Independent financial advisers (IFAs) and intermediaries need professional indemnity (PI) insurance to provide financial protection against the possibility of a client seeking compensation for alleged neglect, error or omission.
Sounds fine in theory. But the reality is that many smaller PI brokers are pulling out of the market, leaving it to the larger specialists who are being accused of gaining a stranglehold.
IFAs are compelled by the Financial Services Authority (FSA) to have PI cover. The regulator stipulates that cover must extend to at least three times the annual income of the firm. PI insurance is also a compulsory requirement for intermediaries who are members of the General Insurance Standards Council (GISC). But many advisers claim that they are being taken advantage of because the specialist PI providers are charging extortionate premiums. So is PI insurance simply an unnecessary extra expense or an essential evil?
The need for PI insurance to protect against the potential financial risks and liabilities of those directors, partners and individuals running a business has never been greater than in these highly litigious times.
Court awards have risen sharply in recent years and, without insurance, the financial security of a business is likely to be threatened. In addition, as mentioned previously, many insurers have left the PI market or simply will not provide cover for certain IFAs, and the remaining handful can effectively name a price.
Consumers are more financially astute and clients will not hesitate to pursue a claim if they feel that they have received poor service by an adviser whom they consider to be an expert.
Catherine Nicoll, head of communications at the GISC, the incumbent watchdog for health insurance intermediaries, says: “PI is a compliance issue but it is not a particularly problematic aspect of our rules. There was a capacity crisis in the market after September 11, causing some people to have difficulty in renewing their [PI] policies at the levels they had previously. If that is a market-wide problem we would have to look at that, but we do not anticipate it being a problem.”
Paul Smee, director general of the Association of IFAs (AIFA), suggests that IFAs find themselves a good quality PI broker who knows the market and can place the risk effectively.
“PI insurance has an important function to play. If IFAs get claims for errors and omissions they could end up in a lot of trouble,” he warns.
“The PI market is very difficult for everyone. It is very important going forward that there is some understanding of these difficulties by the regulator. It should look with great sympathy on those who cannot, for whatever reason, get cover that is wholly compliant.”
He adds: “The FSA needs to have a flexible attitude and an understanding of how IFAs operate so that risks are underwritten individually rather than generally on the claims experience of IFAs as a whole.”
Medical Insurance Services director Stephen Walker explains that PI is compulsory for GISC membership and without it no insurer would give intermediaries an agency.
However, he says that the minimum amount of cover to protect his Brighton-based PMI intermediary business used to be £250,000, but since the GISC’s inception the cost has rocketed to a minimum requirement of £1m.
“PMI intermediaries will give the view that this is overkill because there has never been a claim made against them, the premiums have risen dramatically and there is the GISC membership to pay annually as well,” says Walker. “My monthly premium used to be £180 but now it has gone up to £475. Other intermediaries could be paying around £200 more than that.”
It is worth noting that the Association of Medical Insurance Intermediaries (AMII) has an arrangement with a PI broker whereby it can offer its members a preferential rate.
Intermediaries and IFAs would rather pay for PI insurance and not have to think about it, but last year’s terrorist attacks on America have had a trickle down effect through the entire insurance industry, causing a sharp rise in PI premiums.
According to industry experts, intermediaries could run the risk of facing extortionate premiums if they do not pay special attention when renewing.
The spate of recent pension and endowment mis-selling claims within the IFA market, has led underwriters to be cautious and this has compounded the rises in liability costs. PI cover for a typical IFA rose by at least 30-40% during the last year, and rises of between 200% and 500% have been reported.
An underlying factor causing claims to be high is the culture of blame in today’s society and IFAs are currently in the spotlight, according to Ian Burgess, managing director of JLS, the PI division of insurance brokers John Lampier & Son. But premiums for PMI intermediaries depend on what they do and the type of clients that they are acting on behalf of.
The same goes for IFAs. Burgess says: “Two IFAs next door to each other may have completely different premiums. It depends on the type of work they are involved in, even if their income is similar.”
The situation prompted Burgess to produce advice on how to minimise premiums. For further details, see the box inset below.
Burgess says that by leaving the underwriter in no uncertainty as to any aspect of the business, advisers can best ensure that premiums paid are the most appropriate from the limited deals available.
Andrew Macpherson, associate director at Dickson Manchester & Co, says that PI market rates are generic to all professions but have been “soft” – a term used when referring to lower rates – since 1987 and have gone down every year until last year, with two notable exceptions where rates have been very high:
• IFAs – pension mis-selling • Chartered surveyors – property crashes in 1980s and 1990s He suggests other reasons as to why rates have rocketed, such as market deterioration and claims statistics specifically for commercial brokers. “Underwriters have rarely made a profit from commercial brokers historically. And we are entering “hard” [higher rates] market conditions as rates go up for the first time in many years.”
Macpherson is hopeful that the causes of the current hard market will ease off gradually over the next couple of years but says that it is also dependent on the general economy.
He says that history tends to repeat itself. “When underwriters feel they have made a profit – for example, when interest rates rise – insurers have a short memory and they forget about the problems when there is more capacity and competition again.”
Advisers gain much more profit in a hard market, Macpherson explains, especially with renewals and client retention.
“This means they get a double whammy because PI insurance is rated on the fee or commission income and if the market rates are increasing this is applied to a broker’s income, for example 50%, and then on top of that we would apply a rate of 100%.”
But he offers suggestions about how to work in the PI insurer’s favour to get positive rates. “The only way to reduce the effect of a hard market,” he says, “is to have a good risk management procedure.”
Macpherson adds: “We would only look at PI business renewal applications if they are put together in a professional manner, with questions answered in full and not referring us to last year’s form. For example, if losses occurred, what practical measures have been put in place to avoid it happening again?
“Insurers look at 50 risks a day and they don’t want to waste their capacity. We get so many poorly put together applications from brokers who should know better.”