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Winter 2004/05 The Willis Index

Financial Institutions Newsletter nN=OMMS qÜÉ=cáå~åÅá~ä=fåëíáíìíáçåë=fåëìê~åÅÉ=~åÇ=oáëâ=j~å~ÖÉãÉåí=nì~êíÉêäó

The Willis Index is a quarterly Conditions and Results of the publication reporting on the relevant issues affecting the insurance industry and the impact they have upon the Market Survey Financial Institutions sector. The main _ìëáåÉëë=~ë=rëì~ä mêáã~êó=mêÉãáìã=o~íÉë=J=åÉñí=íÜêÉÉ=ãçåíÜë feature is an extensive market survey In the last Willis Index, we ventured that the insurance taken from over 50 insurers, providing responses on key indicators including losses resulting from Hurricanes Katrina, Rita and Wilma Crime might result in a tough and expensive premium, excesses and cover. renewal season for insurers and Our quarterly analysis provides hence costs might have been passed onto financial buyers with an overview of insurance institutions in 2006. The feedback we have received market conditions and our assessment from the market suggests that our fears of a hardening of the future outlook. market in 2006 driven by reinsurance appeares to be 45% 55% unfounded, as we understand that for the most part, insurers have been able to negotiate flat reinsurance premiums. In light of this we are not expecting insurers to seek premium increases across their renewal book for cases where the risk profile remains unaltered.

We are still waiting for closure on the many large Directors & Officers claims that are still outstanding (Wordcom, laddering, Enron). It is possible that these could move towards final settlement during this year, however we do not anticipate they will affect pricing at least until Q1 2007. 47% 53% Our observations are reinforced by the results of this quarter's Willis Index which conveyed that for the first quarter of 2006 approximately half the market feel that rates will remain unaltered whereas the other half predict there will be reductions of up to 10%. The exception to this is Professional Indemnity where 75% of the market believe that rates will remain flat. As ever Professional Indemnity there is some disparity between insurers predictions and marketplace realities. Our experience of the first quarter 25% is that financial institution clients are still able to negotiate discounts at renewal, however the amount of discount that can be generated is variable and is generally dependent on several factors including:

mêÉîáçìë=êÉåÉï~ä=íÉêãë 75% If a large discount was negotiated last year for example, `çåíÉåíë 20% plus, then it is unlikely that it will be possible to j~êâÉí=`çåÇáíáçåë=~åÇ=oÉëìäíë=çÑ=íÜÉ replicate a similar saving. It is more likely that the j~êâÉí=pìêîÉó= N market will offer a moderate discount of between jçåÉó=i~ìåÇÉêáåÖ O The data is based on criteria presented 5-10%. ?c~í=cáåÖÉêë?=~åÇ=qê~ÇáåÖ=oççã=içëëÉë P Unchanged by multiple risks and does not relate to jÉÉí=íÜÉ=qÉ~ã Q any one risk in isolation. The rate 1-10% Reduction reductions are not cumulative. pÉãáå~ê=réÇ~íÉ Q 3613w_index_institutions.qxp 17/03/2006 18:29 Page 2

Business as Usual Money Laundering – A Growing Threat (continued)

páòÉ=~åÇ=k~íìêÉ=çÑ=_ìëáåÉëë The scale of money laundering and the damage that it causes to and society in general is an Small to medium sized clients performing international problem. Official estimates suggest that in the UK alone, over £25 billion is laundered activities that insurers deem as 'low risk' are still every year. able to generate better terms in the marketplace than larger institutions, particularly those who The existing anti-money laundering regime consists of measures ranging from provisions in the operate in fields which insurers deem as 'high criminal law to punish money launderers and to deprive them of their proceeds, to the obligation on risk'. the financial services industry and other sectors to identify their customers and to report suspicious activities where necessary. Failure to comply with money laundering regulations could leave company iáãáí=mìêÅÜ~ëÉÇ directors and individual employees open to legal action and possible two year jail sentences. The larger the limit of indemnity purchased the more insurers are required to participate and ^=Äêç~Ç=çîÉêîáÉï=çÑ=íÜÉ=rhDë=êÉÖìä~íçêó=ëóëíÉã=Ñçê=ãçåÉó=ä~ìåÇÉêáåÖ hence the level of competition that the broker can introduce is limited. This mainly applies to mêáã~êó=iÉÖáëä~íáçåW fåíÉêå~íáçå~ä=pí~åÇ~êÇëW the global financial institutions. Proceeds of Crime Act 2002 Financial Action Taskforce (FATF) 40+8 Recommendations j~êâÉí=pÉäÉÅíáçå pÉÅçåÇ~êó=iÉÖáëä~íáçåW Each insurer will have a unique perception of Money Laundering Regulations 2003 how much an individual risk should pay. Some carry the burden of historical losses while others fåÇìëíêó=~åÇ=mêçÑÉëëáçå~ä=dìáÇ~åÅÉW have only existed in a period of market e.g. Joint Money Laundering Steering profitability and hence are often able to offer Group (JMLSG) more attractive terms. b`=iÉÖáëä~íáçåW oìäÉë=~åÇ=pìéÉêîáëáçåW Money Laundering Directives `ä~áã=eáëíçêó e.g. Financial Services Authority (FSA) Any claims payments or circumstances likely to result in claim will have a negative effect on renewal pricing. Parts of the current regime are relatively new and will need time to settle to allow the controls to be properly tested. The Third Money Laundering Directive was formally adopted on the 26th October As ever, the Willis Index is a tool to predict and 2005 and it will need to be implemented by the 15th December 2007. Its aim is to consolidate and record overall trends in the market place, there revise the previous directives, and there is certainly room for improvement and clarification. will always be exceptions to the general trends. The only constant is that it is only when the There is widespread confusion, for example, among financial institutions, solicitors and accountants, broker is fully versed in the client's demands and regarding the legal obligations to disclose any suspicions of criminal activity or the proceeds of needs that the optimum renewal can be crimes, however minor. There is no de minimis provision in the act which means disclosure is required achieved. no matter how paltry the sums involved.

There is also a real danger that client confidentiality could be breached when suspicious activity reports are submitted to the National Crime Intelligence Service (NCIS). Furthermore, clients must not be alerted that a suspicious activity report has been made about them. This is proving to be problematic for many institutions, for denying a customer access to certain services may very well alert that client to the suspicions of the institution.

The requirements to identify customers are a key element in money laundering obligations but concern has been expressed as to whether the 'Know Your Customer' (KYC) controls create a proportionate and effective regime. One of the key issues of the Third Money Laundering Directive for the UK is the provisions for customer due diligence procedures.

The changing regulatory system for money laundering has placed an increased burden of responsibility on companies, their directors and individual employees. Director's & Officer's Liability and Professional Indemnity insurance policies offer a level of comfort in the event that a claim is made for a breach of regulations. Whilst wilful acts of money laundering are clearly not covered, the policies provide valuable cost coverage in defending allegations, and in certain cases will cover the award of any damages where the breach has been proven to be inadvertent or innocent.

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'Fat Fingers' and Trading Room Losses

The dramatic expansion in the Following Basle II and the  in excess of permitted credit reflects OMMQ=k~íáçå~ä=^ìëíê~äá~=_~åâ accelerated development of financial limits, or the dynamism in today's trading rpaOSSã 'Operational Risk', Financial  outside of permitted product and dealing rooms. As the market The former head of NAB's foreign Institutions recognise that there lines, or has grown, regulators have options desk, Luke Duffy, are many ways in which traders  not with a designated become increasingly concerned colluded with three other traders can expose the firm and the counterparty. that the 'back office' might fail to to falsely claim that his desk had consequences can be far-reaching. cope with the volume of trading made a profit and hence generate Whilst the development of a single mêçÑÉëëáçå~ä=iá~Äáäáíó especially at a time of crisis. The personal performance bonuses. In viable Operational Risk insurance fåëìê~åÅÉ of England is very aware of fact the team had been able to solution is still some way off, there A professional liability policy the potential problems and has capitalise on weaknesses in the in- are various insurance products provides protection to a firm in commented that financial firms are house trading system 'Horizon' to available that can provide a respect of its liability to third exposed to "significant risks". manipulate results, cover up illegal solution to many of the problems parties or customers arising out of trades and hide losses. generated in the trading the provision of its professional Management's current drive to environment. services. A firm is vicariously liable update back office processes is OMMQ=`Üáå~=^îá~íáçå=láä for the acts of its employees and improving matters to some degree rpaRMMã `êáãÉ=fåëìê~åÅÉ= therefore the insurance will but correcting all the errors and This state controlled entity Typically, crime insurance will protect the firm's liabilities losses is proving to be more breached its mandates when protect the firm against the incurred through the errors of its difficult. 'Fat finger' losses taking large unauthorised infidelity of its employees. Cover is employees. resulting from simply pressing positions in oil derivatives. The provided for financial loss caused incorrect keys, and most if not all trades which proved to be loss by employees who intend to cause aáêÉÅíçêë=~åÇ=lÑÑáÅÉêë unauthorised trades, should be making resulted in a spectacular the firm a loss for their own iá~Äáäáíó=fåëìê~åÅÉ captured in the back office, but collapse in China Aviation Oil's benefit or for the benefit of others. A D&O policy protects the many continue to slip through share price. However, insurers are so personal assets of the directors the net. concerned with the risks inherent and officers, the assets of the firm OMMO=^ääáÉÇ=fêáëÜ=_~åâ in trading that they restrict (if it indemnifies its directors and Since Nick Leeson's unauthorised rpaSVNã coverage so that it is only officers) and, as an , the trading caused the failure of AIB revealed that John Rusnak, a provided in the event that the firm itself in respect of its own Barings Bank we have witnessed within their Allfirst employee intended to both cause corporate liability to shareholders. many similar examples of serious subsidiary, had incurred losses by the loss and actually make a gain. Liabilities that arise from any losses. The number of problems taking directional bets on currency perceived management failure generated by the dynamics of movements and then concealed Whilst the restriction can be following a rogue trade are trading rooms is increasing, and the losses by claiming to have diluted to some degree, it would protected and it follows that the the recent problems recorded hedged his deals with fictitious be imprudent to rely on these policy would respond to actions below illustrate that individual counterparties. insurances for protection for 'fat from shareholders or regulators. traders continue to circumvent finger' errors or unauthorised even the most robust of risk In situations such as the trades. It would be imprudent to consider management systems and foregoing, the total loss to a firm the events at Barings as a 'one controls. is rarely capped at the amounts rå~ìíÜçêáëÉÇ=qê~ÇÉ=fåëìê~åÅÉ off' as the risks posed by rogue listed. The consequences of large This insurance is specifically traders are very real and OMMR=jáòìÜç=pÉÅìêáíáÉë operational losses of this nature designed to provide the protection potentially catastrophic. Insurance rpaPQMã can include: lacking in a crime policy with solutions will help mitigate these A 'fat finger' error in Mizuho  a marked drop in the share regard to unauthorised trading. risks, but to be truly effective, only Securities resulted in a sell price The policy is based upon a a specifically structured multi-line for 620,000 J-Com shares (more  reduced credit rating recognition that a rogue trader manuscript insurance programme than 40 times the number of  as in the case of Barings, the may not necessarily wish to cause can provide significant protection. shares in existence) at Y1, instead collapse of the organisation the loss or to make a direct Willis has a proven track record in of 1 share at Y620,000. Despite  Regulatory sanction in the financial gain. Instead it needs to constructing such programmes for recognising the error, the form of formal and public be shown that the trading was Financial Institutions with wide Exchange compounded the admonishments and/or fines. concealed or falsely recorded and ranging risk profiles. problem by blocking attempts to that it was cancel the trade. Above all, the firm and its board with an actual counterparty which of directors will suffer significant at the time of the trade was: damage to their reputation.

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Meet the Team Seminar Update

eìÖÜ=táäëçå Hugh's career was representing Willis at the FINEX's first Financial Institutions seminar of awards ceremony at Buckingham Palace and 2006 was a great success attracting nearly 50 Hugh began his insurance being presented to the Queen and other delegates. The Breakfast Briefing attracted career in 1985 at Willis members of the Royal Family. He recalls that company secretaries, finance directors and risk Faber & Dumas as a broker "Her Majesty was very interested in what was professionals from Financial Institutions, several in the Financial Institutions happening at Willis and particularly what had of whom had travelled long distances to attend. Division, providing crime become of Messrs. Faber & Dumas". related insurances for a The guest speaker, Matthew Allen of Eversheds, variety of commercial and financial services In 2002, in a "moment of madness", Hugh was gave an insight to the psychology of disputes accounts around the world, including some of the lured away to head up a financial institutions and dispute resolution. Duncan Holmes of major money centre in the USA. In 1990, team at another Lloyd's broker. Hugh re-joined FINEX provided an update on the financial lines following the merger with Corroon and Black, Willis at the start of 2006 as part of the newly insurance market based upon the latest market Hugh transferred for two years to the Los created Financial and Executive Risks (FINEX) survey of underwriters trends for premiums and Angeles office to become the Willis UK West Team. Hugh commented recently that "It's policy conditions. The Breakfast Briefing was Coast Representative, responsible for helping the wonderful to be back at Willis and to have the part of our ongoing FINEX Seminar Programme 14 offices on the West Coast access the opportunity to be part of such a dynamic, designed to deliver added value to our clients and European markets on all classes of insurance. focused and talented team again". and prospects. The next Financial Institutions seminar is scheduled for the 26th April 2006 at Hugh was co-opted onto the local softball team Prior to joining Willis, Hugh was a professional our Trinity Square office. with mixed success in becoming the only person cricketer for seven years representing Surrey and to score two runs off the same strike whilst at Somerset, as well as a number of MCC touring For further information please contact Derek the same time failing hopelessly to catch teams around the world. Amongst various Reeves on +44 (0)20 7975 2944. anything whilst using a "mitt”! cricketing records he has the rather unique distinction of having batted live on television on On his return to London, Hugh headed up the three occasions and being out first ball every International and North American Financial time! In 1985 Hugh married Michele and they Institutions teams being part of the Division, have a son, Harry (12 years old), who has which in 1996, won the Queen's Award for hopefully inherited some cricketing genes given Export Achievement. One of the highlights of that Michele's father played for England!

Willis is one of the World’s leading risk management and insurance intermediaries. We have 15,800 professionals in over 300 offices around the World.

cçê=ÑìêíÜÉê=áåÑçêã~íáçå=éäÉ~ëÉ=Åçåí~ÅíW aÉêÉâ=oÉÉîÉë aìåÅ~å=eçäãÉë eìÖÜ=táäëçå= Tel: +44 (0)20 7975 2944 Tel: +44 (0)20 7975 2708 Tel: +44 (0)20 7975 2898 Email: [email protected] Email: [email protected] Email: [email protected]

Willis Limited, Registered number: 181116 England and Wales. Registered address: Ten Trinity Square, London EC3P 3AX. FIN/3613/03/06 Lloyd's Broker. Authorised and regulated by the Financial Services Authority.

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