If a Martian with an interest in financial services had fallen to Earth two years ago, she would have gained the impression that banks were suffering huge legal problems and that their brother companies in insurance had virtually none. The quarterly banking results have been such a litany of legal provisions that there was surprise when, in Q4 of 2015, Morgan Stanley shrank its legal costs and went into profit.

Total bank litigation costs

The roll call of bank results dragged down by legal costs has hit banks across the US and Europe. For instance, JP Morgan, the biggest US bank by assets, announced legal costs of just under $1b last year - and went on to warn of more.  Altogether, US and EU banks are predicted to pay out $300b in litigation costs by 2016, according to Morgan Stanley.

Global liquidity crisis

But our Martian friend would find little in the headlines to warn of high legal costs among insurers. If she persisted and looked at the accounts themselves she would find more. AIG - the century-old, 130-country, 88m-client business— is the largest insurer in many markets, including the UK. Its 2014 accounts reveal $258m in net provisions and costs for ‘favorable and unfavorable settlements related to events leading up to and resulting from AIG’s September 2008 liquidity crisis and legal fees incurred as the plaintiff in connection with such legal matters’. 

Aviva - huge liabilities?

Similarly, Aviva - the UK’s second largest insurer, with operations in 16 countries - does have legal issues although they attract little media comment. In March, the Financial Times mentioned  that the insurer ‘could be threatened by huge liabilities arising from historic contracts’ in France - although this suggestion was largely dismissed by chief executive Mark Wilson. 

Payment Protection Insurance scandal

But it is also clear that insurers have recently done better at staying out of regulator trouble than their banking colleagues. ‘Insurers have generally done all right by focusing on the core products they know back to front,’ says Adam Samuel, an international financial services compliance consultant and Anglo-American qualified lawyer. Ironically, UK banks have been involved for over a decade in the mis-selling of an insurance product - payment protection insurance (PPI) - which has so far cost the top five £24b in compensation and costs, according to the BBC. It is this kind of ‘add-on’ - an insurance policy added on to the back of a loan or to the sale of a mobile phone or some other product - which has proved attractive to banks and got them into trouble, says Mr Samuel. He says: ‘Add-ons are really about selling extra insurance which people do not really need.’ In many, many cases, add-ons were unnecessary because the people who bought them were already covered under other policies or regulations. Insurers in this market have also suffered serious regulatory attention and corresponding losses.

Ombudsman complaints

Banks have also been more aggressive in trying to make profits. Counter staff were encouraged to try to sell products to customers - and, in the more specialist departments, Forex teams sometimes went as far as rigging the conditions in which they operated to give themselves an advantage. Statistics at the Financial Ombudsman Service in the UK - the largest Ombudsman service in the world - shows new complaints against AIG amounting to 38 in H2 of 2014 and those against HSBC, the UK’s largest bank, amounting to 11,345 in the same period. 

Insurers cautious on sales However, trends in litigation come and go in different sectors. The insurers got a nasty lesson in the UK twenty years back when they had to compensate 1 million people who had been badly advised by their (commission-earning) sales staff to trade in top-rate employer pension plans for second-class insurance-based plans. Since then, the major UK insurers have become more cautious on sales across the full gamut of its products from commercial insurance to life cover, pensions and investment management. The insurers are far less likely to mis-sell because they are far less likely to sell in the first place.

Scope for insurance regulators

They are dependent on financial advisers and other middle-men to sell their products. This means that the biggest risks left facing mainstream insurers are probably poor product design and customer service regarding insurance claims. 'In these areas, standards vary considerably amongst the insurance companies,' says Mr Samuel. There is a lot of scope for regulators to march in on the claims side and clean up. The regulators are already taking similar steps with regard to product design in the add-on market.'

Aviva profits - 'entirely inadequate' The move away from bearing the risks of running large and lively sales forces takes its toll - as any good underwriter knows - on the amount of profit that insurers are making. A 6% rise in Aviva profits in the 2014 annual results was described as ‘entirely inadequate for where we could be’ by Mark Wilson. Changes in the pensions and annuities market in the UK are seeing business dropping fast for insurers in the life area. Some of the insurers are now seeking business elsewhere - in Latin America for Legal and General and in Indonesia and China for Aviva. And Aviva currently does a fifth of its new business in Poland, Turkey and Asia - markets which must be increasing the organisation’s risk profile. 

Collaboration among regulators 

Our friendly Martian might not fully understand the workings of Earth’s most sophisticated insurance and banking markets but, if she knows about capitalism, she will know about the way trends grow and then fall off again. Even regulators are affected by fashion - and the world’s banking regulators have started working together to catch their prey. Insurance regulators have taken more of a back seat in recent years - but that could change, even from one day to another.