made against FCA-regulated entities. To date, most of the regulatory scrutiny has fallen on the banking sector and not in the investment management space. However, there are organisations within the insurance industry that are making provisions to assist investment managers as it is far better to help clients be prepared, rather than respond after regulatory action has been initiated. Regulatory investigations can take up considerable time and resources and insurance can be an effective tool to offset those costs while supporting investment managers in assisting the regulator with an investigation. Mitigation cover, which allows costs to be incurred under the policy prior to the insurer being notified, is a further development designed to help reduce or mitigate a third party claim, which is clearly valuable for both the insured and insurer.

The other issue of particular concern for many investment managers is the growing risk of a cyber breach and subsequent loss of data. This threat has also long been testing the minds of legislators as to how best to counter the threats. The EU Data Protection Directive, which will lead to specific legislation in the UK, will set out guidelines and penalties in the event that data is lost. Investors too are concerned by the threat of a cyber-attack and, in the same way that potential investors will ask if an investment manager has professional indemnity (PI) insurance, we expect investors will begin to routinely question if adequate cyber cover is in place in order to have the confidence to invest.

Part of the problem here is that while the insurance market provides a broad variety of cyber cover, through the traditional PI, crime and computer crime policies, the introduction of Cyber as a standalone product (available since the late 1990’s but something that has really come into focus in recent years) – which covers, for example, the specific costs relating to a data breach or non-damage business interruption, has caused confusion to insurance buyers.

It is not uncommon therefore to discover that clients don’t fully understand the level of cyber cover they already have and so it is for their broker to not only explain but identify any gaps. Following a broker’s assessment, some clients may say they do not want a standalone policy but it is still the broker’s job to identify the potential issues to ensure the client can make an informed choice.

Currently insurance market conditions are hugely favourable for investment managers due to the competition arising from ample capacity within the market. Investment management firms are very attractive to insurers — with a relatively benign recent claims history many insurers are keen to underwrite more business in this segment. This is also an attractive area to those insurers that used to underwrite tier-one banks and which are looking to diversify their portfolios. All of which spells good news for investment managers.

Demand for standalone cyber products is likely to increase and, given the availability of insurance capacity and the appetite of insurers to gain market share, so too will the availability of multi-year premiums with a locked in discount, which some clients have obtained this year.

Given these conditions, there is great potential for insurance to build its relationship with, and be of greater assistance to, investment management firms. The mature specialty insurance markets in London have a long history of innovation, which is a fundamental reason why London has remained a leading market for complex commercial risks globally. Brokers and insurers that are willing to identify where the exposures are for individual clients, and take a proactive approach to understanding the shifting complexities, will continue to produce innovative insurance solutions that can assist investment managers with these emerging issues, as they seek to grow their standing in this appealing area of financial services.