Advisers struggling to obtain comprehensive professional indemnity cover may be compromising their independent status, experts have warned.
Advisers who have renewed their PI insurance in recent weeks say prices have risen significantly and insurers are making increasingly onerous data requests as concerns over liability issues grow.
PI broker IFA Solutions says premiums have increased by 40 to 50 per cent in the past year across the market, while its own rates have gone up by about 20 per cent.
Experts say firms are being forced to accept higher excesses and more exclusions to keep premiums down.
UBS Wealth Management executive director Graeme Price says: “Some advisers are accepting exclusions in order to get cover.
“But if you have exclusions on certain types of business, can you call yourself independent? What happens if that product is suitable for a client?”
The FCA says having exclusions does not necessarily mean firms cannot call themselves independent, but says businesses will have to hold extra capital in relation to any advice not covered by their PI policy.
PI brokers say unregulated collective investment schemes are a common exclusion, but exclusions can also extend to structured products, exchange traded funds, venture capital trusts and the enterprise investment scheme. Some policies exclude all unregulated products.
IFA Solutions managing director Jamie Newell says: “More exclusions are being applied than in previous years without a doubt.
“In particular insurers are applying exclusions for esoteric areas and aggressive tax mitigation solutions.”
Marsh UK senior vice president Stephen Morton says the majority of policies either have an exclusion for certain types of business or an exclusion “by the back door” via a non-disclosure clause.
Price says: “As you get into more mainstream solutions, it gets difficult. VCTs and EISs are an obvious area where a firm might have taken an exclusion to keep their premiums affordable. If an adviser identifies a need for that product they must be able to meet that need to satisfy the FCA’s independence criteria.”
The FCA’s prudential handbook for investment firms says PI policies must not exclude any type of business which has been carried out by the firm in the past or will be carried out by the firm in the future, unless they hold additional capital to cover the liability.
The regulator issued a warning only this week to advice firms recommending pension transfers to Sipps, saying many firms had inadequate PI cover in place or had failed to disclose to insurers the true nature of their business model.
A spokesman for the regulator says: “Having exclusions to your PI insurance does not, by itself, mean that you are not independent.
“This is because firms can hold extra capital to cover any exclusions which may be necessary to ensure that the firm is still willing and able to advise on the whole of the retail investment product market.”
But experts say “self insuring” in this way is risky and impractical, particularly for smaller firms.
Former Tenet group director Geoffrey Clarkson, who is working on a deal with insurance broker Marsh UK to collectively insure distribution firms’ historical advice liabilities, says: “In practice, a firm will be less likely to recommend a product they know they are insuring themselves, as opposed to one covered by their PI.”
And Price argues self-insuring “is not a practical solution for 99 per cent of advice firms”.
He says: “If you recommend one client puts £100,000 in VCTs, there is £30,000 tax relief on that, so if the scheme gets disallowed by HM Revenue & Customs you would need to hold £30,000 as an absolute minimum just for that one client. The numbers will get very large very quickly.”
Price says independent firms must have a process in place for liability on exclusions, such as partnering with another firm prepared to take full liability for the advice.
So why has the PI market hardened so sharply?
Newell says insurers are shying away from the adviser market because of high claims experience on liability issues.
He says: “It is becoming a case of supply and demand.
“There are only three or four insurers willing to look at both renewals and new business, a few more do renewals only, and they are being really pernickety with risk profiles.”
He says that while areas such as Ucis have long been of concern to insurers, there are a number of emerging issues insurers are also cautious about.
Newell says: “Transfers from defined benefit schemes is a hot potato at the moment, as is investors exceeding the lifetime allowance.”
As a result, advisers say insurers are asking for much more detail about the nature of their business when applying for cover.
“If you have exclusions on certain types of business, can you call yourself independent? What happens if that product is suitable for a client?”
Yellowtail Financial Planning managing director Dennis Hall says: “The questions asked by insurers have become increasingly invasive, requiring more in-depth data on past business and on business written longer ago.”
Investment Quorum chief executive Lee Robertson adds: “Insurers’ forms are much more detailed now. They are asking for business to be broken down by business category and case size, making the process much more time consuming.”
But compliance experts say this is not necessarily a bad thing.
RGP Compliance managing director Simon Collins says: “It is perfectly understandable that insurers are asking for more detailed information, given some of the liability issues in the past.
“Firms need to be more joined-up as the information they need for renewing PI cover will be similar to information they need for other areas, such as FCA visits.
“Advisers should view PI renewal as part and parcel of running their business, rather than as a chore. The more engaged the adviser is with the process, the more comfortable the insurer is likely to be with their business.”
Experts say increasing excesses on policies are also becoming problematic.
Morton says: “An excess of £5,000 is fairly standard for investment advisers. But if it rises significantly above that, the policy is merely there to satisfy the regulator rather than being anything of value in spreading risk.”
Independent or restricted
Whether a firm is independent or restricted can also have an impact on the terms they can negotiate.
Newell says: “Smaller financial advisers are becoming very hard to place, particularly those who are independent.
“Insurers are worried one- or two-man bands do not have sufficient resources to complete all the due diligence necessary to meet the independent requirements.”
Independent regulatory consultant Richard Hobbs says: “Independent firms are clearly operating in a more risky environment than restricted advisers, so it stands to reason that underwriters would view restricted firms more favourably.”
Earlier this year Money Marketing revealed national advice firms and networks were in talks with Marsh UK to investigate the possibility of brokering a deal to incorporate several firms’ liabilities under a single arrangement.
But Hobbs says: “The problem with advisers banding together is you create a sub-risk pool of the better risks which means those outside of it either have higher premiums or cannot get cover at all.”
Chase de Vere head of communications Patrick Connolly says: “Exclusions have been rising to almost ridiculous levels, meaning advisers are forced to accept a policy providing very little value.
“The biggest risk for insurers is legacy product sales. Once they work their way through the system claims will reduce and insurers may return to the market.
“However, that looks to be at least three years away.”
It seems advisers still have some way to go before affordable and accessible PI cover is within their grasp.
EXPERT VIEW: Graeme Price
How advisers can improve their PI risk rating
PI insurance is the keystone of a financial planning firm’s risk framework. If a firm is able to improve its risk framework, then it will have by default improved its PI options. PI insurance can be viewed as a monetary expression of the market’s view of the robustness of the risk framework employed within a business.
There are a number of things firms can do to put themselves in a better position when renewing their PI cover. Factors which contribute towards a superior risk framework include:
• A chartered or certified business
• Use of cash flow modelling in the financial planning process
• Use of an investment committee with a clear audit trail and monitoring of processes
• Use of a robust, repeatable centralised investment process
• Use of independent risk profiling tools
• A risk profiling process that takes account of term and any legacy assets or issues
• Use of risk-rated models or funds where appropriate
• Where the potential PI liability exceeds the limits of the policy, the business should have the ability to fully outsource this risk to another partner
• Use of due diligence audit trails to justify the choice of business partners, such as platform providers.
Graeme Price is executive director at UBS Wealth Management
ADVISER VIEW: Philip Milton
The detail required by insurers means renewing PI has become a very onerous task. This year our existing insurer wanted to ratchet up our premium
significantly, and we had to join support services firm Bankhall to access a competitive deal.
Philip Milton is managing director at Philip J Milton & Company
ADVISER VIEW: Aj Somal
The rise in PI premiums and excesses is concerning. Increasing excesses will put more pressure on firms, particularly small ones, to hold more capital at a time when cash flow may already be under pressure.”
Aj Somal is chartered financial planner at Aurora Financial Planning