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Richard Hobbs: Can bulk liability cover work in practice?

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The attempt by a global insurance broker to put together a facility to insure what amounts to the run-off risk for major networks’ and nationals’ advice makes eminent economic and commercial sense.  Making money by putting together such facilities is what brokers do for a living.  Tidying up balance sheet risk is what any self-respecting chief executive of a large distributor should try to do.  The question is, can it be made to work?  If so, on what terms and what would the implications be?

Historically, the risk is advice given to clients turns out to be bad.  There are several types of “bad” advice. 

The adviser really did not do their job properly.  The adviser did a good job but investment conditions confounded the advice leading to an unwarranted complaint that is nevertheless upheld, typically because the record keeping was not good enough to prove the goodness of the advice. 

The regulator seeks a review of past business based on thematic work or advice from the Financial Ombudsman Service on complaints trends.  This either uncovers genuinely poor advice or inadequate record keeping which leaves the firm unable to defend itself.

It is immediately apparent that considerable moral hazard is present.  There is also the paradoxical outcome that the better any insurance arrangement is in paying out, the more interested the regulator will become in pressing for past business reviews.  The more distance between the Financial Services Compensation Scheme and regulatory intervention, the more likely regulatory intervention becomes.  This is perhaps the most daunting moral hazard an underwriter would face in responding to the broker’s attempt at pricing risk for the facility.

So is this facility a runner?  Underwriters are pretty familiar with this risk.  Their experience with professional indemnity insurance for advisers will inform pricing.  This class of business has had protracted pricing issues because generic past business reviews have invalidated previous pricing assumptions.  Some financial advisers have found obtaining PI cover impossible at different phases of the insurance cycle.  The facility currently in contemplation would have to overcome that problem. 

It appears to have been suggested in some quarters that a facility covering several large firms would behave differently to PI insurance providing some risk diversification that the brokers and underwriters could rely on to achieve an attractive price for reasonable cover.  This looks to be the nub of the issue. 

Any facility does not obviously diversify risk.  Rather it appears to aggregate it if all major firms were free to join.  Poor record keeping and the inability of advisers to defend themselves appears pretty generic regardless of class of business written.  If there is a differentiator it is likely to be in compliance performance.  Just as with PI cover, the better firms could always obtain cover.  And so in this situation firms with better compliance would be subsidising those with worse.  They would secure competitive advantage by staying out of the facility.  Perhaps this factor is the cause of the apparent delay in putting the deal together.

The issues underlying this plan are deep seated and go to the heart of how advice is regulated in the UK.  Using PI insurance as surrogate capital was intended by regulators to help the advice market financially but it has a fraught and difficult history.  Perhaps the brokers and more particularly underwriters can persuade themselves that it is different this time.  But the prognosis must be either the cover will not be very strong or the facility will not be long lived.

Richard Hobbs is an independent regulatory consultant           



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