What affects Financial Planners PI insurance premium?
The insurance market for professional indemnity insurance to financial advisers continues to be difficult and unprofitable for most insurers. As a result insurers/underwriters are leaving the space or increasing premiums to ensure this market segment is profitable. Consequently, all financial planning firms, regardless of their claims history, are being affected with the same skyrocketing Professional indemnity insurance premiums.
The collapse of Storm Financial, WestPoint and Basis Capital to name a few, have combined to create a difficult and unprofitable market for insurers with significant payouts needing to be absorbed by ever increasing premiums since 2007. Even though your firm may have no exposure to these failures, the depth and breadth of these claims have become so expensive for the industry that it impacts the entire financial services PI market and puts upwards pressure on all financial services participants premiums.
At an individual Licensee level, there are a number of characteristics of your business that insurers will consider when assessing premium rates.
Each insurer assesses risks differently; however broadly speaking, insurers will all look at generic areas of an AFSL's business when calculating the premium:
- risk profile of the licensees business,
- the nature of the licensees business,
- competency and experience of management and staff, and
- the level of excess and required limit of indemnity.
Which factors make a financial planning business a more attractive risk for an insurer?
- Split of business – Insurers assess that some areas of a licensees business pose a higher risk than others. For example some insurers and underwriters have blanket exclusion for Managed Discretionary Accounts. – With no exceptions. Further, the split of a financial planning business should mirror the expertise of the firm; that is the insurer will want some comfort that the firm has the relevant experience to undertake specific type of work such as recommending direct shares.
- Regulation and compliance – insurers will consider a firms measure of compliance. Insurers will gain comfort by understanding factors including how many client files are regularly reviewed, the ratio of clients to staff, and how often the firm completes a license review from an accredited provider. The Licensee review should assess the licensee against both legislative requirements and industry best practice. The areas covered by the review should include; general licence obligations and responsibilities; documented policies and procedures; compliance arrangements; risk management procedures; the financial adequacy, human and information technology resources; and key business documents and marketing material.
- Complaints and Claims history - An up to date complaints register will show the frequency of claims or complaints and what type of complaints have been made. Insurers will require clarification as to how and why the complaints or claims arise and importantly what actions have been taken by the licensee to prevent future claims. Potential claims and client complaints should always be declared/notified to insurers and it is important to note that they are not always viewed negatively. It is important for all licensees to note that if claims/complaints are not notified this could invalidate the policy.
- Quality of personnel – the job experience of all employees in a firm (especially those who are client facing) and how the licensees corporate structure works is a key consideration for all insurers. Insurers will require an understanding of the experience, the ongoing training and areas of expertise of all key personnel.
- Your products and services –What type of service do you offer? For example insurers and underwriters rate firms that simply use managed funds vs those who recommend direct shares, or use MDA's and access leverage via margin lending very differently. Firms can range from servicing a wide audience of wealth accumulators to retirees, to specialising in niche products for HNW investors. Therefore the insurer will look to understand the firm's experience and culture, and consider the risks each model presents.
What can I do to reduce my Professional Indemnity premiums?
Whilst PI cost is a legitimate consideration, before you drive forward on a cost reducing exercise, firstly make sure you are satisfied with the product you are purchasing and fully explore the cover being provided. – Not all insurance policies are the same and there can be significant differences in policy wording which will have implications in the event of a claim. You will only know how good your cover is in the event of a claim. Always look at the additional covers and exclusions that are available and ensure your cover meets the minimum requirements for adequate PI insurance as per ASIC's regulatory Guide 126.
All insurers are not the same and your research should take in the solvency and strength of the insurer/underwriter, their financial rating and their claims management process. Further the Professional Indemnity market for AFS Licensees is a brokered market; therefore Licensees would do well to consider the support and advice they are getting from their broker.
Some brokers will place policies across a number of insurers whilst others will hold exclusive schemes. It is also important that your broker is a PI specialist with strong insurer/underwriter relationships who can; in the first instance support you through the underwriting process and in the second instance support you in the event of a claim. There are already too many risks in business; you shouldn't take risks with your PI cover.
There are two key variables of any policy premium; the limit of indemnity and the excess. Whilst ASIC is quite prescriptive around the level of cover required, some Licensees do have flexibility around their limit of indemnity. However a word of caution: Whilst a lower limit and higher excess will reduce the premium, the considerations you have to pay attention to are, the capital requirements that a higher excess makes on the firm and if the limit is appropriate to cover you.
A smart way for a Licensee to reduce their PI premium without having to make any significant changes to their business is through ongoing minor modifications/improvements to the way you run your business. These subtle changes could include improving your internal risk management processes, regularly reviewing and updating your disclosure documentation and putting in place more checks and balances that insurers will view positively. Regular reviews will help an insurer to understand what changes the licensee has made since a complaint or a claim, how was it dealt with, and how proactive the Licensee has been in making sure the situation does not reoccur.
Standard documents that should be a part of every licensees business such as client engagement letters, terms of business, or financial needs analysis are tools in mitigating risk. If these documents are out of date or poorly prepared, insurers will view this as an issue. In most cases it will be these very documents that will be considered when a claim arises, and an insurer will look at thses to determine how straightforward it will be to defend a claim successfully.
Finally, be realistic in your expectations. A poor claims history or an over complicated firm structure with many specialist niche products, MDA's or a large number of Margin Lending clients will tend to require a higher average premium against the rest of the market (especially if you have a number of AR's off-site). Your broker should understand these variables and advise where you sit in the spectrum.
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