Top risks facing financial institutions

Episode transcript:

DAVID HILGEN: 2024 presents one of the most challenging environments for financial institutions. Faced with an uncertain economy, rapidly evolving technology, [and the] new way of working, financial services firms have their hands full when it comes to managing risk. Fortunately, they don't have to face these risks alone. Welcome to Future of Risk presented by Zurich North America. We explore the changing risk and resilience landscape and share insights on the challenges facing businesses to help you meet tomorrow prepared.

I'm David Hilgen. Today we're speaking with Alex Muralles, Head of Financial Institutions for Financial Lines at Zurich North America, and Stan Bernard, Head of Financial Institutions for Property and Casualty at Zurich. Alex and Stan, welcome to the podcast.

STAN BERNARD: Thanks, David.

ALEX MURALLES: Thanks, David. Good to be here.

HILGEN: So, the two of you work together at Zurich serving a similar customer base. Can you each explain your role? Alex, you [can] go first.

MURALLES: Yes, happy to. I lead the Financial Institutions team at Zurich North America, specifically within the Financial Lines product. What that means is Directors and Officers Liability, Errors and Emissions Insurance, Employment Practices Liability, Fiduciary Liability and some Cyber Liability.

HILGEN: Interesting… and Stan?

BERNARD: Yes, I'm Stan Bernard. I lead the Financial Institution's Property and Casualty practice and that includes what we refer to as “traditional P & C lines,” which include lines like Property, General Liability, Workers' Compensation, Umbrella, as well as some specialized niche coverages that protect collateral assets for financial institutions.

HILGEN: Okay. Well, that makes it clear now. So, speaking of your customer base, we use the term “financial institutions.” Who exactly are we talking about? Who are some of your customers?

MURALLES: Yes, that's a great question. It's definitely a broad term. When we say, “financial institutions,” we include a gamut of financial services companies. But the main buckets are banks — and that’s community banks, regional banks [and] money center banks — then the next bucket would be asset managers, which includes private equity, private real estate, REITs (Real Estate Investment Trusts) hedge funds [and] asset managers. The final bucket would be insurance companies, just like Zurich North America. We're in the business of ensuring some of our partners and other property and casualty and life insurance companies around the country.

HILGEN: Interesting. So, I want to start off with a big broad question. It's a two-parter if you'll indulge me. First, what are the biggest challenges facing financial services firms today?

BERNARD: David, I certainly agree that that's a broad question and it's really sort of multi-pronged, right? The financial services industry is dynamic and it faces really a number of challenges, particularly the Middle Market Financial Institutions space. But if I could try to sum it up into a few big challenges, I'd probably sum it up into three buckets.

[The] first bucket is the current interest rate environment, right? The uncertainty that exists for financial institutions. I'd certainly say the higher interest rates are impacting financial institutions differently, depending upon what sub-segment you're looking at within financial services. So, it's both a challenge and an opportunity for firms in this space.

The second challenge that I'd hit on is technology. The pace of technological advancements are happening just so quickly and there's a risk of becoming irrelevant if you don't adapt or keep up. So, there's a need for fast adoption in a complex setting when you sort of look at the backdrop of the regulatory space that these firms operate in, and Alex can certainly offer more from a regulatory perspective. But, you know, there's about 8,000 FinTech (financial technology) firms in the U.S. So, that tells you right there, [that] there's just a lot of technology-focused capital that's been poured into the industry over the last several years — so, traditional firms who just need to figure out a way to move quickly in this environment and adapt either through investing in buying these technologies or investing in buying actual FinTech firms themselves.

Then, the last bucket I would mention is just around talent. That’s another big challenge. Just attracting and retaining talent is a significant challenge for this industry. When you look at any financial institution, their number one differentiator is typically their people. Competition for talent just remains intense and it's just not showing any signs of slowing down. So, that's a big challenge for the industry.

The other thing I would add is that many firms [that] are within the financial services space are still trying to figure out how to improve employee engagement and maximize worker productivity in a hybrid work environment. So, I think this is a balancing act that many firms are still trying to get right as well.

HILGEN: I do want to touch on that later, but you talked about the challenges. What impact does all that you just described have on how these financial services firms view risk?

MURALLES: It certainly has a significant impact. It really requires companies to be able to adopt to the changing landscape and what that means is just continually reviewing risk management procedures [and] loss prevention. Then, applicable to us is really continually reviewing your risk-transfer insurance program, making sure it's addressing everything.

HILGEN: Okay.

BERNARD: If I can add something there, too. I think what Alex just hit on is critical. If you were to sort of think about all the categories of risk for any firm — let alone financial institutions — whether it's credit market liquidity, operational compliance or even reputational risk; all of these risks are becoming just increasingly sort of interconnected. So, it makes it really important to take a holistic view of your risk profile and identify partners that can help you craft integrated solutions to manage those risks.

HILGEN: Interesting. I want to take a deeper dive on the interest rate environment. I know everyone seems to be talking about interest rates and trying to figure out how rising and falling rates will affect them. What impact is the current interest rate environment having on financial institutions?

MURALLES: I don't think we know the full extent at this point. What we saw in 2023 was certainly the impact it had in the bank space and came from an area that was a little bit unexpected with bond holdings really impacting liquidity for many banks out there. We saw, I think, five insolvencies in 2023.

Now, what you're seeing with the banks, most recently with a bank that was in the Wall Street Journal, is just loan defaults and increased loan provisions and banks needing to shore up additional capital for what they see as potentially more defaults down the road. And that's just banking. We have a ton of real estate clients out there and REITs in particular, [and] you're seeing them cut dividends. You're seeing bankruptcies go up. So, what you're seeing is just a slowdown in M&A (mergers and acquisitions), too. Just everybody sort of shoring up capital in anticipation of a potential economic slowdown.

HILGEN: Thanks for that. There have been dire warnings of an impending economic recession for months. It's looking like the U.S. economy may make a soft landing after all this inflationary pressure, but fear of recession remains [and] that typically doesn't bode well for loan portfolios. So, what are you seeing from financial institutions as they navigate this uncertainty?

BERNARD: Certainly, there's a reduced demand for loans in this environment and that has an economic impact on lenders. From a property/casualty perspective, we see shrinking payrolls for some of our lenders that focus on the mortgage space and, of course, that has expense implications. So, that's why you see the shrinking payrolls. Also, think [of] when it comes to protecting collateral assets, that becomes that much more important. I think Alex was talking about loan provisions, etc. But if you sort of walk that through, you end up with lenders that actually have to ensure and manage collateral assets that they've taken over via foreclosure or repossession.

So, these assets could be residential assets, commercial assets or even vehicles in some instances. Given the economic environment, we would expect to see some borrowers struggling with loan covenants and payments, etc. So, financial institutions just need to think about how they will protect those collateral assets once they take possession of them. Having a plan in place with vetted third-party vendors is really critical. You want to develop a maintenance plan that includes regular inspections, appropriate security, as well as access to buildings, particularly for those commercial properties.

It's also important to make sure that the appropriate risk management program is in place that covers sort of the full spectrum of that asset, right? From loan impairment or lack of underlying insurance to actual repossession or foreclosure. So, those are some of the things that financial institutions are sort of navigating and working through in this environment.

HILGEN: It seems like the risk never goes away; it just changes. It just evolves, it seems.

BERNARD: Yes, that's for sure.

HILGEN: So, I want to pivot over to technology here. Tech is changing rapidly across all industries, and I'm not just talking about artificial intelligence, although that's part of this evolution. How are financial institutions leveraging technology to accelerate their digital transformation targets, Stan?

BERNARD: There's certainly a race towards digital transformation across many sub-segments within financial institutions. If you think about the asset management space, for example, firms are leveraging technologies like robo-advisory services, which provide automated investment advice by analyzing customer data and offering investment recommendations based off of that.

HILGEN: Sure.

BERNARD: There's varying degrees of those types of technologies that are being implemented. And the common theme is the ability to access more customers in a more personalized, differentiated way and doing all of that more efficiently. So, it's really important for financial institutions to take full advantage of that, right?

We talked about the rapid pace of play, if you will, but while these technologies are transforming the ability to offer products and services with speed and efficiency in a customized way. These technologies do create some additional dependencies on technology service providers. So, it's really important for financial institutions to not only sort of develop strong business continuity for their own operations, but it's critical that they understand the business continuity plans of the vendors that they're working with because it has such an outsize impact on their operating models in this environment.

HILGEN: Interesting. So, Alex, are there any regulatory concerns associated with this digital transformation?

MURALLES: Yes, absolutely. When I hear technology, [the] first thing I think about is cybersecurity and the impact that has on privacy and personal information. Then, fraud protection, the protection of money and securities, and that creates compliance risk because there are so many privacy laws out there at a state and federal level. Most recently, you just saw the SEC passed the Cybersecurity Disclosure rule that effectively requires organizations to disclose their risk management and governance around cybersecurity. So, definitely a high bar for organizations from a regulatory standpoint when you think about technology and digital transformation.

HILGEN: Interesting. I want to talk about [something] Stan touched on earlier about the hybrid work environment and its impact on financial institutions. I know the move to hybrid work was well underway before COVID-19, but the pandemic certainly accelerated the move, making hybrid work — we're talking like two days at home, three days in the office — the norm for many office workers, including those in the financial institutions industry. What do you see are the biggest challenges in financial institutions from this shift to hybrid work?

BERNARD: First of all, I agree it appears to be sort of a structural shift in terms of how we work and where we work. But firms are really able to access broader pools of talent, right? We talked about talent being one of the big challenges facing this industry and the ability to offer a hybrid work environment certainly helps the effort and attracting sort of top talent. There are also some things to consider. When you think about a work environment and when we think about Workers' Compensation which is one of the solutions that's offered on property/casualty side. There are things that you would expect to be sort of set up in a work office setting from an ergonomics perspective in terms of how your desk is set up and things of that nature that may not be as structured in a home working environment, right? That can lead to workers' compensation loss.

There are pluses and minuses to both sides of it, right? Because there are some advantages [with] things like accidents in terms of commuting — car accidents, things of that nature, right? So, you tend to see less activity in that space and obviously there are advantages from a financial perspective for firms through cost savings. Reduced office space [and] footprints reduces overhead expenses, which is also having an impact on the commercial real estate space indirectly as well. So, I think it's a situation where it's not a “one size fits all,” but firms are sort of figuring out and navigating how best to leverage a hybrid work environment.

HILGEN: Yes, I'm thinking about the impact on the mental health of my dog, for instance, who is now never alone because I work from home.

BERNARD: But that's a good point that you bring up. I mean, mental health is something that we see come through on the workers' compensation side that can have an impact as well, in terms of the well-being of an employee being hybrid but as well as being sort of isolated for extended period of time too, right? So, it cuts both ways.

HILGEN: Sure. So, I want to talk about some of the other risks, perhaps to just to go a little bit deeper, like for instance, cybersecurity is one of the top risks I imagine [that] is a concern for people in a hybrid environment. What are some of the other concerns?

MURALLES: I can take that one. You know, being in insurance, what comes to mind in this new work environment is really Employment Practices Liability. You're seeing in the workplace, four or five different generations working in an office all with the different desires and thoughts on what the workplace should look like. That puts a tremendous burden on the employers and meeting all these demands. And what that potentially creates is risk around employment practices and safety and in our portfolio in particular really, we're coming off the heels of the “Me Too” movement and you would think you'd see a decrease in employment practices liability claims. But in fact, that's not really the case. It continues to be a very active area for us in terms of loss and in seeing litigation around wrongful termination, discrimination, retaliation. So again, [a] new work environment [and] people back in the office … it's a big responsibility for the employer to make sure they're creating the right environment for their employees.

HILGEN: Excellent. Well, Alex and Stan, I want to thank you both for joining us today on Future of Risk.

BERNARD: Thanks for having us on, David.

MURALLES: Thanks so much, David.

HILGEN: And thanks also to our listeners. This has been Future of Risk presented by Zurich North America. If you like the show, leave a comment or review wherever you get your favorite podcasts, or drop us a note at media@zurichna.com. We hope you join us for future episodes.