Advice is becoming a more risky business, meaning firms must rethink their approach to the issues they face
Given the Financial Ombudsman Service’s compensation limit is set to rise to £350,000, it is time for advice firms to rethink their approach to the risks they now face.
The FCA’s plan is for the new limit to apply to compensation awarded by the FOS for firms’ acts or omissions made on or after 1 April next year.
The compensation limit for acts and omissions made before that date will rise to £160,000, from the current limit of £150,000.
Both those limits will then rise in line with inflation, as measured by the consumer prices index.
Indexation of the limits makes a lot of sense in principle and should help avoid a repetition of the sudden cliff-edge leap in potential liability that will face us next year.
The limits need to be kept up to date and indexation should help to achieve this.
The increased FOS limit is not the only development that makes the advice business more risky.
The change has disturbed the professional indemnity insurance market to such an extent that some insurers have left it altogether, with many others both reducing levels of cover for advice firms and substantially increasing excess levels.
And this is not the only factor leading to PI turmoil. Some advice firms are rumoured to be encountering difficulties in renewing their cover at all.
Businesses that can get PI insurance are said to be finding the premium rates are also on the increase. Covering defined benefit transfer activities could become especially problematic.
Traffic light system
So what should advisers do in the face of all this, aside from making representations to the FCA via Pimfa, the Chartered Insurance Institute and any other body that may influence the situation?
One sensible response is to take a long, hard look at the risks their business faces. The key way to do this is via its risk register, and the body to do that is the risk committee, even if it has just one member.
Compiling and reviewing the risk register provides a systematic and disciplined approach to business risk.
There are several ways to set up a risk register but a simple and practical process is to start with listing all the risks, group them into the main areas of concern – advice, admin, IT, disaster and so on – then rank them according to both their probability of happening and their potential impact on the firm: high, medium and low. A traffic light system makes it more vivid.
High-impact, high-probability risks are a total no-go. For example, in the unlikely event you are selling tax avoidance schemes, stop now and get advice on your previous sales. It is probably too late already.
You may have some risks with potentially high-impact but low to medium probability. The traditional way to deal with high-impact and low-probability risk was to buy insurance. DB transfers would come under this heading.
But the changed FOS and PI situation has propelled these risks into a much higher category of impact and it is likely the probability of challenge has also increased. Now may be the time to consider a change of direction, further restricting or possibly even stopping this activity.
High-probability with low to medium impact risks need better management of that risk. Some IT and administrative mistakes might come under this category.
You need to look at your processes and responsibilities, making sure someone in the business is responsible for these areas of concern. One area coming into focus now is the potential for mismatching the service promised to clients with what is actually provided.
In fact, poor admin can have a high impact on a firm in the absence of effective PI cover. Money not invested, rebalancing not completed, pension annual or lifetime allowances inadvertently breached and life cover not put on risk in time can lead to substantial claims. And if the value of claims exceeds the cover or a high excess applies to multiple claims, that could mean the disappearance of the firm.
An approach to increased resilience – if not lower risk – is to keep more money in the business to deal with the possibility of claims. How many excess payments of £50,000 or £100,000 could your firm afford to pay out?
Danby Bloch is chairman of Helm Godfrey and consultant at Platforum