HFM FOCUS PLANNING FOR THE FUTURE

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FOCUS ON

Rawden Leigh and Neill Harman, of Marsh, update HFMWeek on operational risk and insurable events

OPERATIONAL RISK FRAMEWORKS

One of the outcomes of the financial crisis of 2008 is that asset managers have be-come more focused on their operational risk frameworks (ORF), and more trans-parent in disclosing their key risks. Com-pliance and risk departments have not

only worked to address the regulatory obligations im-posed by the AIFM directive and Ucits IV, but have also needed to consider the risk implications of outsourcing, use of IT, disclosure of business critical information for reporting purposes, and mandate breaches.

When considering the role of the ORF within a typi-cal asset management organisation, it will come as no surprise that a number of asset management firms have already recognised the strong connection between the supporting role played by insurance, specifically profes-sional indemnity and crime insurance, and the key risks facing the business. In certain cases asset management firms have been able to secure capital relief under Pillar II of ICAAP, as a result of actively demonstrating that a firm link exists between their insurance arrangements and their operational risk frameworks.

Recent research conducted by Marsh into the fre-quency of claim notifications facing asset managers,

both pre and post credit crunch (2006 – 2014), identi-fied a wide range of risks which are likely to fall within the scope of operational risk as an insurable event. For an asset management firm, linking such risks to an in-surance product can have the benefit of helping to se-cure capital relief with the regulators. Alternatively, it can allow the business to identify areas where they may be over-provisioned in terms of capital risk alloca-

tion and can potentially free up funds, or resources, for other purposes.

Key risks associated with administrative, trading and hedging errors were identified as key insurable areas likely to fall within the scope of a typical operational risk framework. These are typically the types of risk covered by a specialist professional indemnity insur-ance policy. Furthermore, tailored professional indem-nity policies, available to asset managers, are increasing-ly recognising that firms may need to mitigate an event or error before a claim is brought by an investor. The ability to take such action forms not only a key element of cover, but, also directly supports the role of active risk management within an ORF.

Other notable claims notification areas include breach of investment mandate and product failure. These core operational risk exposure areas are directly addressed by specialist asset management professional indemnity polices. This tailored cover is usually de-signed to provide the policyholder with an indemnity for the cost of correcting, or putting right, such errors that may occur.

The judgment in Standard Life Assurance limited versus Ace European Group and others, (ACE Eu-

ropean Group & Ors v Standard Life Assurance Limited), demonstrated the significant value to a business of introducing effective mitigation costs language within an insur-ance policy. The court found that Standard Life had necessarily incurred costs to compensate inves-tors for a decrease in the value of the Standard Life Pension Sterling Fund, and as such were entitled to reimbursement from

insurers. The outcome of this case served not only to reinstate the position of the investors, but also played a key role in protecting the brand and reputation of Standard Life. This demonstrates the tangible value of linking insurance provisions as part of a ‘pre-claim’ risk management process.

The value of insurance as a risk transfer mechanism, and also as a source of risk capital, is likely to increase

Rawden Leigh, ACII – Chartered Insurance Broker (Marsh FINPRO)

Neill D Harman ACII– Asset Management Practice Leader (Marsh FINPRO)

KEY RISKS ASSOCIATED WITH ADMINISTRATIVE, TRADING AND HEDGING ERRORS WERE IDENTIFIED AS KEY INSURABLE AREAS LIKELY TO FALL WITHIN THE SCOPE OF A TYPICAL OPERATIONAL RISK FRAMEWORK

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S P O N S O R E D E D I TO R I A L

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in 2015 with the Insurance Act 2015 bringing about the biggest change to English insurance contract law in over 100 years. The Act is a positive step for policyholders, and will ultimately lead to policyholders taking into ac-count key provisions of the act within their own ORFs.

Asset management firms should regularly stress-test their own risk scenarios against their insurance policies. This will reveal what is and what is not insured, and will also assist in identifying key risk considerations such as policy limits, geographical coverage issues and the rele-vance of ancillary covers such as employment practices liability and key man insurance.

Typically such risk scenarios identify a high-level of exposure to a specific risk (or risks), which can be cap-tured by a tailored insurance policy, or identified as a key risk area within an ORF.

We fully anticipate that asset management firms will increasingly be making the connection between the role of insurance and their own operational risk assess-ments, especially in the context of assessing capital ad-equacy under ICAAP. n

THE VALUE OF INSURANCE AS A RISK TRANSFER MECHANISM, AND ALSO AS A SOURCE OF RISK CAPITAL, IS LIKELY TO INCREASE IN 2015

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ASSET MANAGEMENT INCIDENCE OF PROFESSIONAL INDEMNITY AND CRIME NOTIFICATIONS 2006-2014 SOURCE: MARSH ANALYTIC DATA: 126 INSTANCES