2019 Outlook for Financial Institutions

Global volatility is a key theme for financial institutions as we begin 2019. In the U.S., the government shutdown, questions about future monetary policy (to tighten or not to tighten) and speculation about reaching the end of an extended corporate growth cycle has translated into market volatility after a period of relative calm. In Europe, uncertainty around Brexit and the prospective relationship between the UK and EU has confounded about operating in the real economy. Regulators who may have regional variance continue to exert influence over the way financial institutions operate.

Of course, the confluence of such a wide range of which doesn’t include agriculture, premiums were up We’re here to issues impacting the operations and performance of 5%. Rates for major accounts were up over 3% with empower results financial institutions ultimately impacts their insurability. risk at rates of less than 1%, while excess If you have questions That in conjunction with insurer performance cycles casualty rates were up 10%, property was up 12% and about your specific leads us to highlight the following short list of critical public D&O was up 8.5%.” coverage or want more themes relevant to the financial lines markets that we’ll - Chubb Q4’18 earnings call information, please need to pay close attention to in 2019: In order to effectively navigate this firming contact your Aon broker. marketplace, Aon recommends: 1) starting the For general questions Pricing in the Financial Lines process early; 2) working with your Aon broker to about Management Markets is Firming understand the marketplace for your specific Liability for Financial risks; 3) clearly defining your renewal goals; In the US and UK financial lines markets we are Institutions, contact: 4) determining what levers you can pull to achieve experiencing a firming rate environment at the start Jim McCue best in class results; and 5) having options. of 2019. Broadly, insurers are pressing for increased Managing Director premium and/or retention levels on a risk by risk Financial Services Group basis. According to Aon’s D&O Pricing Index, in Q3 Isn’t There Abundant Insurance Capacity? +1.212.441.1261 2018, only 8% of primary renewals experienced a In 2018 we experienced another significant year of [email protected] premium decrease. This is the lowest percentage of natural catastrophe activity including Hurricanes premium decreases since Q2 2013. Primary policies Joel Sulkes Michael and Florence and the California wild fires. experienced a premium increase of 3.2% in Q3 and Global Financial While the hit to the insurance industry did not there have been primary pricing increases for seven Institutions Practice Leader exceed the high-water mark set in 2017 (~$150bn), consecutive months. +1.212.441.2364 2018 still produced natural catastrophe insured [email protected] “we began to see some signs of dislocation on the losses in excess of $85bn (exceeding the last 10-year margin in the market as some carriers curbed their annual average). Despite all of this, overall insurance aon.com appetite for certain lines of by reduced line sizes market capacity remains at historically high levels. or exiting from markets altogether. That’s another marker Aon estimates that global reinsurer capital stood at of a firming or market correction. In North America, the $595bn at September 30, 2018, down 2% relative to positive pricing trends in the third quarter continued, in the end of 2017. This calculation is a broad measure fact improved in several areas, particularly in our major of the capital available for which insurers can accounts, retail and E&S wholesale divisions. Overall, risk. Traditional capital fell by USD20 billion to $496 rates in North America were up about 2.5%, the same as bn (-4%), while alternative capital rose by $10 bn last quarter, while renewal price change, which includes to $99 bn (+11%). Further, recent M&A among exposure, was up 4%...In major accounts in specialty insurers, such as AXA and XL, has had no material

1 impact on overall capacity levels. As we progress impactful pricing for excess limits. While primary through 2019, we’ll have to pay close attention to layer D&O pricing has decreased approximately whether pockets of the insurance market will attract 2% over the past five years, pricing for excess limits additional opportunistic capital despite already high has decreased 28% in this time, according to Aon’s levels of overall capitalization. data. Insurers have responded to their profitability challenges not only by seeking rate increases but also by managing (reducing) their overall limits, So, why are rates firming? Record levels adjusting attachment levels, imposing coverage of litigation, underperformance of restrictions (such as proprietary funds exclusions in portfolio and heightened exposures Fiduciary Liability policies) and walking away from deals deemed inadequately priced. As a result, After a prolonged soft market, record levels of Securities “less attractive” risks, such as large D&O and E&O Class Actions (SCA) are contributing to a firming programs, are becoming increasingly difficult and marketplace for financial lines coverages. In 2018 there more time consuming to place. were 403 total SCAs which is on par with the record levels of 2017. M&A litigation accounted for 185 Across the pond in London, Lloyds conducted filings, or 46%. Two hundred and eighteen filings were a market performance review in the second “traditional filings”. The number of 2018 traditional half of 2018 of all syndicate business plans for filings – those that allege violations of Rule 10b-5, 2019. Focusing on consistently underperforming Section 11, and/or Section 12 - was the highest amount syndicates, the Lloyds Performance Director since 2008. The SCA litigation rate for U.S. exchange instructed underperforming syndicates to undertake listed defendants is 8.7%, the highest on record. remedial action in order to return their businesses to profitability. Of the “Decile 10”, or the 10% One notable case in 2018 was Cyan, which has worst performing classes of business, professional certified that under the Securities Act of 1933, indemnity (E&O) was identified as the second worst Section 11 claims can be brought in both federal performing class in the market. and state court, further expanding the number of jurisdictions for Section 11 claims to be brought. This has resulted in an increase in class actions, Cyber as a Risk Driver particularly against companies having initial public Financial statement impact of breaches has shifted offerings, but the state data is more difficult to track to business disruption due to technology failures than at the federal level. or outages (i.e. business interruption, contingent The percentage of cases alleging regulatory business interruption and systems failure). Trading, violations across multiple industries, many of which brokerage and operations, all would be considered event-driven cases, accounted underpinned by technology and connectivity to for about 17% of filings, down 26% from last year. third party networks, can present significant business ICO’s (Initial Coin Offerings) also contributed to the continuity and profit and loss exposure to . Aon’s uptick in federal securities class actions, cyber insurance solutions contemplate meaningful for at least nine suits in 2018. first party capacity for expense and P&L loss resulting In addition to the D&O claims above, financial from a breach of security at either your firm or your institutions professional liability (E&O) continues to critical vendors’ and suppliers’ (e.g. exchanges) see heightened frequency of claims, including those or from a simple failure of your (or your vendors’) related to sales practices, lending and regulatory trading/technology platforms. Coverage may attach at investigations. In tandem with an increase in fixed dollar retentions (rather than after waiting period frequency, companies insuring financial institutions deductibles) and is supported by a claims preparation have experienced an increase in claim severity with and advocacy between Aon’s Cyber recent nine-figure insurable losses in D&O (Side A), Solutions and Property Claims Practices. E&O and Fidelity Bond. Many of the insured losses Unauthorized Transfer or Theft of Client or have largely been borne by the handful of insurers Proprietary Assets (i.e. fraud loss) willing to take a leadership on complex Banks continue to develop new retail capabilities and risks - several insurers had limits of $50mm (some invest in digital asset and blockchain technologies. over $100mm) per risk - and, as these insurers However, regulatory and monetary loss exposure recalibrate, “new capacity” is not anxious to step in only continues to increase as bad actors, criminals or to these risks. The large losses have been particularly nation-states initiate misappropriation of firm financial

2 assets (e.g. and securities) or client financial adverse business impact, such as damage to a assets in the firm’s care custody and control through company’s reputation or strained relationships with phishing, malware, email hijacking and other tactics. investors, and may mandate change in the c-suite. Aon’s unique solutions for these exposures include These events are not only an EPL risk, but also a integrated cyber and crime programs; cryptocurrency D&O risk. crime insurance and 401k theft insurance. Wage and Hour concerns remain high as certain Information / data leakage (i.e. privacy liability) jurisdictions, such as California, institute new In a post-financial crises and General Data Protection regulations that increase exposure for employers Regulation (GDPR) world, where banks are still such as “unrestricted breaks” and an “ABC test” adapting to new regulations and secular changes related to independent contractor classification. to trading and capital markets businesses - and Defense costs alone can lead to significant losses. thus pivoting to more personal-record intense In the UK, regulations requiring large employers lending and retail activities - privacy and non-public to disclose their gender pay gap came into effect information exposure is at an all-time high. Aon’s April 2017 with first reports due April 2018. Reports knowledge and experience can assist clients in must include hourly and bonus pay gaps, bonus accelerating time to compliance and Aon’s GDPR pay proportion, and the proportion of women and Protect Solution can help banks transfer the financial, men at each hourly pay quartile. Firms must publish regulatory, and legal risks associated with privacy within 12 months of the April 5th snapshot date each liability and related regulation. year. It must be published on the employer’s own website and remain there for at least three years from the date of publication, in English and accessible to Digital Assets and Cryptocurrencies all its employees and the public. We entered 2018 in the midst of a surge in the Noncompliance or failure to report is “an valuation of cryptocurrencies and a deluge of Initial unlawful act” falling within the enforcement Coin Offerings (ICOs). This quickly transitioned to powers of the UK’s Equality and Human Rights a vast regulatory crackdown and a plummet in the Commission and could attract “unlimited fines.” prices of cryptocurrencies (down approx. 90%). The Commission could open an investigation While the euphoria has died down, many believe if they suspect a considerable pay gap is being that digital assets will have a meaningful role in hidden by employers. Reputational risks are also a financial services. The flow of ICOs has subsided and consideration if employers fail to comply with the we have seen the emergence of STOs (Securities regulations. Token Offerings) and efforts to comply with regulations. In 2018, traditional financial institutions The data reported could provide fodder for existing continued to invest in and launch digital asset or future lawsuits under the U.K.’s 2010 Equality Act, platforms – a trend to keep an eye on in 2019. a codification of earlier laws, which gives women and men the right to equal pay for equal work, and Companies have prudently been seeking insurance provides a framework for comparing jobs by effort, solutions to address their crypto exposures. skill or decision making. Established financial institutions should consider whether their current insurance policies (including Crime, Cyber and E&O) are covering these Fiduciary Liability – proprietary funds exposures. A traditional crime policy or fidelity bond As 36(b) excessive fee cases are winding down, is often inadequate, making it critical to tailor policy ERISA suits for excessive fees of proprietary funds in wording to address a company’s unique exposures. sponsored retirement plans are growing. From 2011 This is a challenging segment, but Aon has been a to the present, the plaintiff’s bar has initiated at least leader in placing insurance for various crypto and twenty-five “proprietary funds” cases with all but digital asset businesses. three of these initiated over the past three years. Several new cases were filed in 2018. Many Fiduciary Employment Practices Liability (EPL), Liability insurers have responded by attaching Wage & Hour and UK Gender Pay Gap exclusionary language, increasing retentions and/ or pricing and seeking the completion of related Workplace harassment allegations are front page questionnaires at renewal. news and, while first and foremost are devastating to the individuals involved, can have a significant

3 Fintech, Blockchain and Big Data ƒƒ M&A: As the Dodd Frank roll back raises the About Aon’s Financial Financial institutions continue to invest heavily “enhanced prudential supervision threshold” for Services Group in technology as it is an integral part of their holding companies from $50 bn to $250 The Financial Services Group client offering and ongoing pursuit of operating bn in total consolidated assets - will this lead to (FSG) is Aon’s dedicated efficiencies. Blockchain, a “distributed ledger increased M&A in the banking sector? global management liability technology” (DLT), is “live” and being actively ƒƒ Bank Failures: While no banks were taken over by insurance specialty practice. utilized by several large financial institutions. One the Federal Company (FDIC) This team is comprised of of the largest banking institutions in the world by in 2018, this will likely change if we enter an 550 insurance professionals total assets reported $250 bn in settled transactions economic slowdown in 2019. worldwide, all of whom in 2018 using the blockchain technology. Risks are dedicated to serving ƒƒ Cryptocurrency and Digital Assets: In the wake of will vary depending on the structure and features the needs of our clients. the regulatory crackdown in 2018, will there be of the blockchain – for example, is it “public” or FSG globally includes a 67 increased focus on regulation and compliance as “permissioned”? As financial institutions increase person legal and claims these businesses seek broader acceptance? their reliance on technology, Aon recommends an team to assist clients with in-depth review of professional liability (E&O), cyber ƒƒ Climate Change: Aon’s Weather, Climate & claims counseling and liability policies and fidelity bond (crime) to avoid Catastrophe Insight: 2018 Annual Report shows how avoidance. Aon is the market potentially significant gaps in coverage. the last two years’ natural disasters have been the leader in management Regulatory trends to watch and consider costliest on record. Of the $225 billion in economic liability with approximately losses in 2018, only $85 bn (or 38%) was insured, $4.4B in premium placed ƒƒ Privacy regulations: Following in the footsteps of leaving a global protection - or capital efficiency annually across the GDPR, California has promulgated the California - gap of some $135 bn. With increased investor globe. Our accumulated Consumer Protection Act (CCPA) and more states and regulatory scrutiny, climate-related risks are experience from placing are expected to take similar actions. The SEC has a increasingly becoming C-suite priorities. this volume translates into heightened focus on cybersecurity. ƒƒ Cannabis: in the U.S., several states have, or are a keen awareness of insurer ƒƒ Operational Risk: 1) As conduct risk converges considering, legalization of forms of cannabis. capabilities and emerging with operational risk, big banks continue It remains illegal, however, at the federal level. international litigation to struggle with bad actors circumventing As these businesses and their service providers issues. It also offers us an compliance and control frameworks; regulators expand, they are in need of banking solutions, opportunity to impact globally are looking to drive better controls, but banks are cautious not to run afoul of federal insurer behavior regarding governance, oversight, accountability, and capital regulations. Will federal regulations change as pricing, coverage, and the adequacy to manage losses flowing from bad more states legalize cannabis? claims resolution process. actors. Human resource mechanisms pertaining to ƒƒ New Leadership at several key regulators and rewards and compensation continue to have a role committees: House Committee (now in attempting to deter bad behavior/and improve About Aon’s Financial under Democrat control); Consumer Financial performance; 2) As we progress towards adoption Institutions Industry Protection Bureau (CFPB); New York Department of the Standardized Measurement Approach Practice of Financial Services; FDIC. (SMA) for calculating regulatory capital in 2022, The Financial Institution (FI) are banks preparing for the claims recovery data Industry Practice is Aon’s and documentation burden that will be required global specialty practice under the SMA to allow insurance recoveries to focused on lensing the positively impact operational risk capital? broad range of capabilities and solutions across Aon’s business segments (Risk, Reinsurance, Health, Retirement and Data/ Analytics) for the and growth enabling needs of our FI clients.

All descriptions, summaries or highlights of coverage are for general informational purposes only and do not amend, alter or modify the actual terms or conditions of any insurance policy. Coverage is governed only by the terms and conditions of the relevant policy. 4