High Profile Frauds And Their Impact On Insurance Cover. Damian Lynch Zurich Head of Financial Institutions, Asia Pacific

Transcription

1 High Profile Frauds And Their Impact On Insurance Cover Damian Lynch Zurich Head of Financial Institutions, Asia Pacific CSPS

2 Outline Electronic and Computer Crime Unauthorised Trading Cover

3 Outline Electronic and Computer Crime Unauthorised Trading Cover

4 Stanley Rifkin

5 Rifkin s Fraud Independent Computer Services Contractor In 1978 Rivkin was hired to work on the computer systems of Security Pacific National Bank of Los Angeles Discovers Security Weakness Pacific National used a nationwide electronic wire network for fund transfers US$20b per week was transferred from a special room at the bank

6 Rifkin s Fraud Obtains Access To The Wire Transfer Room Access to the room was limited, but because he was known by bank employees he was granted access Memorises That Day s Security Code The code was changed every day, but employees left it posted on a wall inside the wire transfer room

7 Rifkin s Fraud Calls and Requests Transfer of US$10.2m Rifkin pretended to be a fictitious employee named Mike Hansen Requested the transfer to a Swiss Bank account Buys Diamonds Uses the proceeds of the fraud to buy millions of dollars of diamonds from a Soviet diamond trading company Smuggles them into the USA

8 Rifkin s Fraud Is Apprehended Trying To Sell The Diamonds In The US One of his intended counterparties tipped off the FBI Receives an eight year jail sentence The Bank Actually Made A Profit Pacific National recouped $2m And were able to sell the diamonds for $13m, giving them a $5m profit

9 Coverage Issues At The time Data Processing Contractors Were Not Employees The typical Bond at the time would have covered this fraud if he had been an employee But data processing contractors were excluded There Was No Cover At All For Third Party Computer Crime For fraudulent acts of non employees, coverage was on a defined perils basis Computer crime was not included

10 The Conditions Which Led To The ECCP Funds Transfer Converts From Teletype To Computer Computer Criminals Start To Exploit The New Systems Customers Seek Coverage For The New Exposure

11 The Blade: Toledo 16 November, 1981

12 The Blade: Toledo 16 November, 1981 Extending the coverage to the protection of secret information in the data banks of industrial corporations is still some way down the line after we have gained more experience.

13 The Policy Wording Has Not Changed Much Since 1981 But The Coverage Potentially Has Bond Covers forgery or fraudulent alteration of specified documents, basically documents that have value ECCP Covers manipulation of electronic data In 1981 this was a coverage limiting term Now basically every document is in electronic form

14 Outline Electronic and Computer Crime Unauthorised Trading Cover

15 Outline Electronic and Computer Crime Unauthorised Trading Cover

16 Nick Leeson

17 Leeson s Fraud Was manager of a trading desk at Barings Securities Had limited trading experience, but took an exam allowing him to trade on the Singapore Mercantile Exchange (SIMEX) alongside his staff Is Authorised For Two Types Of Trades Futures and options for clients Arbitrage of pricing differences between NIKKEI futures traded on the SIMEX and the Osaka Exchange

18 Leeson s Fraud True Arbitrage Is A Low Risk Low Return Strategy Arbitrage means the simultaneous purchase and sale of an asset in order to profit from the pricing difference Controls Were Inadequate Leeson oversaw both trading and the back office There was little oversight of his trading activities

19 Leeson s Fraud Immediately Began Making Unauthorised Trades Instead of arbitrage, Leeson began taking outright leveraged bets on the direction of the market. Used an error account ; excluded it from management view The Strategy: Doubling 1992 had lost GBP2m 1993: GBP23m 1994: GBP203m 1994 false profit: GBP28.55m

20 Leeson s Fraud In January 1995 the Kobe Earthquake Hit Leeson had placed a straddle, a bet that the market would not move significantly overnight The market fell massively The Fallout Left a note that said sorry and fled Singapore Barings collapsed with losses of US$1.4b

21 Coverage Issues At The Time Unauthorised Trading Was Not Covered Coverage applied only where the trader made an improper financial gain, which does not include bonuses and salary increases

22 Conditions Which Led To Unauthorised Trading Cover High Profile Rogue Trading Incidents Customer Awareness Of Lack Of Coverage Increases Customers Seek Coverage For The Exposure

23 Business Insurance 12 October, 1997

24 Business Insurance 12 October, 1997 [Existing policies] do not cover the financial institution in cases such as the one in 1995 when Barings lost US$1.4b through the actions of rogue trader Nick Leeson. While Mr Leeson s trades were unauthorised the bank was not protected because he had not exceeded his personal trading limit to make a profit for himself, but rather to make up earlier losses. [The policy] will fill this gap.

25 Subsequent Unauthorised Trading Scandals

26 The Product Has Had A Chequered History Initially There Was Little Take Up Expensive premiums Separate limits, not enough to really mitigate the exposure Then Underwriters Loosened Terms Premiums dropped Offered the cover as part of the ECCP cover Brokers could place US$150m

27 The Product Has A Chequered History There Were Few If Any Losses Paid The institutions who had the issues were not purchasers of the cover The GFC Impacted The Market Underwriters backed away from the cover With PI and Bond premiums rising, some banks discontinued