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The search for PI

These are trying times for IFAs. The current high-profile debate about the failure of split-capital trusts, the poor performance of pensions and stockmarket investments has contributed to what is fast becoming a national crisis of confidence in the financial services industry. Sadly, by the very nature of our jobs, IFAs are right in the front line.

But it is not just clients who have lost confidence in the products we sell. Another important stakeholder group now also views IFAs with a great deal of suspicion, namely the insurers, which provide us with the professional indemnity cover which enables us to go about our business on a daily basis.

The truth is that providing PI cover to the financial services industry has cost insurers millions of pounds.

As an industry, we have lurched from one misselling scandal to another because we have not been as rigorous as we should have been about managing risk and ensuring that clients received an appropriate level of advice and service. For example, at the present time, most networks only do sample compliance checks of between 5 and 10 per cent of the business submitted by their members.

In an age where people are no longer likely just to accept that they may have received poor advice and will take their grievance up with a regulator or seek some other form of legal redress, this is asking for trouble.

This complacency has led to a situation where insurers are no longer prepared to provide PI cover as cheaply as they would have done in the past. Insurers do not like paying out claims at the best of times and IFAs in general have become a bad risk. The brutal truth is that bad risks have to pay more for cover.

The reality is that premiums were going to rise anyway but the increases in PI cover which we saw at the end of last year were also caused by structural changes in the insurance market which made a bad situation a lot worse.

There are now only four or five insurers actively looking to write PI business – a significant drop on previous years, which has resulted in a significant shortage of underwriting capacity.

At the beginning of January each year, insurers decide how much PI business they will write over the next 12 months. Once this capacity is used up, no more is available until the following year. In 2002, most of the PI capacity had been allocated by the autumn.

That is why IFAs looking for cover in November and December were experiencing such serious problems. There was too much demand chasing too little supply. This severely distorted the market and put insurers in the position of being able to charge almost anything they wanted.

Not surprisingly, IFAs were outraged by this situation and blamed the FSA for the crisis because it is a regulatory need for IFAs to have PI cover.

Some suggested that one way round this crisis would be to remove this statutory requirement.

The FSA may relax the rules a little but it is unlikely to abandon the need for PI cover altogether. As an industry, we will need to find ways to enable advisers in the short term to obtain PI cover at a reasonable price and in the long term to reassure insurers that we have addressed the issues that currently make us seem a bad risk.

Improving compliance procedures has to be a priority. The technology exists now to enable every piece of business to be checked on a real-time basis. This approach would mean that areas that need second opinions are immediately identified as an application being made.

The increased demands of regulators also means that intermediaries must be able to demonstrate that recommendations are based on a thorough search of the marketplace and proper analysis of the characteristics of the products selected.

Again, technology can come to our assistance. Software is readily available which will provide in-depth product information and perhaps more importantly the small print associated with them.

To address the short-term issue of obtaining PI cover, IFAs starting up today should seriously consider joining a network.

Although there is widespread dissatisfaction with the services provided by the older networks, the reality

is that networks are able to use their size to negotiate better terms with insurers than an IFA could get on their own.

The same argument also applies to directly regulated IFAs who should also consider joining a network.

IFAs who are existing members of a network face

a different problem. They should be questioning whether their network is offer-

ing value-for-money PI cover and whether the network has passed on the cost savings in the past generated through obtaining block cover.

If they have not, but are now asking you to pay more for PI cover, you should consider switching networks.

Networks come in all shapes and sizes and before signing on the dotted line, IFAs should quiz them about their compliance regimes.

Some of the newer networks have identified that compliance is one of the biggest challenges facing the industry and have accordingly structured their businesses to provide a higher level of support.

This may mean that insurers perceive them and their members to be a lower risk and reduced their cost of PI insurance accordingly. Savings made should be passed on to members in the form of lower overall charges.

Some commentators are predicting that the current PI crisis will lead to the number of IFAs falling dramatically. There is no doubt that the situation at the end of 2002 was serious but it was hoped that the new underwriting capacity which came on stream in January would reduce the cost of PI cover in the new year. Unfortunately, anecdotal evidence suggests that this has not happened.

The FSA, IFAs, networks and product providers need to work together to change insurers&#39 perceptions that we are a bad risk.

If we can do that, more insurers should come back in to the market and premiums will fall. The ball is in our court.

As an industry, we have to make a conscious decision to put in place the systems and practices which make compliance as high a priority as selling products.

At the same time, we also need to keep an eye on insurers to make sure that the cost of PI cover is reasonable and that they do not exploit their market power to such an extent that IFAs become an endangered species.

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