The Silicon Valley Bank (SVB) collapse sent shockwaves through the financial industry and brought public awareness of risks in the financial system to the forefront. This failure will likely impact the D&O insurance market; however, whether that impact is enough to reverse the current softening trend and bring about higher pricing and reduced capacity remains to be seen.
Regardless of market impact, the lessons learned from this collapse reveal best practices that financial institutions (FIs) and other firms should consider in the context of their D&O coverage and overall risk management.
Early indicators suggest that SVB’s collapse was the result of a perfect storm of events, set in motion by a faster than expected rise in interest rates. The bank had concentrated exposure to rising rates on both sides of their balance sheet, which magnified its impact.
First, SVB had a deposit base of tech startups that had exploded in size and scope as a result of easy money in the low interest rate environment. This led to rapid growth at SVB and an influx of deposits they had to place somewhere. That takes us to the asset side, where SVB invested a considerable amount in long-term U.S. government bonds. These securities lost value with every rate hike and resulted in nearly $16 billion in unrealized losses of held-to-maturity (HTM) securities in Q3 2022 (relative to book equity of $15.8 billion).
Having a deposit base that almost entirely exceeded the $250,000 FDIC limit (estimates suggest this was around 93% of total deposits) along with the interrelated nature of the tech startup and venture capital (VC) world, the ease of customers transferring funds, and the rapid fire spread of news via social media, the bank was, in hindsight, especially vulnerable to a run.
Projected Market Impact – Rates/Capacity, Reinsurance, and Underwriting Scrutiny
Despite the high-profile nature of SVB’s failure, there has not been immediate movement in the D&O market. The reason is likely that there is still plenty of capacity, with new entrants and MGAs looking for investment return, particularly as global IPO volume continues to fall. Additionally, there is still faith in the financial system, thanks in large part to the Federal Reserve’s fast action. Insurers are cautious but are taking a wait-and-see approach as additional action and guidance develops.
With that said, hardening remains a likely possibility in the market. D&O rates for FIs—particularly community banks—are insufficient to reflect the systemic nature of the risks. It is not uncommon for some banks to see D&O rates that are less than a personal homeowners’ insurance policy purchased by the directors and officers of those banks.
In the coming weeks and months, it will be important to watch for any established D&O insurers exiting the banking sector and whether they are replaced by new capacity. Also, keep an eye on whether reinsurers begin expressing reluctance to take on books with banking exposure, which would impact the limits and capacity primary carriers can provide.
Increased underwriting scrutiny of banking operations is also expected as underwriters are likely to begin examining both the asset mix and deposit base in a different light—not just in terms of credit quality of assets (U.S. government bonds are among the least risky securities available), but in terms of duration of assets, as well as potential “flight” exposure of the deposit base.
Now there are additional elements to consider, such as the extent of uninsured deposits as well as diversity in types of depositors (i.e., limited to one sector such as tech or energy). And while SVB’s asset issues stemmed from its securities portfolio, many underwriters are now looking at banks’ largest asset class, their loan portfolios, for potentially vulnerable concentrations such commercial real estate and wondering if that’s the next shoe to drop.
Finally, what was first seen with the Reddit meme stock fluctuations was reflected in many ways with the SVB run, and that’s the element of social media risk facing public companies. Headline risk has been top of mind for carriers in recent years, and the social media element may add to that exposure and volatility.
Impacts Beyond the Banking Industry
Ripple effects from SVB may be felt beyond banking to other FIs such as fintechs and insurtechs, which have relied on regional banks like SVB and VC firms as critical funding sources. VC firms themselves aren’t immune to these macro issues as indicated by record dry powder from lack of quality investment options, and with fund vintages exposed to the recent troubles seen in the startup space.
Taking it a step further, SVB and the ensuing bank industry turmoil highlights the delicate state of even non-FI risks as the bank’s startup customers had been withdrawing funds to cover their cash burn long before the actual bank run, which is why SVB needed to raise money to cover the losses on their investment portfolio in the first place.
This trend is also apparent with the notable uptick in bankruptcies in Q1 2023. Credit is expected to only get tighter, so it is reasonable to expect financial distress trends to continue and potentially worsen.
Lessons Learned for Financial Institutions
There are several risk-management lessons for FIs that can be learned through SVB’s collapse, including how quickly money can move. Customers withdrew an estimated $42 billion within a single day – almost a quarter of the bank’s total deposits – leading to the second largest, and quickest, bank failure in U.S. history.
In today’s digital banking world, the relationship between a bank and its customers is no longer as “sticky” as it once was. And it’s not just brokered deposits that are a concern—any customer can move their money anytime to anywhere. With rising interest rates, customers may be increasingly inclined to move for more competitive rates elsewhere, and with the concerns brought on by SVB, businesses are increasingly turning from banks to money market funds.
Criticism around regulation has also been leveled, particularly that rolling back some parts of the Dodd-Frank Act in 2018 was another cause of SVB’s collapse. However, the bank would likely have passed the original Act’s stress tests because they were designed to replicate an economic turndown, rather than the rising interest rate environment that occurred. Regulation and oversight may be lagging in addressing some of the modern risks we’re seeing with the recent bank failures, including digital banking and the quick movement of money, as well as cryptocurrency.
Risk Management Best Practices
When companies fail, shareholders look to board members and officers who made decisions and hold them responsible. Predictably, following SVB’s downfall, a securities class-action lawsuit was quickly filed against the bank board and chief executives.
From these lessons, there are several risk management best practices banks and other companies should consider to improve their risk profile:
- Assess the board. Companies should review both their current board makeup and their director appointment process to ensure that the board has the collective financial experience and acumen needed to perform its oversight role. This will help in decision-making for key financial service providers (such as banking relationships and how to best manage liquidity).
- Appoint a designated risk officer. Amazingly, SVB did not have a chief risk officer (CRO) for the last eight months of 2022, even as the economic storm swirled around it. CROs need to assess not just the quality and performance of the bank’s own portfolio but look deep into the organization at the quality and qualifications of executives and management, structures, and safeguards, as well as relationships with vendors, partners, investors, and regulators. While this is most obvious for banks and other FIs, companies across a variety of industries could benefit from having someone with designated responsibilities and accountability for assessing and mitigating the firm’s exposure to micro and macro developments.
- Diversify. A key factor in Signature’s collapse was its concentration in crypto, and SVB’s collapse was its near-singular focus on tech companies, startups, and the VC investors who influence them. Risk is best mitigated by diversifying assets and customers, which are also two key areas of focus for regulators and underwriters. Just as you wouldn’t want your entire revenue stream to come from one or a small concentration of customers, you might not want your firm’s assets at risk from a single investment or institution holding your assets.
- Maintain a preemptive PR strategy. Social media was a big player in the run on SVB, underscoring the need to control the narrative in a crisis. It’s essential that any firm, and especially a publicly traded FI, works to increase its social media presence and interact with its customer base to develop a trusted relationship before any concern arises.
The Role of D&O Coverage
Although the need for D&O coverage is well-understood on the public company side, it can still be difficult for retail agents to demonstrate the need to private companies, even ones with higher risk in the FI space. When a bank fails, investigations and lawsuits will follow, and without proper coverage, directors and officers are at personal risk, not just from investors and depositors, but from employees, vendors, business partners, and of course regulators.
As the D&O market evolves for banks, it’s important for retail agents and brokers to partner with a wholesaler like Amwins that understands the market and has the expertise to navigate the changes and challenges that will occur.