Tuesday, 22 September 2020

The FCA business interruption Test Case – Closure, or grinding onward?

The UK High Court handed down its verdict on the Financial Conduct Authority’s test case on Business Interruption on September 15. Some of the 370,000 policyholders affected will now be hoping to receive insurance payouts in time to stave off bankruptcy. Others will now be considering whether they have viable grounds for appeal.

There were a number of battlegrounds in the case. BILA (British Insurance Law Association) will be holding a webinar on September 28, but in the meantime some of the interesting points were:

  • Causation: The Court held that the proximate cause of the business interruption was the composite peril of the business interruption following the occurrence of the notifiable disease. Individual outbreaks were deemed to be part of a national whole.
  • Public authority and prevention of access clauses differed between the policy wordings under consideration, with some being deemed to provide narrow, localised cover while others were deemed to respond to government regulation when it was issued on March 26.
  • Trends clauses are relevant to the calculation of the insured loss because they take account of the circumstances/trends of the insured business.  Insurers relied on the decision in Orient Express Hotels v Assicurazioni Generali Spa (UK)* to argue that the insured could not show that the business loss would not have been suffered ‘but for’ the insured peril because many businesses would have suffered loss in any event due to the Covid-19 epidemic. The court felt that Orient Express had been incorrectly decided and therefore did not follow the precedent.

Appeals from both sides are likely, and then a key question will be whether the Court of Appeal chooses to hear the case or leapfrog it straight to the Supreme Court. An expedited appeal might be heard in late 2020 / early 2021, but not even that will really bring closure. Major UK insurers who are not currently part of the FCA test case will likely find that policyholders seek to read judgments across to their coverage, and thus find themselves embroiled in coverage disputes.

Meanwhile in the background and on the sidelines, the skirmishing will continue.

The FCA has published a Dear CEO letter suggesting quite strongly that insurers should not seek to deduct furlough and similar government payments from any claim settlement, but they have not provided any guidance on how else such payments might be fairly treated.

Reinsurers have already given strong indications of their intention to scrutinise any payments which insurers may make and for which they may seek to recover under their reinsurance arrangements. Certainly catastrophe reinsurers will be considering:

  • The operation of hours clauses: the treaties are designed to respond for specific identifiable events such as earthquakes and windstorms. In the case of a disease outbreak, is it a natural catastrophe? When does the event begin and end? Is it one event, or several?
  • Loss quantification: if an insurer has been using poorly drafted policy wordings which resulted in coverage being awarded where none was intended, can the reinsurer argue that this qualifies as some sort of ex gratia payment and is hence not recoverable?
  • Loss aggregation: a large composite insurer may have multiple portfolios of risk – say SME property/BI, marine and event cancellation (to name just a few). If treaties are written on different bases (eg occurrence vs risks attaching) how will insurers aggregate their losses? 

And so the Business Interruption battle will grind onward – in adjudication as well as in arbitration. Certainly many new precedents will be set. It’s an interesting time to be considering insurance and reinsurance disputes.

* Trading as Generali Global Risk, [2010] EWHC 1186 (Comm).

This post has been written Shirley Beglinger (Advisory Board Member) at Crescendo Advisors.  

Crescendo Advisors (www.crescendo-erm.com) is a boutique risk management consultancy. Crescendo Advisors has a solid track record of successful engagements in both adjudication and arbitration. 

Wednesday, 9 September 2020

Lessons Learnt from Covid-19 ... or Not?

Covid-19 is a health crisis, a business crisis and an economic crisis which has struck the insurance industry hard.

Claims spiked in some areas while volatile financial markets made it almost impossible to steer the investment portfolio, and lockdown measures kept staff at home while struggling to cope with surging call and claim volumes. Meanwhile, there is vocal pressure from some quarters for a “flexible” approach to claims, where “flexible” is shorthand for dishing out large amounts of money for claims which may or may not be covered.  

How has the industry coped, and what lessons has it learned?

To answer that question, Crescendo Advisors carried out a series of structured interviews with a selection of risk and finance professionals from insurance firms. Most of the firms were UK based, with an aggregate turnover of £120 billion in 2019.

Although the firms varied in size and portfolio mix, there was a high degree of consensus in their opinions. Here are Crescendo’s top five findings and conclusions:

  • While most UK firms have weathered the crisis to date, it appears that few did so as laid out in their pre-Covid-19 business continuity planning.  Business continuity plans usually assumed local outbreaks and had to be re-created in the face of a total and global shutdown.
  • All firms who viewed their lockdown experience as ‘successful’ attributed that to excellent, ongoing communication from senior management to all stakeholders;
  • The traditional hostility to staff working from home has changed from “not possible” to “why not?”. Going forward firms expect staff to continue working at least part-time from home, and hence plan on reductions in their office footprint;
  • As remote working and virtual teams have become the post-Covid vogue, the purpose and value of The Office is being critically re-evaluated. It may still be the best place for meetings and staff onboarding, but do we really need all those desks crowded together?
  • With staff working remotely, the cost-benefit dynamic of outsourcing could be changed so that firms will find it beneficial and desirable to bring activities back in-house.

Interestingly, while most participants anticipated the need for a lessons learnt exercise, only one of them acknowledged at the time that his firm was already kicking off such an exercise.

Are insurers perhaps being complacent? They had six weeks to prepare for lockdown and they put the time to good use. By the time staff were required to stay home, many did so with newly acquired laptops and secure connections. The main limitations on productivity came from the lack of suitable home office facilities or from inadequate broadband speeds. The show stayed on the road with remarkably few wobbles.

Next year UK insurers are likely to work in the implementation of operational resilience requirements.  There are lessons to be learnt from Covid-19.  But here’s a thought, if working from home is no longer the backup disaster recovery plan – it is the new normal – what is the new disaster recovery plan?

This post has been written by Isaac Alfon (Managing Director) and Shirley Beglinger (Advisory Board Member) at Crescendo Advisors.  

Crescendo Advisors (www.crescendo-erm.com) is a boutique risk management consultancy.  We would be happy to share an overview of the findings of this survey.  We can also support your efforts to both learn lessons from Covid-19 using the tools we developed for this survey and consider the implications of working from home arrangements for the risk and control environment.

Sunday, 14 June 2020

Delegating Decision Making to AI Tools – Choices and Consequences*


Sometimes when I hear about Artificial Intelligence (AI) tools it seems like it is all about the technical details of the model and the data, which is certainly very important. This post is about another important aspect: the operating model in which the AI tool will operate.

There are many aspects of such an operating model.  Some are practical, such as ensuring that the tools integrate with other parts of the business.   In this post, I am focusing on the delegation of decision making to the AI tool – the choices that exist in most cases and the implications for the control environment.  These are summarised in the figure below.

At one extreme of the delegation of decision making, you have AI tools that operate independently of human intervention.  An example is algorithmic trading or an automated trading system which trade without any human intervention to use the speed and data processing advantages that computers have over a human trader.  Interestingly, this also represents one of the few prescriptive examples of PRA intervention where it requires that a human has the possibility of stopping the trading system.[1]

At the other end of the spectrum, there are AI tools used by experts in a professional environment.  For example, actuaries might use machine learning techniques to undertake experience analysis and support reserving work.

Between these two examples, you have AI tools that provide a forecast or recommendation for consideration by an analyst.  For example, the AI tool could provide a credit rating that validates a rating derived using more traditional methods.

Another middle of the road alternative is ‘management by exception’.  This means that the AI tools have a degree of autonomy to operate within a ‘norm’, which is inferred from historical data.  Cases that are outside the norm are then referred to an analyst for consideration to improve and verify the predictions. 

These are business choices and in turn have implications for the development process of AI tools.   You would expect controls around data and model documentation in all cases.  But broadly speaking you would also expect a tighter control and a more intense validation for AI tools that operate more independently of human intervention.  This includes the depth of model’s understanding, including:

  • explainability – why did the model do that;
  • transparency – how does the model work;
  • the impact on customers – e.g., the difference between Netflix recommendations and credit card underwriting.

The choices of operating model also have important implications for staff training.  AI tools operated by staff that have not been involved in its development must be trained to the appropriate level to ensure that the AI tool operates effectively.  For example, where ‘management by exception’ is adopted, staff would need the appropriate knowledge and skills to deal with the exceptions.

There are important choices for the operating model into which AI tools are deployed.  These choices have risk management and control implications and these choices may change over time.  An AI tool might start operating in an advisory capacity.  As trust in the AI tool increases then the delegated decision making can be increased.

These implications and choices should be considered as part of the model design.

We hope you found this post of interest. You can subscribe and receive further posts by email. See the box on the right-hand side of the blog's screen or click here.



*  This post is based on my contribution to a virtual panel discussion organised by ActuarTech on AI Governance & Risk Management.

[1] Prudential Regulation Authority (PRA), Algorithmic trading, Supervisory Statement, 5/18, June 2018.


Wednesday, 26 February 2020

Good risk management is not just about good ideas



One might say that this is stating the obvious and that it is understood that implementation also matters.  A recent FCA enforcement case against Moneybarn would suggest that it is not so obvious after all.

Moneybarn is a lender that provides motor finance for used vehicles to ‘non-standard’ customers.[1] The case against them related to the regulatory expectations for treatment of and communication to customers that fall into financial difficulties, i.e. the exercise and communication of appropriate forbearance by the lender.  Here, we seek to tease out the implications of this case for the risk management activities of FCA regulated business.

1.  Appropriate policy design

As one would expect, policies need to cover the appropriate ground.  This can include articulating the appropriate range of options (in this case, for customers forbearance and resolution), the considerations that would be taken into account and the governance that would apply to different options. 

It is worth noting that in this enforcement case, it appears that the FCA had no obvious concerns about the relevant policies and procedures reviewed.  

2.  Implementation

The challenge is how these policies and procedures are translated in the business, e.g. whether the call scripts are consistent with the policies.  In some case, this means that calls would be far from “linear”.  Customer service agents will have to consider a range of options and guide the customer.  This would have implications for training and tools available for customer service agents. 

The FCA notes that “from the review of the sample the use of any other forbearance options”, other than clearing their arrears over a short period of time, “despite the fact that policies and procedures referred to other available options”.   

3.  Monitoring and assurance

There is usually a combination of first line monitoring and oversight by 2nd and 3rd line functions.  To some extent, who provides assurance becomes less important than whether assurance is provided.

It is important to recognise that assurance should be provided about the processes and about the outcomes.  Where the nature of the issue involves considering customers’ individual circumstances in response to financial difficulties, then it is important to evidence that the range of options set out in the policy have been delivered.   This is more challenging to monitor than following a process. 

It is interesting that in this enforcement note there are no references to assurance or to the role of 2nd and 3rd line functions.

4.  Regulatory relationship management

The FCA initial engagement starts with a seemingly low-profile review of a “limited number” of files and call records leading to a visit in July 2016 to assess forbearance and termination practices.  There were then several interactions with the FCA in September 2016 and January 2017, leading to a formal request for imposition of a requirement in June 2017 and eventually enforcement action.  One must wonder if a more proactive engagement with the FCA would have prevented the escalation to enforcement.

It is usually noted that proactive engagement with the FCA and the issues raised would have been expensive.  Hindsight may be a powerful tool but it is not clear that the cost of the proactive engagement would have been unlikely to exceed the enforcement costs, which ended up being very substantial – the fine of £2.7m, the impact on senior management’s time, and the £30.3m of compensation paid to customers potentially affected by these failings. 

This post is part of the materials discussed in episode 3 of RegNut Podcast.   If you found this post of interest, subscribe to RegNut.  You can also subcribe to the blog and receive further posts by email. See the box on the right-hand side of the blog's screen or click here.






[1] Non-standard customers are those that cannot access finance from mainstream lenders because they have a poor or no credit history or past problems with credit due to unemployment, ill health or other adverse events.

Monday, 27 January 2020

Operational Resilience


By Shirley Beglinger, Advisory Board Member, Crescendo Advisors

In today's interconnected financial world, "organisational resilience" must be taken to mean much more than just "a fully tested disaster recovery plan". Regulators are requiring boards to see beyond the walls of their own firm and identify its position in the economic, IT and service-delivery ecosystem with an emphasis on important services provided. This is a completely different perspective on risk.  Boards and CROs need to reconsider many tried and tested risk methodologies and metrics.

In reviewing the drivers of potential operational disruption, the CRO may identify several which are difficult or expensive to address. "Reliance on legacy infrastructure" for example will likely lead to a lengthy boardroom discussion of the expense and dangers of IT integration projects. Supply chains and data sharing quickly lead to the realisation that even if the firm's own arrangements are top-notch, there are probably other firms in their ecosystem who may not have the same level of preparedness.

Having identified potential sources of disruption, the board must then quantify potential costs (internal and external) and assess the ability to recover from severe and plausible scenarios of operational disruption and compare these with the firm's stated tolerance for operational disruption. Where necessary, remediation plans must be put in place.

While no board member wishes to explain to the regulator why their firm was the first domino in the ecosystem to fall over, such far-reaching change needs to be carefully managed.  To implement these requirements firms will benefit from a pilot that enables them to develop an understanding of the steps that would be required.  This will be less disruptive and more beneficial than a firm-wide initiative.

However, the need to scale up means that firms will need to identify or acquire in-house "resilience capabilities". A key aspect of the output from a successful pilot project would be to identify exactly what capabilities are required and how they can best be embedded within the firm's business.

If you found this post of interest, you can subscribe and receive further posts by email. See the box on the right-hand side of the blog's screen or click here.