COVID-19: Insurance Implications for Financial Institutions

The negative sentiment towards financial services companies in Australia arising out of the Royal Commission is being swept aside as the community recognises, in the midst of the current COVID-19 pandemic, the benefits of strength and the absolute necessity of our large Banks and wide financial services industry underpinning the economy.  The government, central bank, regulators and financial services companies are working in lock step to combat a weakened global economy and its impacts on Australia.  Perhaps due to the Royal Commission, the banks have never been more community-focused and Australian boards of directors have never been more prepared for a crisis. 

As companies and boards of directors navigate the crisis, we must not forget that the pandemic could potentially affect financial institutions' operations and insurance provisions in many ways.

Financial institutions (FIs) need to address various challenges; liquidity must be chief amongst these.  In addition: maintaining employee safety, facilitating business continuity, ensuring the principles of treating customers fairly remain embedded in the business and maintaining the financial infrastructure.

Beneficially, regulators have announced a number measures to support our FIs. These measures facilitate an FI’s dedication of time and resources to maintaining operations and supporting customers.  Measures include the Australian Prudential Regulation Authority (APRA) deferring its scheduled implementation of the Basel III reforms in Australia by one year.  This approach is also consistent with the recent decision by the Basel Committee on Banking Supervision (BCBS) to defer, from January 2022 to January 2023, the internationally agreed start dates for the Basel III standards.

APRA has also announced temporary changes to its expectations regarding bank capital ratios, to ensure banks are well positioned to continue to provide credit to the economy in the current challenging environment. 

Over the past decade, the Australian banking system has built up substantial capital buffers. The highest quality form of capital, Common Equity Tier 1 (CET1) capital, reached $235 billion at the end of 2019. As a result, banks are typically maintaining capital levels well above minimum regulatory requirements.  The strength of the Australian banks compared to our global peers has never been more important as we consider a period which is likely to impact the solvency and continued operation of many sectors of the economy. 

Banks will no doubt need to utilise some of their current large buffers to facilitate ongoing lending to the economy. This is especially the case for banks wishing to take advantage of new facilities announced by the Reserve Bank of Australia to promote the continued flow of credit. Provided banks are able to demonstrate they can continue to meet their various minimum capital requirements, APRA has indicated it “would not be concerned” if they were not meeting the additional benchmarks it announced in 2017 during the period of disruption caused by COVID-19.

Despite the positive steps being undertaken, it is critical that the pandemic's potential impacts on financial institutions’ insurance programs are considered. The economic effects, and likewise impacts on insurance, are likely to be magnified in light of the current lockdown imposed by the Australian Commonwealth and State governments.

Directors and Officers Liability Insurance

Our Australian Government has passed the Coronavirus Economic Response Package Omnibus Bill 2020 making temporary amendments to the Corporations Act 2001 (Cth) and Bankruptcy Act 1966 (Cth) to lessen the financial impact of the pandemic on individuals and businesses.  Chief among the amendments is the temporary safe harbour provision / relief to a director for liability for insolvent trading.  Historically this has been the source of many claims against individual directors and officers.  Insurers now have the exposure of these liability claims reduced or even, arguably, removed from their Directors’ & Officers’ (D&O) portfolios!  It remains to be seen however, whether insurers concerns over D&O claims for insolvent trading is alleviated by these amendments. 

Share price volatility and the resultant impacts to D&O policies is a constant in Australia.  Given recent stock market volatility, a stock drop after any announcement relating to COVID-19's impact on a company is a possibility. Such stock drops could attract securities class actions alleging disclosure deficiencies, breaches of fiduciary duty, and corporate mismanagement, which may trigger coverage under D&O insurance.  With our opaque continuous disclosure regime and prevalence of litigation funders, the risk of a securities class action has never been more real.

Areas that may attract particular attention in the financial institutions sector in this regard include:

• Increased loan/mortgage defaults and arrears.
• Potential deterioration in the housing market and the consequent effect on collateral value.
• Follow-on impact on tier-one ratio and loan coverage ratio.
• Interest rate sensitivity.

Derivative actions and/or regulatory investigation also remain possible. Globally we have seen the UK’s Financial Conduct Authority (FCA) yet to relax any regulations or reporting requirements. The US Securities Exchange Commission (SEC) has offered some extensions of filings required under the Securities Exchange Act, and specifically encouraged public companies (and their auditors) to disclose the anticipated impact of COVID-19 on the company to investors.

Current D&O policies incepted prior to the pandemic do not contain specific exclusions for COVID-19, but both public company and private company D&O policies commonly have some form of bodily injury exclusion that may be relevant to insurers' position.  

Locally, we are aware that regulators are asking questions of our large FIs regarding business preparedness and have emphasised that they expect all FIs to have tested contingency plans to deal with major events and business continuity. Failure to have such operational resilience is another area where future D&O claims may focus.

Professional Indemnity/Civil Liability

Professional indemnity (PI) and some civil liability insurance policies are intended to cover claims resulting from allegations relating to a company’s professional services – for example, whether it is a bank lending money to an individual or corporate, or a fund manager handling clients' financial portfolios.

The liabilities resulting from COVID-19 that may be covered under a PI policy depends largely on the type of professional service the company provides. For claims relating to a company's professional services, or failure to provide such services, PI policies are likely to be the most applicable insurance policy.

In a recent statement, the UK’s FCA made clear it expects FIs to be flexible in supporting consumers, bearing in mind individual circumstances, and welcomes FIs taking initiatives that go beyond usual business practices to provide that support.  One example of where the FCA has focused is on FIs showing more flexibility to customers in persistent credit-card debt. FIs need to be aware of this FCA guidance and act accordingly, in order to avoid potential third-party claims or regulatory sanctions alleging breach of these higher expectations.  While we have not seen a similar focus in Australia, APRA will likely be monitoring this position.

Employment Practices Liability Insurance (EPL)

Claims by employees alleging discrimination or harassment against protected classes could possibly increase, as a result of HR policies implemented in response to the COVID-19 outbreak. This further emphasizes the importance of proactively managing business continuity, including in relation to HR policies.

EPL policies also often contain bodily injury exclusions that may be relevant to any COVID-19-related claims.

We expect employment claims and in particular unfair dismissal claims to be on the rise with many companies expected to reduce the size of their workforce over the coming months.

Cyber and Crime

COVID-19 has resulted in one of the largest ever work-from-home situations. As a result, companies' cybersecurity will likely be stressed to an unprecedented level around the world.

To the extent that cyber criminals can exploit weaknesses from the surge in remote connections, claims under cyber policies may arise.

With most employees working remotely, there could be more "social engineering" fraud as people may be less likely to follow standard protocol given their remote access.

FIs need to ensure controls are maintained as tightly as possible in the current conditions, and that there is a culture of verifying requests in circumstances where usual controls are challenged.

Australia’s response to COVID-19 is continuously evolving and the economic impact can be clearly seen as the government moves to lockdown society and contain the pandemic. With the potential impact on FIs directly aligned to the economy, FIs need to stay apprised of the evolving risks and work alongside their broker to understand how their insurance may address them.

_{Disclaimer: This document and any recommendations, analysis, or advice provided by Marsh (collectively, the ‘Marsh Analysis’) are not intended to be taken as advice regarding any individual situation and should not be relied upon as such. Any projections are subject to inherent uncertainty, and the Marsh Analysis could be materially affected if any underlying assumptions, conditions, information, or factors are inaccurate or incomplete or should change. The information contained herein is based on sources we believe reliable, but we make no representation or warranty as to its accuracy. Except as may be set forth in an agreement between you and Marsh, Marsh shall have no obligation to update the Marsh Analysis and shall have no liability to you or any other party with regard to the Marsh Analysis or to any services provided by a third party to you or Marsh. Marsh makes no representation or warranty concerning the application of policy wordings or the financial condition or solvency of insurers or re-insurers. Marsh makes no assurances regarding the availability, cost, or terms of insurance coverage. LCPA No. 20/122.}