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The Financial Institutions insurance market continues to harden, with reduced capacity to underwrite risk as we progress further into the 2021 calendar year. Insurers are pressing for increased premium and/or retention levels on a portfolio basis (rather than a risk-by-risk basis) to grow the premium pool.
Global volatility presents a major concern for insurers, given the anticipated resurgence in the markets and has been the key driver for increased premium rate momentum. With the Australian market floating on an unprecedented level of monetary and fiscal support, investors sitting on large cash reserves, and rapid accelerations in equity gains; underwriters are concerned about sudden devaluations to the market and consequent investor legal suits. In addition, the lingering effects of the Hayne Royal Commission remain an integral rating factor, as well as any potential long tail claims arising from COVID.
Despite the above however, we are starting to see bright spots in terms of risk appetite navigation. Following multiple years of the hardening phase, and notwithstanding the unpredictable market cycles, insurers have carved out much better clarity, visibility, and consistency with respect to their appetite across the different FI sectors.
In Q3, Financial Institution clients who were hardest hit typically exhibited some of the characteristics below:
Insureds with substantial FUM increases experienced higher prices, as FUM typically indicates the overall magnitude of potential losses. Conversely, large redemption runs were heavily penalised, given the harbinger for potential investor claims.
The type of fund was also an influential factor. Hedge funds with high gearing ratios and an aggressive alpha focus were impacted, compared to those with more benign strategies. Underlying alternative asset classes were also a key premium driver, with funds exposed to private credit, quant strategies and commodities most impacted, especially those to oil futures which briefly entered unprecedented negative territory. Hedge funds with a history of shareholder activism were also impacted (this can be a major source of claims), in addition to those Hedge funds that were targets themselves – similar to the GameStop short squeeze scenario.
Feeder fund and other similar “fund of fund” structures were also affected, due to their higher exposure to international markets, particularly when exposed to the more litigious US investor base.
Passive index funds which delivered solid beta returns with low management expense ratios were least affected, as well as mutual funds with low-risk strategies. Funds with considerable retail investor bases were impacted, due to the more litigious nature of this class, compared to the sophisticated wholesale/institutional sector.
There were pricing and coverage implications in the venture capital/private equity funds space, depending on the underlying investee company portfolio. Investee companies with enduring profitability models, recurring and stable revenue streams and strong Series Round interest were looked upon favourably by underwriters.
As banks’ lending criteria have been subject to tighter controls, we have seen an influx of managers allocating alternative capital to private debt and distressed assets. While not impossible to place these risks with insurers, insureds exposed to one undiversified single underlying asset (especially property development), found it difficult to source a solution.
LICS with high discounts to Net Tangible Assets had underwriters concerned, especially where the risk of further drops was high. Valuation risk and Directors’ and Officers’ SIDE C continuous disclosure are key concerns in this space.
Insureds making aggressive return forecasts or assurances of minimal investment risk in PDS documents have been highly scrutinised. This had been fuelled by the Federal Court finding that promoter Mayfair 101 engaged in false advertising by targeting investors who used Google search engine terms such as “best term deposit”.
Driven by their ability to quickly scale and hence attract higher valuation multiples, we have seen a wave of IT and Cloud focused SaaS companies listing. Higher multiples can leave companies vulnerable to large devaluations, which can be concerning to insurers. As such, underwriters have been extremely diligent when deploying capital in the IPO insurance area.
Underwriter appetite in the FI insurance space is highly dependent on the general economic climate.
As long-term bond yields have increased, institutions have moved capital from equities to lower risk fixed interest instruments, with negative consequences for share valuations. While this is a sign of market recovery, the remaining instability is concerning to insurers. Going forward, insurers will be highly focused on the underlying asset class and risk strategy of each insured, individual fund manager performance, and exposure to retail (compared to wholesale) investors.
Ultimately, the financial markets will need to stabilise before premium increases level off.
The financial institutions market has been awash with new asset management-focused FinTechs, introducing considerable capital into this space. Many of these FinTechs are challenging the standard rules of investing, trading, clearing, settlement and custody, funds as a service; and insurers have been slow to onboard these risks.
The insurance market is also seeing a higher volume of digital banks and more insurer scrutiny following the recent collapse of one of the first mover neo banks. This has raised questions among insurers, with many adopting a “wait and see” attitude before deploying capacity. There are positive signs for the sector however, with APRA now insisting neo banks have an income-generating product e.g., lending product before taking on deposits.
We are seeing more institutions recognise decentralised finance (DEFI) and cryptocurrency as a legitimate asset class. Many allocators are now acknowledging Bitcoin as a solid store of value, and a “digital gold”. Alternate currencies such as Ethereum are gathering momentum, given their potential for smart contracts in DEFI infrastructure. Major asset managers such as Ark Invest and Van Eck have been pioneers in this space, with others now following suit. Furthermore, as a discrete asset class, crypto is not regulated, however on the basis cryptocurrency is classified as a “financial product” under the Corporations Law, it is subject to ASIC regulation. This means insurers may become more open to the class. A number of carriers are now receptive to providing coverage, depending on the weighting of crypto assets to total FUM.
Funds are increasingly embracing the ESG (Environmental, Social, Governance) theme, promoting investments in the electric and renewables space. Younger investors have been known to focus on this area and arguably, underwriters perceived this as lower risk as it is driven more by ethical investing concepts rather than pure investor return.
Feel free to reach out to discuss your risk exposures.
Head of Professional & Executive Risks
Client Manager – Professional & Executive Risks
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