Financial R&R: What Are the Risks and Exposures of Crypto and Digital Assets?

Intro (00:00):
Welcome to Financial R&R, a show dedicated to financial insurance and risk management solutions and trends shaping the market today. Here are your hosts, Ron Borys and Ryan Farnsworth.

Ron Borys (00:14):
Well, welcome everyone. This is Ron Borys. I'm here with Ryan Farnsworth, and this is the Financial R&R. Today on our show we have Drew Logue, Drew leads our cryptocurrency and digital assets practice within our financial institutions business at Alliant. And as we all know, crypto digital assets have been around for a while now. Certainly have gotten a lot of attention probably in the last 12, 18 months with, some of the headline grabbing sort of news regarding failures of firms and some other allegations that I think even recently today there was a group of executives that just pled guilty to some charges. And as we know, right, unfortunately, fraud exists in all industries, right? We've seen this for 20, 30 years and we went through the WorldCom and Ron Tyco issues back in the early 2000’s, which certainly left its mark on the insurance industry.

Have had plenty of insider trading issues in financial institutions, whether it's hedge funds or, otherwise broker-dealers over the years. So, listen I think given the fact that digital assets blockchain sort of technology and cryptocurrencies is still to date, somewhat unregulated, although I think every day that goes by the industry is sort of being presented with some new challenges on the regulatory front. We're really happy to have Drew take the reins and lead this for us. And I know he's been really busy over the last six or seven months with just a lot of different opportunities that have come in from a minor perspective and so on. So, Drew, welcome to the show and thanks for joining Ryan and I.

Drew Logue (01:36):
Hi guys. Thanks for having me. I appreciate the introduction and we do have some top-notch clients that are not involved in the fraud that you've seen in the news and prospects alike. So, definitely happy to talk about the insurance placements that we've already sorted through and as well as some potential placements down the line and kind of walking you through different risk exposures and everything that these clients are seeing because they're different than your traditional financial exposures.

Ryan Farnsworth (02:00):
And Drew, it seems like we've seen this game before, right? When hedge funds and private equity funds were going through their first round of regulation 15, 20 years ago, the insurance market didn't quite know what to do with them. And how to price for those risks. And it seems as though the regulators tried to put off addressing the risks and exposures of digital asset and crypto firms for as long as they possibly could. But clearly, the industry has their attention now. So, as we at Alliant try to help our clients find that more rewarding way to manage risk, what are the risks and exposures that crypto and digital asset firms face that even before we think about an insurance program, what are some of the risks and exposures that they're facing?

Drew Logue (02:41):
Sure. To start with, it really depends on their operations, Ryan. A bitcoin miner is going to have different risk exposures than technology company operating on the Ethereum blockchain. So, all of these companies face D&O exposures across all blockchains. They're still facing a D&O exposure that our traditional financial companies are seeing. But carrier appetite is very restrictive compared to what we're seeing now in the hedge funds. I can't speak to when they were first getting that go around and the regulatory landscape has a lot to do with that. And then as you kind of work through the other management professional liability sections, right, the Ethereum and development of the tech space is going to have more of a professional indemnity, right? They're going to have more technology cyber where Bitcoin miners, and to a lesser extent, other Bitcoin companies, they're not really working with the smart contracts and the other tech-based features.

So they may be looking at crime exposure if they're holding onto Bitcoin or they're holding on a client asset if they're an exchange or a fund, right? They may want look at a species policy. The Bitcoin miners are definitely heavily involved in looking for P&C solutions. The mining equipment itself is very expensive and there aren't many insurers that want to write that. And then the buildings, those large data processing centers that go along with housing these units, there's also a big exposure there. So, it really depends on the operations, but each of these companies and the companies on different blockchains all have different exposures that we have to tap into and then work with different insurers because appetite does not fit one size fits all crypto digital asset appetite. So, we're really going to a multitude of carriers and just trying to find the solutions that fit that client's specific risk exposures.

Ron Borys (04:20):
Yeah. So, Drew, right, when you think of insurance and I was talking with a group of fellows the other day on insurance, right? We all understand how important insurance is to business, certainly from a physical damage, property and casualty perspective. I think when people think of digital assets and cryptocurrency, they think more of the liability. You've really opened my eyes recently to the thought of this vast world of property risk, right? Because you're right, they're building these facilities. They're setting up these highly complex and super expensive servers, a water leak or a significant storm of any sort that were to take out these facilities or these equipment I would imagine that's going to cost a significant amount of money. So, when you think about these firms that are approaching us for insurance, what's the major considerations right now? Certainly, D&O is always on front and center because the folks that are running these businesses, especially considering the environment where other people who are running these businesses have been accused of wrongdoing. D&O without a doubt is an important cover. But can you talk to us a little bit about some of the other exposures that these firms are, are considering or thinking about or concerned about?

Drew Logue (05:22):
Yeah, and like I said it really depends on their operations, right? So, a technology-based Ethereum developer that's working with smart contracts isn't going to have the P&C risk exposure of a Bitcoin mining facility that has a couple thousand units operating in one building, right? So it's really just, we need to get on calls with these clients and prospects and make sure that we talk to them about their business, right? Because they're all working with different custodial, they're all working with different banks and everything like that. And we saw how the banking sector went left pretty quickly and we just need to make sure that we're talking to them. But again it really depends on the operations where the Bitcoin miners, their biggest factors, as you said, are the D&O, like everyone has. And then the P&C risk, the Ethereum and tech developers working with smart contracts and blockchains that support contracts, they're almost more like growth tech firms, right?

They're a true startup, but they're utilizing blockchain technology. So, they're having very similar risk exposures to FinTech. Unfortunately, they're kind of being sidelined by the insurance companies because of the blockchain aspect of it. They're kind of lumped in with the bad actors in the crypto space until we talk to the insurers and educate them on why they should be giving these guys a second look as they would any other FinTech or startup tech company, right? It is a new technology, but the risk isn't that much different. They're trying something new and the internet, that was something new 30 years ago and we're starting there with a new technology and trying to develop something on a new technology, right? It's really educating them on these different aspects of the risk. But it's very technology focused on that side of it.

Ryan Farnsworth (06:55):
That's super interesting, especially as you think about the process of these companies are all so different and the process needs to be so tailored and integrated into an underwriting process on every single one of these. And perhaps it's more tenable today now that D&O marketplace in particular has become more competitive and more open. By the way, we're not going to let you come on this podcast and call us old geezers by talking about how you can't recall what it was like to ensure hedge funds for the first time, clearly implying that you're too young to remember that type of industry. But as you think about the solutions that we're crafting, whether it's from directors office liability or otherwise, what are some of the ways that we're able to overcome some of those hurdles of helping underwriters understand what the risks and exposures are and how to transfer those risks to insurance policies?

Drew Logue (07:45):
Sure. I mean, the biggest thing is educating the insurers, right? And that starts with several topics. We need to work with them on the industry, the regulatory landscape that we talked about in the beginning, the court process too, right? They just settled, or at least the court came to a decision in the Ripple case, carriers are entering and exiting this space every day. We're educating and bringing more carriers in. So, one of the solutions to kind of overcome these hurdles is bringing more people to the table and kind of educating them as we did with any new business type is kind of getting these insurance companies comfortable and showing them that maybe this risk is different, but they're still having the same types of claims aside from these large black swan events of the fraud from some of these other companies.

But it is still misrepresentation, breach of contract and other claims that these insurance companies are used to with other more traditional risks, right? Another hurdle to jump over, right? Is making sure that we shine the best light on our client. If they're seeing a lot of Bitcoin miners, why is our prospect or client a more favorable risk than the others, right? And then same goes for these Ethereum developers or the exchanges or anybody like that where they've maybe seen some issues of fraud or anything like that. Like why is our prospect not going to have this issue, right? That they're above board and again, it's to shine the best light on them. And that's not just on the insurance carrier side, right? A lot of these are true startups. So we do run into hurdles too, Ryan, on kind of walking the client through and educating them on the process and the cost and what that coverage is there for.

Some of these people may never have considered D&O insurance before branching out and starting their own company. And so there are hurdles on the client side as well that we always have to kind of bear in mind as we kind of walk them through the process. It's not going to be in your traditional hedge fund or private equity fund that kind of knows that they need that D&O and E&O insurance. It's kind of making sure that they're aware of what this does and why it's important to have and why it's worth the cost that it is.

Ron Borys (09:36):
So, Drew, recognizing our role as a broker, right, which is essentially representing a seller of risk, which in many cases is our client and the buyers of risk, which in many cases are the underwriters, the insurance companies. Where do you think the market is in fully understanding this risk? I mean, I know we've gone above and beyond with our clients and prospects and others to really try to help people understand this because oftentimes in the conversations I'm having with, with some of the folks on the carrier side, it's just really hard to understand and carriers don't like to, especially in the liability world, where risk in some ways can be a multiple of what people might perceive it to be like, like when you're insuring a server or a warehouse of computers, you know what those computers cost, you know what the replacement costs of those computers are. If there is a fire or a flood, you have a pretty good handle on what that exposure and risk is. Where do you think the market is in fully understanding and quantifying the magnitude of these potential risks? I think that's a hurdle that we as a collective industry will need to continue to get over in order to effectively provide this industry with the solutions that they're looking for.

Drew Logue (10:44):
I love the insurance industry as, as much as anybody else, and I'm not saying anybody's old Ryan, but we move at a snail's pace. The industry itself does not adapt to these newer technologies or these newer processes very quickly. So, I would say that we're in the very early stages to answer your question, Ron, like we are having insurers more interested, right? Like when I meet up with some of our underwriters for lunch or just the meeting, they're asking me more and more questions knowing that we're in this space and that we're actively marketing this, but that's still something that they need to talk to their managers about and speaking through with their legal team, their coverage team, there's a lot that goes into making sure that somebody's comfortable and potentially underwriting these risks. And the black swan events kind of don't help.

Every time something bad is in the news, then we're dealing with the backlash of like, well, it's just that crypto industry again. And fortunately there's a lot of good actors and it's similar to any other industry where a lot of, a few bad people are hurting a lot of good people. And it's really just our job to continue working. So, I would say it's in the very early stages of what it could be, right? And people understanding it, people willing to underwrite to it, we're still getting a lot of declinations kind of right as they review the initial submission. Whether that's a hard declination because of the industry or a soft declaration like, hey, like, I'd like to hear more, but I'm not sure how this is going to go. But I do think there's a lot of room for growth and we're seeing more and more insurers, write the D&O.

We're seeing more and more insurers write the tech cyber and the E&O and the crime and the P&C risk, like you said, it's definitely similar in the sense of like an office or a data processing center where you know the cost of the machines in there, but people are still hesitant to write it. So, it's really just making sure that we find solutions for the clients because there are solutions out there and there are clients that are willing to pay for them and they are looking for them. So, we just need to do our best to continue to educate the insurers and get them comfortable with the risk, even if the word crypto is associated with it.

Ron Borys (12:38):
Well, great. Well, I don't want to speak for Ryan, but I think the both of us would certainly say this. This has been a fantastic discussion. I think we both feel very fortunate to have you leading this very important vertical within our vertical. We certainly know it's not going away. I think we've said that on prior podcasts. I think digital assets and cryptocurrency are here for the long haul. You know, as a leader in this space, I think it's important that we continue to pioneer solutions and be out in front with the markets and our clients and trying to educate them on the risks, the exposure, the market appetite, etcetera. So, for those of you listening and who would love to learn more about what we're doing in digital assets, feel free to look us up on the web, www.alliant.com. I know there's a lot of people, a lot of questions on this very important topic. The insurance is expensive, the market is limited, but I have a lot of confidence in the fact that with you leading the charge here for us, we're going to continue to find great solutions for our clients and great ways to trade with the insurance carriers who are writing this business. So thanks a lot for joining Ryan and I.