Over the past few years, ESG was all the rage. Proponents, opponents, and everyone in between seemed to be talking about this topic on an endless loop. That was certainly the case within the financial and executive liability insurance industry.
Now, it appears to be AI’s turn to walk in the sun. Flaunting its efficiency, AI has reduced the current hot topic from three letters down to two, virtually surpassing ESG as the most talked about subject in the insurance industry. If you’ve attended an insurance conference, looked at a newsfeed, or scrolled through LinkedIn, you’ve likely encountered AI-related content.
Be that as it may, there is good reason for this topic to be at the forefront of insurance discussions. The benefits of AI, particularly generative AI, are seemingly endless, but the associated risks are complex and evolving, and their impact on an organization’s risk profile cannot be taken lightly. As a risk transfer mechanism, insurance should be incorporated into AI discussions to determine what impact, if any, these risks may pose to an organization’s insurance portfolio.
The following commentary analyzes AI through the lens of insurance, specifically highlighting key issues privately held asset managers should consider when reviewing their financial and executive liability insurance programs.
Judging by the recent hype, one would think AI was invented last week. However, trading systems, robo-advisors, legal and compliance, research and analysis, marketing, and customer service are just a few areas where AI has already been incorporated, to varying degrees, within the asset management industry. What has changed, and what will continue to evolve, is the advancement and sophistication of this technology and its wider proliferation across all industries, including asset management.
To remain competitive, it is expected that asset managers will continue to incorporate AI even deeper within their operations. Further, AI’s potential to create greater value for investors will most certainly become an avenue for differentiation within the industry. With these advancements, however, comes increased risks, including regulatory scrutiny over how AI is being utilized and deployed, and what statements are being made to investors regarding its benefits.
Within the US, regulatory focus has noticeably increased over the past year. For example, in July 2023, the SEC released a proposal to address conflicts of interest where analytics, including AI, are used to make investment predictions. Then in December 2023, the Wall Street Journal reported that the SEC was conducting sweeps of advisers, seeking information on marketing, algorithmic models, training, compliance and oversight. Further, the White House issued an Executive Order outlining AI best practices, while certain US states and European countries enacted and/or proposed laws or regulatory frameworks focused on these risks. As AI continues to evolve, regulators will likely take additional steps to protect investors, especially those at the retail level.
The UK and the European Union look set to adopt different approaches to the regulatory oversight of AI. The European Parliament have recently approved the EU AI Act which will seek to introduce a comprehensive regulatory framework for the use of AI which will rate the risks associated with AI platforms, imposing strict requirements on those deemed to carry higher risks. Firms generally will be required to adhere to higher standards of data governance and risk management as the EU looks to set the standard for future AI regulation.
The UK Government, however, have favored a less prescriptive, outcome-based approach which is underpinned by five core principles: safety; security and robustness; appropriate transparency and explainability; fairness; accountability and governance; and contestability and redress. Their aim is to strike a balance between regulatory oversight and promoting innovation, however asset managers will still have to adapt their governance frameworks to account for the nuances of AI and machine learning technology, especially with respect to individual accountability under the Senior Manager and Certification Regime (SMCR).
Given all this attention, it was not much of a surprise when the SEC announced in March 2024 that it brought charges against two advisers alleging several AI-related violations, including “AI washing”. This latest use of “washing” generally refers to the alleged false and/or misleading statements regarding the use and value of AI within the investment management process. While the $400,000 penalties imposed upon the advisers may seem relatively tame, the SEC’s actions in this matter provided useful insight into how the regulators might approach this issue more broadly moving forward, and what advisers should consider before promoting their use of AI.
While the benefits of AI are clear, there are numerous risks that must be taken into consideration. Though these will most certainly evolve, examples of AI risks applicable to asset managers include, but are not limited to, the following:
As with all scenarios, the applicability of the referenced insurance programs will depend on the specifics of the particular claim and the language within the actual insurance policies.
While each insurer will have their own perspective, and each insureds’ risk profile is unique, asset managers should be prepared to address AI-related questions as part of their financial and executive liability insurance renewals. Areas of interest may include, but are not limited to, the following:
The opportunities and benefits of AI are extensive, but it is critical that firms have a close eye on the risks and the evolving regulatory and legal landscapes applicable to AI. During the renewal underwriting process, it is important for asset managers to demonstrate their understanding of AI risks and how they may affect both their firm and their clients. More importantly, it is critical to clearly communicate the policies and procedures in place to mitigate those risks. In doing so, asset managers are likely to achieve a more favorable outcome when their insurance programs renew.
