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Directive selling

PI is turning into a conflicting calculation for IFAs, with the FSA seeming to be intent on freeing IFAs from many of the constraints of the current PI regime while the EU may force it to increase the PI burden.

The FSA pledged last week to make life easier for IFAs struggling in the constrained professional indemnity insurance market but in the very same set of proposals it admitted that many smaller IFAs will see their cover requirement nearly double in less than two years time due to a European directive.

However, leading industry figures have raised the prospect of two Euro directives cancelling each other out to the benefit of IFAs.

Last week&#39s CP193, Professional Indemnity Insurance for Personal Investment Firms: Proposed Policy and Rules, talked extensively about how the regulator is embarking on a dramatic change in its attitude towards IFAs&#39 PI woes.

FSA head of investment firms David Kenmir has won himself the grudging respect of many IFAs for his attempts to alleviate their difficulties in finding affordable PI and last week&#39s paper represents his latest effort to sort out the situation.

The paper discusses how much more responsibility is going to be left with senior managers within firms to decide what type of PI policy is suitable for them.

Much more attention will be paid to the relationship between capital reserves and the amount of cover which is necessary. Firms with greater capital adequacy will be able to have lower excesses.

But Sofa chairman and Informed Choice managing director Nick Bamford says: “I think what they are miss-ing is it is not the relationship between capital adequacy and cover which needs to be addressed. Would it not just be better to have significant capital reserves and not pay a premium in the first instance?”

Firms will be allowed to take out policies with exemptions from various types of business, split caps or structured products as long as they set aside enough money for any possible misselling claims made against them.

For many, this is tantamount to suggesting that they should pay a premium for insurance that will not protect them when they really need it.

LIA head of public affairs John Ellis says: “I think that what we are looking at is higher capital adequacy requirements through the back door and a lot of smaller IFAs are going to suffer as a result.”

Several times throughout the paper the sentiment is expressed that the goal of the regulator is not a zerofailure market, making it clear that firms that get it wrong will be allowed to go bust.

Syndaxi Financial Planning principal Robert Reid says: “It is tidying the whole thing up – the concept that you could set up a company with very little cash behind you was a false one. This is going to force consolidation but that will increase professionalism.”

The FSA is scrapping its definition of a compliant policy, hoping it will foster competition among insurers both on price and types of policies.

Magian Mutual director Glyn Morris says: “If it does create greater competition it will only be because the standards have been lowered. The right way to do it would be to demonstrate to underwriters that there is nothing to fear from the FSA and the ombudsman, not to lower standards.”

However, despite the generally positive overtures of this message, the same paper spells out potential disaster for IFAs, especially the smallest ones, telling them the amount of PI cover they will have to take out is going to nearly double by 2005.

The European Insurance Mediation Directive, which has reached its final draft and is set to be implemented in member countries by January 2005, demands an increase in PI levels.

This means that firms with less than £166,000 in capital – 1,808 of them representing 45 per cent of the total, according to the FSA, will have to increase their coverage from £500,000 to £949,000 – the same amount that firms worth £6m have to take out.

Life Policies Direct partner Jason King says: “It is not going to be good news for small IFAs, it is going to force more of them into the arms of networks or even retirement.”

Medium-sized firms will fare better as IFA business worth between £166,000 and £6m will be able to reduce their cover. For example, an IFA with between £1m to £6m currently requires a £3m level of cover, this will reduce to £949,000, the same as for the smallest firms.

The FSA disagrees with the cover levels being raised, saying it believes that a £500,000 limit is sufficient for firms up to £3m in size, but its hands were tied by the IMD.

But the regulator has not thrown in the towel just yet. Alongside Aifa, it is hoping that another EU directive, the Investment Services Directive, could overrule aspects of the IMD, including those dealing with PI.

Aifa director general Paul Smee is cautiously optimistic that the fight will be successful and he believes that if the current draft of the ISD remains the same, then IFAs will not be caught by the restrictive measures of the IMD.

He says: “At the moment, it looks positive but the directive is not yet in its final form. I would feel very confident about the situation, however.”

But, as it stands, in addition to sharp increases in levels of PI cover for smaller IFAs, the FSA will no longer be able to hand out cover exemptions to listed IFAs which are capitalised at more than £50m and will have to abandon its plans to offer exemptions to firms which have an annual turnover of more than £10m.

In a separate move, the FSA, without any pressure from Europe, has decided that the biggest IFA networks will also have to substantially increase their level of PI cover.

The two biggest networks are Sesame – formerly Misys – and the Tenet Group, which are each capitalised at over £40m, which means their PI cover levels will rise by £6.5m up to a maximum of £23m.

However, the big two are unconcerned about the proposals, saying the amount of cover they currently have on their books is greater than that required by the FSA.

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