Financial institutions looking to navigate operational hazards effectively should focus on not just mitigating risks but strategically optimising insurance to safeguard the institution's operational integrity and financial stability. 

 

This approach fosters a culture of vigilance and preparedness, essential in an era where operational risks are increasingly complex and pervasive, according to Yolla El-Khoury, CEO of ACE Gallagher Holding WLL.

 

Financial institutions are perpetually at risk, navigating a landscape rife with operational hazards. As these risks evolve, so must the strategies to manage them, particularly through robust insurance programmes. 

 

Spectrum of threats

Operational risk within financial institutions encompasses a spectrum of threats from internal fraud to cyber breaches, each requiring nuanced understanding and strategic coverage. The goal is to mitigate risks while optimising insurance in order to secure comprehensive protection and operational resilience.

 

A growing area of concern is the increasing risk of cyber incidents. As detailed in the Global Financial Stability Report 2024, the risk of severe loss from cyber incidents is on the rise. Such losses could hamper companies’ funding efforts and even put their solvency at risk. Since 2017, these losses have increased fourfold to $2.5 billion. The indirect costs, including damage to reputation and the expenses associated with security enhancements, are considerably higher. This highlights the critical need for robust cybersecurity measures and comprehensive insurance coverage that includes forensic investigation costs and crisis management.

 

Understanding internal fraud and liability

Another significant threat to financial institutions is internal fraud, which remains one of the most prevalent and damaging risks for financial institutions. These institutions often face significant losses due to dishonest employees who exploit trust and procedural lapses. For example, in one case, a bank's head teller, over 35 years of service, embezzled $10 million by manipulating cash records and leveraging his senior position to avoid scrutiny. This incident underscores the importance of rigorous internal controls and vigilant oversight.

 

Further exacerbating the issue is the transient nature of the workforce in regions like the Middle East, where expatriates frequently fill positions, often resulting in high turnover rates. This mobility can lead to delayed detection of fraudulent activities, as seen when dishonest employees flee after committing fraud. Implementing strict verification processes and fostering a culture of accountability are critical measures to mitigate such risks.

 

In addition to internal fraud, professional liability is another area where financial institutions must be vigilant. Errors and omissions, alleged wrongdoing, and breaches of managerial duties can expose institutions to substantial legal and financial repercussions. For instance, a bank was found liable for a $21 million loss due to an employee's misrepresentation in a commercial loan agreement. Such cases highlight the necessity for comprehensive Professional Indemnity coverage to protect against claims arising from negligent or dishonest actions by employees.

 

Exploiting system defects and cyber vulnerabilities

System defects and cyber vulnerabilities present another layer of operational risk. As financial institutions increasingly rely on digital platforms, the potential for exploitation by both internal and external actors grows. In one notable case, a customer exploited a defect in a bank's cross-currency transfer system, resulting in a $6 million loss. The bank's system failed to update exchange rates correctly, allowing the customer to transfer funds at inflated rates.

 

Cyber criminals also pose a significant threat. In one case, a group of hackers gained access to a bank's ATM network, installing malware that bypassed withdrawal limits and allowed fraudulent transactions totaling over $500,000. This incident underscores the critical need for robust cybersecurity measures and comprehensive coverage that includes forensic investigation costs and crisis management.

 

Aligning insurance with operational risk

Optimising insurance coverage requires a strategic approach that aligns with the specific operational risks faced by financial institutions. Clarity and adequacy are two pillars of this alignment.

 

Clarity involves understanding what is covered, what is not covered but could be, and what cannot be covered under existing policies. Financial lines programmes are complex, often involving bespoke wordings tailored to specific risks. For example, cyber risk coverage must address direct financial loss from cyber fraud, costs for forensic investigations, and liabilities arising from privacy breaches. Mapping these risks to insurance coverage ensures comprehensive protection.

 

Adequacy requires stress-testing insurance programmes against potential exposures through scenario development and risk mapping. Benchmarking against peers and ensuring that the coverage provided by underwriters meets acceptable security ratings are essential steps. Moreover, the insurance programme should be well-understood by all stakeholders, ensuring that it can be effectively accessed and utilised in the event of a claim.

 

A robust insurance programme should not only provide coverage but also demonstrate its effectiveness in paying claims. This involves detailed due diligence and regular reviews to adapt to evolving risks.--TradeArabia News Service