Are advisers getting a rough deal on PI cover?

Michael Klimes digs into the torturous complexities of professional indemnity insurance

Pieces are missing from the professional indemnity puzzle for advisers looking for DB transfer cover

For advisers that operate in the defined benefit transfer market, professional indemnity insurance rarely seems to leave their mind.

For many months now, advisers Money Marketing has spoken to have repeatedly mentioned the endless worries it gives them. Some say they have seen DB transfer coverage excesses increase 10-fold, from £10,000 to £100,000, on renewal.

Furthermore, there are reports of non-specialist broking firms entering the market and advertising themselves as PI specialists. A specialist PI broker who really knows the sector can make all the difference to an IFA who needs to renew their insurance and stay in the transfer business, but a number of other factors are also putting pressure on the market.

A first reading of the FCA’s handbook (provision IPRU-INV 13.1.10) suggests an adviser needs cover to the tune of €1.25m (£1.1m) for a single claim and €1.8m in aggregate to be on the right side of the rules.

Yet it appears there are insurers that have insisted on placing a sub-limit cap on any PI cover up to £500,000 for advice in relation to DB transfers. It is questionable whether this is compliant with FCA requirements.

Money Marketing has delved into the numbers to see where advisers really stand when it comes to getting a fair deal on their PI cover.

Demystifying data

One way to see if IFAs were being charged unfairly on PI would be to measure the likelihood of a firm having to pay out on a DB transfer claim compared with increases in PI bills. Unfortunately, when one digs into the figures they are not definitive and demonstrate how complicated the subject is, lending themselves to conflicting interpretations about what is happening in the market.

Take, for instance, the number of individual transfers from DB to defined contribution schemes and the amount of money transferred. These should be relatively straightforward to pin down unequivocally but are not. The FCA has published figures about the number of DB-to-DC transfers that have occurred since October 2015 in its sector views bulletin. These are reported on a six-month basis and have sharply risen over a three-year period from October 2015 to October 2018. Counted together, the number of transfers that have occurred stands at 82,774.

However, a response from The Pensions Regulator to a Freedom of Information Act request published in May 2018 gives a different picture. It says for the period from 1 April 2017 to 31 March 2018 alone, DB pension schemes reported approximately 72,700 transfers out.

TPR adds these transfers were not specifically to a DC scheme and estimates the actual figure to be in the region of 100,000.

The regulator points out not all schemes that reported transfers could say exactly how many they carried out and it did not take non-responses into account. It also estimated the total value of the transfers to be at least £14.3bn.

Meanwhile, Office for National Statistics figures show the total value of transfers from DB schemes was £12.8bn in 2016, £37bn in 2017 and £27.4bn for the first three quarters of 2018. While these statistics give advisers, PI insurers and regulators an indication of the volume of transfer activity, there is a lack of similar data with breakdowns on how the PI market has evolved.

Take the data published by the Financial Ombudsman Service last November about the 318 complaints it has received related to DB-to-DC transfers since 2015. Reassuringly for advisers concerned about PI bills, DB transfers actually made up just 2 per cent of all pension complaints between April 2015 and March 2018, over which period the FOS received a total of just under 15,000 complaints on pensions in general.

An average of 33 per cent of complaints were upheld in each of the three years, meaning most went in advisers’ favour.

Delays in advice accounted for the highest number of complaints over DB transfers, at 119, along with the highest uphold rate, at 44 per cent.

The second-highest number of complaints, 73, related to administration, with an uphold rate of 29 per cent. The suitability of advice ranked only third with 47 complaints, of which 38 per cent were upheld.

Historically, the uphold rate for DB transfer cases pre-pension freedoms was around 65 per cent, whereas post-pension freedom cases have a much lower uphold rate of around 33 per cent.

To put this into the overall context of FOS complaints, fewer than 0.5 per cent of them are against advisers. In the most recent financial year, FOS received 1,678 new complaints against financial advisers but, in total, it received almost 340,000 new complaints over the period.

Adviser view

Jarrod Ellis
Director, Delta Financial

IFA practices can be different in terms of the business they handle so it is important to get a PI broker who understands what your firm does. We had a conference call with our broker and underwriter. This helped them understand the risk and price it accordingly. We also provided them with a copy of our suitability letter and report that gave them an appreciation of how thorough we are.

This resulted in us getting fully compliant cover. On our application form we have been asked questions from 20 years ago, so start your application several months in advance.

The sources of PI pressure

The sheer amount of money being transferred combined with the relatively low number of DB complaints received by the FOS does seem strange when contrasted with the horror stories of the PI market. What are the possible explanations for the gap between what IFAs experience and what the figures indicate? One possibility is that there is a significant time lag between the client deciding to transfer and the subsequent complaint they may make about it.

Therefore, it is possible the volume of FOS complaints against advisers will increase over the years as clients come to believe they have been badly advised regarding transfers.

To anticipate this potential storm of complaints, PI brokers and insurers could be changing their policies and terms of cover to ensure they are insulated from any fallout that occurs.

Some data on where DB money is being transferred to lends itself to the interpretation that a wave of future complaints may be brewing. Much of the fallout from the British Steel Pension Scheme saga relates to the costs clients suffered from moving their money into high-charging Sipps.

In August 2018, a report by pensions consultancy XPS analysed more than 6,000 transfers totalling over £1.4bn since 2016, finding that charges can vary by up to 2 per cent per annum even among the 10 platform Sipps that dominate as a destination.

XPS finds the average transfer size is £230,000 and 95 per cent of them end up in a personal pension or Sipp, the remainder falling mostly into occupational schemes, including master trusts.

Depending on where the funds are placed, XPS says that pensioners could run out of money seven years earlier or buy an annuity worth £4,000 a year less if they make the wrong decision.

XPS senior consultant Helen Ross says: “Trustees and sponsors are more supportive of partial transfers. More schemes will set them up this year. Many members end up in Sipps with complex charging structures when they could be in simpler low- cost products.”

Whichever way you read XPS’s findings, they suggest there might be a major problem with DB transfers developing and those in the PI sector are probably wise to shield themselves from it.

Another possibility is that PI brokers and insurers are taking advantage of the heightened level of perceived risk arising from DB transfers to increase fees. But such a cynical view of PI brokers and insurers exploiting advisers is hard to prove conclusively. The filings from PI brokers and insurers on Companies House suggest that while some are increasing margins, others are seeing profits being squeezed.

For example, AmTrust Europe increased the number of staff working on underwriting and claims activities from 125 in the 2016 financial year to 153 in 2017. Its retained profit for the year went from £52.5m in 2016 to nearly £70m in 2017.

Lockton Companies saw its profits increase from £53.4m to £56.4m over the same period.

However, at Liberty Speciality Markets, the number of staff who work on underwriting stayed constant at around 182, while profits for the year in 2016 were £5.9m and £6.9m in 2017.

A final explanation could be that it is a small number of IFAs who are responsible for the difficulty all the others experience with renewing PI insurance. Since the FCA started work on the DB transfer market in 2015, 19 firms have chosen to stop advising on transfers, including those related to BSPS. Between them, these firms have arranged 4,659 transfers.

In December last year, the FCA published its most recent file review where it found that less than half the transfer advice it assessed from a separate set of firms was suitable.

This means thousands of transfers from the firms who have had their permissions removed could have put consumers at risk.

Adviser view

Nigel McTearNigel McTear
Director, Signpost Financial Planning

Start your application early and at least three months prior to renewal as everything takes longer than you think.

Do not switch PI underwriter just because they are cheaper as being with the same underwriter for years allows them to get to know your business.

Also accept that higher excesses are becoming the norm and plan ahead to fund higher FCA capital reserves. If you are getting complaints, it is probably too late so stay close to your clients and keep them fully informed.

The management of investor expectations is part of your business’s risk management. Use a professional PI broker who really understands the market.

Regulatory roulette?

Clearly all the available data only gives a partial picture of what is happening, but the most pressing problem for advisers could be what the FCA’s handbook says about PI cover. The FCA’s handbook suggests an IFA needs cover of €1.25m for a single claim and €1.8m in aggregate to  be compliant with the rules. But if IFAs can only get PI cover below these thresholds for DB transfers, are they in breach of them?

An FCA spokeswoman says there is no specific provision under IPRU-INV 13 – the section that governs PI cover for advisers – that addresses the application of a sub-limit of indemnity with respect to a particular business activity, such as providing advice in relation to DB pension transfers.

She adds that a sub-limit of only £500,000 applied to DB business, depending on the amount undertaken relative to the other activities of the firm, is likely to be deficient with respect to the liabilities that could possibly arise in the future.

The FCA points IFAs to IPRU-INV 13.1.20R in the handbook and says it expects them to check if their PI insurance is “subject to conditions or exclusions which unreasonably limit its cover (whether by exclusion of cover, by policy excesses or otherwise)”. So while IFAs can still avoid a PI compliance trap, they certainly need to remain watchful as the pressure is likely to continue.

Expert view

Ensure you have a good PI broker for a decent deal

Bad applications to insurers for PI cover, which can be a combination of IFA and their broker, are causing reputational damage. Some brokers just send proposal forms without accompanying evidence of records such as suitability reports, client testimonials and invoices.

The quality of a broker makes a big difference to renewing PI insurance successfully.

Sometimes IFAs are tainted by poor submissions.

The way you have to think about pitching to an insurer is that you are selling your business.

The insurer is being rewarded for the risk of taking you on and something bad occurring. In terms of the watchdog, my understanding is the FCA is in discussions with insurers to understand the risks of the market better.

But the regulator has to be careful it does not scare underwriters off.

The FCA’s data gathering would be swifter if it got exclusions directly from the IFAs, rather than Gabriel returns. It is hard for underwriters to understand individual IFAs and identify the risky ones.

Many underwriters have never made a large margin from PI but I believe that this is going up again.

Nonetheless, insurers are braced for a potential DB fallout.

Russell Facer is managing director of Threesixty

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Comments

There are 5 comments at the moment, we would love to hear your opinion too.

  1. The FCA “adds that a sub-limit of only £500,000 applied to DB business, depending on the amount undertaken relative to the other activities of the firm, is likely to be deficient with respect to the liabilities that could possibly arise in the future.”

    This seems to demonstrate a fundamental failure of the FCA to grasp that PI is on a “claims received” basis and any insurer is entitled not to renew if and when they think claims might actually be received.

    An insurer who is not committed to being there when you actually need them will give you as much protection as a chocolate fireguard.

  2. To add insult to injury of course, if you believe there may be a problem, you are obliged to notify even if there is no complaint. The PI insurer will then say, it can’t be noted as there is no complaint and then when renewal comes up, they will exclude. QED firm now either has to increase capital adequacy to cover the potential liability OR it automatically will breach it’s capital adequacy = ceasing trading = PI fails to renew and PI insurer off the hook and any and all claims that come in fall to FSCS. The system is seriously flawed.

  3. What many are also failing to grasp is that with a £100,000 access comes additional pressures re capital adequacy. Any business should have sufficient cap ad to cover the normal cap ad of running costs requirements, but should at least be able to cover one potential claim at £100,000.

    The true outcome of a £100,000 access is one claim could put many advisers business into insolvency. Four or five would most definitely.

    The issue is uncertainty of FOS outcomes, regulation and no legal long stop. Last year we saw cases being raised as far back as the early 1990’s. How can any PI insurer possibly underwrite effectively this type of risk.

  4. IPRV-INV 13.1.10’s indemnity limits relate to insurance distribution business and so probably apply to most IFAs, but you need to think about the next three provisions too dependent upon the firm’s business model.

    Then there’s IPRU-INV 13.1.25 and 26, which bring in an additional capital charge for big excesses (revenue-dependent but figure a good £50k extra capital for a £100k excess on ANY line of your business).

    And the real kicker is 13.1.24: “The firm should hold additional capital resources in excess of those minimum amounts set out … where the required amounts of additional capital resources provide insufficient cover, taking into account the firm’s individual circumstances.”

  5. If PII insurers raise their claims excesses to £50K per claim or withdraw cover altogether, the FCA’s CapAd requirements will become impossible for all but the very largest firms to meet. And, assuming the business volumes of large firms are proportionate to their size, even they’ll struggle.

    So, in addition to more and more small to medium sized firms going under as a result of just a couple of upheld complaints, we’ll see large firms failing to meet their hugely increased CapAd requirements. Will the FCA then withdraw their permissions in certain areas? Even if it does, that won’t address their exposure to the liabilities in respect of business already written. Armageddon may be approaching.

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