Since the 1980s, professional indemnity insurance has been compulsory for all Financial Advisers, and it's been the source of much controversy ever since. It's important to have some understanding of how this niche insurance market works to be able to make an informed decision on which product is best for your firm.
In this short guide, we take a look at the main issues surrounding professional indemnity insurance for Independant Financial Advicors (IFAs).
- How much does it cost?
- Professional indemnity market for Financial Advisers - an overview
- How is the premium calculated?
- Why use an insurance broker?
- Do I need to create a good impression?
- Points to look for in the policy
- How much cover do we need?
- Trading without compliant PI insurance
- How do we get a quotation?
In normal insurance market conditions, premiums for the IFA sector generally range between 1% – 3% of turnover, although this may be higher or lower depending on the many risk factors taken into consideration by an underwriter. This is known as the insurance 'rate', and in recent years it has been rising quite significantly.
The 'rate' charged is dependent on a number of different factors which the underwriters will consider carefully. It's necessary to supply a considerable amount of information that enables them to assess the level of risk to which your firm is exposed, and the premium will then be based on this assessment.
Minimum premiums also apply, which vary between insurers. The 'minimum premium' is the insurance company's starting point for insuring a risk, and they can vary significantly for Planners. A minimum premium could be £ 2,500 with one insurer, or £ 5,000 with another.
From the IFA's point of view, it is foolish to compare professional indemnity insurance policies based on premium alone. You need to fully understand exactly what kind of cover you are getting for your money before you make a claim and discover that the wording does not mean quite what you thought.
- There have been many instances of coverage disputes occurring in this marketplace, and the best way to avoid this situation is to get specialist advice from a broker at the outset. Call us on 0345 251 4000 – we're happy to help you find exactly the cover you need, and peace of mind, for the lowest possible premium.
Over recent years, financial advisers have generated more professional indemnity insurance claims than most other professions. The sector has found itself mired in significant instances of misselling. On top of this, IFAs face an escalating level of uncertain risks associated with the introduction of Pension Freedoms. So the premiums and market capacity for this sector are both limited and volatile.
This perfect storm of adverse factors means that the industry is now more heavily regulated than ever before and there’s a smaller number of insurance companies willing to provide cover. There are many brokers active in the IFA market, but the reality is that they can only approach just a handful of insurers. So those insurers with an appetite for IFAs face less competition, which enables them to increase premiums and reduce cover, particularly for higher-risk products.
In recent years, many IFA firms have found themselves unable to obtain any PI insurance, and most firms carry policy exclusions for fund insolvency, defined benefit pension transfers, UCIS etc. This is mainly because PI insurers provide insurance for professional negligence risks rather than for misselling or compensating for funds or product providers who become insolvent. The PI market refuses to be a compensation provider for the financial services regulators.
So the choice of broker in this minefield is extremely important to achieving the best terms.
The rating of a Financial Services business or any professional indemnity risk is a complex process. Underwriters need to be highly skilled and require a significant amount of information to enable them to provide a quotation which accurately reflects the risk they are pricing. Premiums are calculated based on many factors which will include:
- The claims history of the firm
- Categories of work performed by the firm
- Any past product legacy issues (UCIS funds etc.)
- The number of partners / directors / staff
- Firm's revenue
To assess the risk, the underwriter will require a fully completed proposal form which they will consider in detail. They will also look at the firm's website, or they may even look deeper online into a firms background.
Presentation is more important than you might think. The underwriter is assessing the professionalism and quality of your firm. If the information is badly presented, it may influence their judgement and the premium they offer, or they may even decline to quote.
Given all the issues surrounding professional indemnity insurance for IFAs, it's no surprise that almost all firms use a specialist broker. The broker’s expert knowledge is invaluable when it comes to securing the most appropriate cover, with the least restrictions, excesses and exclusions, whilst minimising premiums. Their advice and assistance is not only hugely beneficial throughout the application or renewal process, but especially so if a claim should arise.
For a quotation or free advice call us on 0345 251 4000. Also read our guide Why You Need An Insurance Broker.
To obtain a quotation, you have to complete a lengthy proposal form which will be reviewed by an experienced underwriter. Remember that the proposal form is a representation of the quality of your business to the insurance market, so it's worth spending some time making sure it looks professional. An underwriter will be using it to judge you, and they will also look at your website and perhaps your financial information.
If you spend time and money on risk management and improving quality, make sure your insurer knows about it. This could easily be overlooked and not reflected in your premium so add some notes on this subject.
The underwriters will want detailed information covering:
Total commission / fee income - one of the clearest indicators of the exposure to risk that you represent.
Business split – extent to which the firm is involved in high risk activities
Complaints and claims history - insurers will want to know the circumstances and any measures taken to prevent a recurrence of the situation as well as subsequent changes to procedures, such as internal reviews and the introduction of sign-offs.
Client documentation - insurers may require sight of the standard documentation that a firm uses, such as engagement letters, terms of business, fact finds and reports. These documents can help show how well defined your services and audit processes are, and whether they can be relied upon to help defend a claim.
Compliance - insurers will consider the internal compliance functions within a firm. Your position may be further strengthened if you have an external compliance provider who conducts regular reviews on your business.
Internal risk management – if you have a robust system in place, one that puts you in a strong position to defend claims, then insurers will look more favourably on your firm.
Personnel – the quality of the team regarding experience, qualifications and training are all very important. If a firm is part of a quality group or network, then this will also be viewed positively as it normally indicates a higher set of standards.
When reviewing the wording, pay particular attention to the following:
- Are there any exclusions for any activities your firm is involved with today, or has been involved in the past? If the answer is “yes” this will leave your firm exposed should a claim arise, including for work you did in the past. You may also be required to carry additional capital as set out by the FCA.
- Does the policy have an Insolvency or Failed Fund Exclusion? A common exclusion that can exclude claims that arise from the failure of a financial institution or suspended fund.
- Does the policy allow Inadvertent Non-Disclosure protection? This guards against insurers exercising their right to avoid the policy in the event of an inadvertent, material non-disclosure, misrepresentation of facts or untrue statement.
- Is there an extended reporting period for claims/circumstances? This is a clause that obliges insurers to accept notice of circumstances during a limited period of time after the expiry of the policy, provided that the matter being notified first came to your attention during the period of the policy.
- The importance of "May" vs "Likely". You must be familiar with and understand the implications of all aspects of your policy wording, specifically in relation to the notification of circumstances/claims. The words "May" and "Likely" are especially important in this regard – they make a huge difference when insurers decide whether to accept or reject a claim. If you are not clear on the implications, get in touch with us on 0345 251 4000 and we'll be happy to talk it through with you in more detail.
Unlike other professions, such as solicitors and surveyors, the FCA does not enforce a standard wording for financial advisers, more commonly known as ‘minimum terms’. As a result, the levels of coverage offered by insurers vary widely.
There are, however, more general rules governing professional indemnity for financial advisers. These include rules relating to the limit of indemnity and excess levels.
The FCA requires all firms to carry a specified minimum level of indemnity for both a single claim and aggregate claims per year. Firms that fall under the Insurance Mediation Directive, the current minimum levels are set out in euros:
- €1.25 million for each and every claim
- €1.85 million for claims in the aggregate
These minimum levels are based upon a firm’s “relevant income”. Where that relevant income is in excess of £ 6m, firms will (in the majority of cases) be subject to higher minimum limits of indemnity.
FCA regulation allows financial advisers to carry an excess at any level they like, but those levels are usually dictated by the insurer. Where an excess exceeds £ 5,000 for a particular product, or across the board, the firm will need to hold “additional own funds”.
If you want to offer your services in the European Economic Area (EEA) then there are further requirements regarding the limit of indemnity or capital adequacy. Contact us 0345 251 4000 for further details.
This represents a serious breach of the regulatory requirements and firms will be closed down if they cannot show they have fully compliant cover and are operating within all the rules.
Because of the historical problems surrounding the industry, it is highly regulated and insurance cover has become more restrictive and expensive. Given this, we cannot over-emphasise the importance of maintaining robust internal risk management systems, ensuring you have a good risk profile and getting expert advice from a specialist broker. It’s also important to begin your renewal process in good time. As the market tightens you may be faced with higher premiums and less favourable terms – so don’t put yourself in the position of having to accept a policy you are not happy with simply because you’ve left it too late to explore alternatives.
For a general chat, some free advice or a competitive professional indemnity insurance quotation, please get in touch.
This guidance note is intended for information purposes only. Whilst all care has been taken to ensure the accuracy of the guidance note, it is not to be regarded as a substitute for specific advice. This guidance note shall not be reproduced in any form without our prior permission. © Professional Indemnity Insurance Brokers Ltd