Collegiate News

Advisers are trading without PI

28 April 2005


Money Marketing-28-Apr-2005

The FSA is failing to crack down on firms operating without professional indemnity insurance, leading to concerns that IFAs could slip through the net, says Collegiate managing director Tony Howe.

In 2003, the FSA adop-ted a sympathetic approach to IFAs struggling to obtain PI cover by granting waivers to firms. This ended in January this year with the onset of the Insurance Mediation Directive, requiring intermediaries to have £1m in PI cover but Howe estimates that up to 40 IFAs could be trading without PI cover, leaving consumers unprotected and other IFAs to foot the bill through the Financial Services Compensation Scheme if a firm fails.

Howe says despite the availability of PI cover in today's more benign market, some IFAs are not showing any urgency to get cover. He says: "Some IFAs are putting together presentations which do not put them in the most favourable light.

"It is now a matter of enforcement. I have seen little evidence that the FSA is acting quickly enough on this. At the very least, I would expect clients of IFAs without PI cover to be informed."

But FSA spokesman Robin Gordon Walker says the regulator is not responsible for ensuring IFAs take out PI cover.


He says: "The onus is on IFAs to do the acquiring. If they are required to have PI insurance and do not have it then they are non-compliant."



Take note of a costly subject

28 April 2005

Financial Adviser 28 April 2005

Tony Howe, chief executive of Collegiate Insurance Brokers

 

The subject of professional indemnity insurance and networks is not without interest – particularly to those who have to pay the cost of PI insurance.

 

However, it is somewhat technical in nature. This is unavoidable and I can only apologise for it.

 

Under the current legal framework, businesses who wish to carry on business giving investment advice but not to be directly authorised can do so only if they obtain an exemption. They can achieve that automatically by becoming an AR – an appointed representative of an approved person.

 

Section 39 of the Financial Services and Markets Act provides that an AR is exempt from the general prohibition by virtue of his contract with an authorised person who has accepted responsibility in writing for his activities.

 

This without more would not be binding on any third-party client now turned claimant, but subsection 3 makes the authorised person responsible as a principal for everything done or not done by the AR in carrying on the business for which responsibility is accepted.

 

This does not mean that the AR has no duties to his clients. Just because his principal may have accepted responsibility and, by virtue of the statute be exposed to third-party claims, nonetheless, the AR retains residual responsibility to his client both in contract and in tort – civil wrongs recognised by law as grounds for a lawsuit.

 

Furthermore, even if the network has accepted responsibility for the activities of the AR, it will probably seek full indemnity under the network’s membership agreement for everything the AR has done.

 

The network itself, however, has potential liabilities. It may be the subject of a complaint or be sued by the AR’s client. Though the liability can be passed onto the AR, it may not always happen.

 

The AR may say that the complaint would not have occurred but for some culpability on the part of the network in respect of the services it provided. More often the indemnity may not help simply because the AR is unable to meet the liability.

 

As the authorised person, the network is obliged to meet the financial resource requirements in Chapter 13 of the Interim Prudential Sourcebook: Investment Business.

 

In addition to having adequate capital resources, the network is obliged, no matter how great those resources may be, to take out PI insurance. The amount it has to purchase will depend upon the total commission income of the network. The policy it buys must comply with the general principles laid down, and any failure to meet these has to be reported to the FSA within 28 days of renewal.

 

On top of the basic financial resource requirement, like any other authorised entity the network is obliged to provide additional own funds if it bears levels of excess more than £5000 per claim, or if it agrees to exclude from cover claims arising from lines of business which have been or may be undertaken by the network businesses.

 

Networks therefore have choices in arranging their insurance. They might simply cover their own liability and require their ARs to buy cover in the general marketplace.

 

Their second choice is to arrange separate cover for the network and a master policy for the network members who would be required to participate in those arrangements, or as an alternative to arrange one composite policy with different aggregate limits and sub limits, the network members being co-insured.

 

The main advantage of these latter methods is that the network has complete control over buying the cover and is able to satisfy itself that the ARs will be able to meet claims against them or arising under the indemnity.

 

PI insurance has also been seen as a recruiting sergeant for the networks. If cover can be got at reasonable prices with low excesses, then the network is able to offer an attractive package to an AR who would clearly be concerned as to his exposure to his client base, as well as the potential liabilities he incurs under the indemnity to the network.

 

Whereas until a year ago, cover had to be purchased from a UK authorised insurer, the rules have been relaxed. Some or all of the regulatory required cover can be bought through its own captive insurance.

 

An alternative may also be available in the form of a comparable guarantee.

 

If a network opts for captive insurances, it must satisfy the FSA as to the financial standing of the captive and confirm that the captive is not breaching the general prohibition against transacting business within the UK.

 

The use of captives may offer networks a welcome respite from the vagaries of commercial cover, when inadequate capacity led to high premium rates and restricted cover with a high degree of pound swapping necessary to satisfy the low excess requirements of the member companies.

 

These pound-swapping premiums would be grossed up not only for commissions, but for an element of profit to justify the insurer offering its limited capacity.

 

It can be anticipated that there will be an underlying frequency of claims happening every year. A small number of larger claims may arise, say every three years, and lastly the occasional catastrophe will arise once every blue moon.

 

The use of a captive programme coupled, say, with three-year alternative-risk transfer reinsurance would be leaving the unexpected catastrophe to the insurance market. This can be highly efficient.

 

Arranging insurance on behalf of the network members also carries with it the complication of allocating costs among the network members.

 

This may involve an element of individual underwriting. Here some guidance should be found from the network’s broker or scheme underwriter.

 

When members leave the network, it would be well advised to have a provision in the network agreement enabling it either to require the former member to continue to maintain PI cover, or preferably, entitling the network to buy such cover for the former member at his expense.

 

Obtaining a deposit of, say, 300 per cent of the individual member’s final year’s premium would be sensible to enable the network to purchase at least six years’ run off for the departing member concerned.

 

That may seem a lot, but it would represent a deduction of 20 per cent a year recognising a reducing exposure to claims against the former member over a six-year period. The liabilities arising from that member’s activities could far exceed that period.

 

However, since January it has become relevant to ask whether a network in arranging insurance for its members is acting in breach of the prohibition against acting as an insurance intermediary without authorisation.

 

In the FSA’s view, a person brings about a contract of insurance if his involvement in the chain of events leading to the contract of insurance were important enough that without it there would be no policy. Most networks compulsorily would seem to fall into that provision.

 

However, there is an important potential exclusion for persons whose principal business is other than insurance mediation activities where the provision of information may reasonably be regarded as being incidental to that professional business.

 

Thus, within the exception are things, such as as dental insurance being incidental to a dentist’s activities. If a network wants to establish whether this exemption is of any help, it would be well advised to ask the FSA to confirm it has no objection to the proposition that the company is not engaging in a regulated activity without permission.

 

If the FSA considers otherwise, then the route open to the network is either to extend the scope of its permission or to seek formally an exemption from the requirement.

 

Last year’s relaxation of the financial resource rules was a mixed blessing.

 

Some networks would have been exempt by virtue of their share capital from the requirement to buy cover at all.

 

While not to have done so may have been imprudent and unpopular with members, the network was free to make whatever arrangements it wished – including in particular avoiding the prescriptive policy wording which had caused so much difficulty with PI insurers.

 

Now all networks have been dragged into the net. However, they benefit from the reduction in required limits of indemnity and greater flexibility over the terms of cover, permitted exclusions and excesses, not to mention the possible use of captives.

 

Lastly, the regulation of general insurance with effect from January this year has given networks something else to think about.

 

The insurance of networks involves intellectual challenge and offers interesting opportunities to be explored by the networks and the unhappy brokers who advise them.

 

Tony Howe is chief executive of Collegiate Insurance Brokers