LSM: Stability and flexibility to protect European financial institutions

How can a company offer stability, continuity and flexibility to its customers at the same time? That's the question the financial institution insurance industry has to answer every day, and few are able to provide answers as effective as Liberty Specialty Markets (LSM).

On the one hand, its clients are banks, asset managers or even other insurers that work in highly regulated markets where operational security and financial solvency are valued.

On the other hand, it is a sector highly impacted by new technologies, subject to systemic events and where new business models emerge at all times. As if that were not enough, financial institutions are also notably exposed to macroeconomic and geopolitical uncertainties, of which there is no shortage today in the world.

"The great challenge for the financial market is to learn to live in a scenario of permanent uncertainty," says LSM's Director of Financial Institutions Underwriting for Europe, Jorge Chao. "These are concerns that we, as an insurance company that is part of the financial market, also share."

There is no doubt that Chao knows what he is talking about. In more than two decades working in the segment, the executive lived through a wide range of situations that shook European financial institutions. An example was the global crisis that followed the bankruptcy of Lehman Brothers in 2008 and the consequent banking concentration in Spain. Next, the emergence of digital banking, the Covid-22 pandemic and the explosion of cyber risks were seen. And more recently, the sector had to navigate a long period of quantitative easing policies followed by an era of monetary tightness the likes of which has rarely been seen.

One lesson that became clear to Chao, after so many experiences, is that in the midst of volatility, insurers cannot stop innovating, since their customers in the financial market do not have the option of accommodating either.

"As insurers of financial institutions, we must adapt very quickly to the needs and demands of our customers, who are in a phase of technological revolution," says Chao. "For example, we are introducing very clear subscription parameters for payment platforms, which to date were addressed very tangentially and by very few subscribers. And we have to be able to give a response to the crypto market."

The crypto industry illustrates well the challenges that the segment often faces. Its rapid growth does not stop despite the many controversies that accompany it and the dramatic ups and downs of the prices. As a result, banks and fund managers are becoming more involved in the sector, even if they are not absolutely sure how that market will evolve. Clients need their insurance partners to be stable and reliable however the market evolves.

"We bet on this segment because we have to go hand in hand with our customers, and they are demanding it from us," says Chao. "What we have to do is guarantee the viability of financial assets that do not have any type of underlying, something that we are not used to from the insurance world. But we are looking for a technical solution that guarantees the stability and continuity of these operations in the mid term run; an answer for the crypto market that lasts 3 months is not a viable option."

The crypto market is not LSM's first rodeo and it won't be the last. The commercial and specialty insurance arm of Liberty Mutual, LSM has been working with European financial institutions for more than 20 years and continues to invest in the expansion of its brand in the region. Today it is present in six countries (Germany, Italy, Holland, Switzerland, France and Spain), and new offices are being set up in Belgium and Norway, giving continuity to an ambitious investment plan until 2030 on the continent.

Together with Chao works a team of more than 20 underwriters distributed throughout Europe. The emphasis of his work is on ensuring that financial institutions have access to global insurance capacity, while prioritizing the stability of placements. To this end, LSM is also investing in the introduction of new work technologies, such as artificial intelligence, with the aim of automating repetitive tasks and freeing up more time for underwriters to effectively understand their clients 'needs. Chao notes that LSM's philosophy for the financial institution segment prioritizes flexibility in the services provided to policyholders. And, to know what the market wants, it is necessary to be in permanent contact with insurance buyers.

"We  are by definition a very customer-centric multi-line operation. Every underwriter has to be prepared to respond to all needs of  our type of customer."

LSM works in the segment with a differentiated approach according to the size of the companies and the markets where they operate. In France, for example, the figure of independent financial advisors, many of whom are small companies, are decisive actors in the market, while in Spain they have a much smaller role. Small innovative companies such as Fintechs enter  within its risk appetite, as well as large banking and fund management groups in the main markets of the region.

The products offered include Bankers Blanket Bonds, professional liability, D&O coverages and insurance for public offerings of securities. It is a wide range of products that continues to evolve as the financial market itself is transformed, exposing companies in the sector to new types of risks. Likewise, the offices located in the different countries have local capacity, thus counteracting the volatility of foreign markets, and sufficient autonomy to implement the LSM philosophy according to the needs of each country.

"In all our offices there is the same rating process and the same underwriting guidelines. We try to ensure that uniformity across Europe, which in my view is key to serving the financial sector," says Chao.

He adds that, , LSM offers the market a reliable presence certified by its long-standing commitment to the European market. Despite the many crises experienced by the financial sector during previous years, the company never stopped offering insurance capacity for its customers. It also did not stop doing so during the long  hard market of the last decade, even though several of its rivals became extremely selective in their risk-taking. . And LSM remained active in the recent soft market, when margins dwindled due to high competition in countries such as Spain.

"Our performance is a long-term commitment that prioritizes the needs of the client and the broker, as well as the community we serve," says Chao. "It is a position that is endorsed by the corporate values of the Liberty group. The fact that we are a mutual allows us to cultivate relationships in the medium and long term, without the pressure of having to deliver short-term results to shareholders. We take it frankly to the extreme, and there are clients who are still with us after 20 years."

The financial sector recognizes such constancy and reliability and will take it into account now that, once again, market conditions are changing. Chao observes that the financial institutions segment is currently experiencing a process of tariff softening that does not correspond to the structural conditions of the market, which may have severe consequences in the future.

"There is a brutal contradiction between a macro situation of uncertainty worldwide and an extremely soft market," says the executive. "We are experiencing a soft market that comes from an excess of supply that derives from the  apparently good operating results of the sector in recent years. This has led to the emergence of new capabilities, of new investors looking for a short-term return."

It is a process widely known by the market. The inflow of opportunistic capital ends up unbalancing the accounts of insurers and, in extreme cases, motivates the relaxation of the underwriting process. The most prudent insurers know that such a trend is not sustainable over time and slow down the growth of their portfolios to protect their technical results.

For those that bet on too aggressive underwriting, the inevitable market correction will be painful, and many will end up withdrawing capacity from the segment. In the end, it is the customer who suffers, who will have to remake their programs under less favorable conditions, not to mention the risk of having entrusted their programs to insurers that will not be available to pay eventual claims.

"In certain market segments, today, premiums are already clearly insufficient. Actuarial departments are warning us about this phenomenon after updating predictive models, incorporating risks that did not exist 5 years ago," says Chao. "It is necessary to redirect premiums to their technical levels in accordance with the new predictability parameters of the models."

That is why LSM gives prominence to the quality of technical underwriting. When premiums and conditions are adjusted to the client's risk, Chao says, the result is a stable and long-lasting relationship that benefits both parties. And stability is essential for companies navigating a market where risks are increasingly evident, as is the case in the financial sector.

Chao observes that the industry today faces a series of increasingly overwhelming challenges, such as regulatory risks. Financial institutions have never had to adapt to so many European directives at once, and others are known to be on the way. This means that companies must implement robust systems of cybersecurity, data protection, control of artificial intelligence technologies, sustainability and other related issues.

These are welcome rules because they increase consumer protection, but they also create new exposures for financial institutions that need to be transferred to the insurance market. It is a process that worries and that is only getting worse, warns Chao.

"Regulators continue to focus on strengthening their consumer protection rules which can lead to higher compliance costs and a potential increase in legal risk," he says. "We are already seeing in Europe even the appearance of litigation funds dedicated to this specific niche."

He highlights that another major risk for the sector is the volatility of interest rates at the global level, which especially affects institutions that have a balance sheet structure that is too monolithic and without the diversification necessary to mitigate changes in monetary policy. This was what victimized, last year, banks such as Silicon Valley Bank in the United States, or Credit Suisse in Europe.

To all these elements must be added the increase in intensity and frequency of financial fraud carried out through the Internet. Financial institutions, especially banks, are one of the most desired targets for cybercriminals, and Chao notes that cyber risk exposure levels are much higher today than they were  some years ago.

 As a conclusion, there are many threats faced by a systemic sector of the economy. Amid so much uncertainty, financial institutions know that they can count on LSM's support to mitigate their exposures to a wide range of risks.

"Despite the successive crises since 2008, our commitment has always been to behave in a countercyclical manner, minimizing the impact on our customers," concludes Chao. "“One couldn’t be a leader in the insurance market for financial institutions in Europe for 20 years, unless our clients and brokers were absolutely convinced of the good work we are doing."