Stormy skies

PROFESSIONAL INDEMNITY (PI) insurance has proven to be a touchy subject in financial planning circles, with a varied and often volatile spectrum of views being articulated.

Although PI insurance for financial planners is required under the law, planners have reported both difficulty in seeking and obtaining cover and significant cost increases.

ifa found getting a clearer picture was made more difficult due to the wall of silence erected by three of the market’s four major underwriters – Vero, Axis and Dual. The fourth, AIG, agreed to comment.

Broadly speaking, these providers service a majority of the industry. However, several insurance brokers have indicated there are also other smaller or ‘emerging’ markets available.

Some practitioners support insurance providers; some are vehemently opposed; some boutique advisers are saying loud and clear that if costs continue to increase, they may be priced out of the market.

What’s happening with PI insurance?

Although there is no consensus around the nature and scale of price increases for PI insurance, several practitioners agree the cost of coverage has risen, particularly since the global financial crisis (GFC).

Premiums have increased “significantly” in the past five years, according to Trent Franklin, managing director at Enrizen Financial Group. Smaller, independent licence holders in particular have suffered increases of “at least 50 per cent” from market lows, he says.

Matthew Clarke, Australasian PI manager for AIG, agrees that PI costs have increased for AIG policy holders, with the scale of the increases varying across AIG’s portfolio.

Clarke also notes the company’s base technical rate, the minimum criteria against which every planner insured by AIG is rated, has increased.

“Certainly, from AIG’s point of view, we’ve been pushing premiums up for probably the last three to four years,” Clarke says.

“We’ve had minimum increases over the last couple of years of 20 to 25 per cent year on year. During that period a good clean risk still increased 20 per cent.”

Clarke adds that the risks that have had a poor claims history during that period “have increased dramatically”.

Although AIG has also been more selective in whom they provide insurance for, Clarke emphasises the company has not reduced the level of cover provided within a policy.

“We certainly will review the way [the insured] do their business, and will decide on whether or not we’re happy to accept that risk,” Clarke says.

“If we are happy to accept that risk, we accept the risk entirely; we don’t tell them what they can and can’t do.”

There has also been a “general realignment of the book” and an underwriting perception that this is a problematic professional segment, according to Gary Gribbin, director at Insurance House.

“I’m just not aware of any dealer group which is in the fortunate position of having rollover terms... that is, everyone is looking at rate increases. It’s really all about the size, not about the fact of rate increases,” he says.

Conversely, Stephen Hughes, general manager of professional services at Strathearn Insurance Brokers, believes there are still insurers writing good financial planning risks at a “reasonable” rate, particularly for planners with a good claims history.

Michael Gottlieb, director of Mega Capital, says those AFSLs whom insurers regard as a low to medium risk profile and who have not experienced significant loss ratios are “not experiencing significant premium increases”. He adds, however, that minimum premiums have increased across the board.

“So it doesn’t matter how attractive your risk profile is. If insurers continue to increase minimum premiums and you fall into this category, the premium will continue to increase,” Gottlieb says.

‘A hard life’

Rising premiums are “a bitter pill to swallow” for advisers who haven’t made a claim, with many boutique advisers feeling they have been unfairly affected by these increases, says Wayne Roggero, Boutique Financial Planning Principals Group (BFPPG) president.

Many boutique advisers are subject to minimum premiums, which have risen since the GFC, according to Franklin. Boutiques, he adds, are not necessarily in a high-risk category; the increase is a function of their turnover not being high enough to get a scaling benefit.

Tony Gillett, director of Retirewell and executive committee member of the BFPPG, adds that “it’s a really hard life for the small AFSLs – the amount of cover available in the market has shrunk, and it’s typically a lot more expensive.”

Philip Windsor, director at independent firm Chrysalis Lifestyle Planning, says his premium increased by 66 per cent last year. Windsor says he had no claims, is a “very vanilla” practice from a risk perspective and has tightened his risk management procedures.

This experience is ‘across the board’ for boutique planners, according to Windsor, who believes he is at the lower end of the increases – he is aware of planners who have had 100 per cent increases in their fees.

It has also been difficult for boutique planners to get insurance in recent years, says Windsor, who claims it took him approximately three months to get his application processed and approved.

“I think there are probably only three players in the marketplace that I can choose from and probably only two of them want to really play at all,” Windsor adds.

If these costs continue to increase, small operators may reconsider maintaining their independent status and move to dealer groups aligned with their philosophy, he says.

“It’s like the whole industry is starting to get commoditised,” Windsor says. “I am quietly concerned about the future in this profession. Maybe the day of the independents is drifting off into the sunset.”

Risky business

Many practitioners suggest insurers’ losses are a key contributor to PI insurance price increases, and that financial planning is a high-risk business.

“It’s an area that’s causing more claims than other areas of professional practice,” says Paul Girard, director and national underwriting manager of Mint Plus, an underwriting agency.

“If you’re going to write planners you have to have a reasonable premium pool to cover the claims that you are more than likely going to get,” he says. “If you don’t do that … you’re going to find yourself, in time, with inadequate reserves to pay claims and you are going to be running at a substantial loss.”

Clarke says AIG’s price increases have been a factor of losses – such as those encountered during the GFC – and local issues, such as collapsed funds and property syndicates.

These losses, he says, have either been paid out in recent years or are just starting to be paid out.

“It’s only now that we’re understanding the true magnitude of the losses from those ’08, ’09, ’10 and ’11 policy years,” Clarke says. “So as that claims history continues to deteriorate – we had to take corrective actions with our portfolio.

“From our point of view, we price our policy to ensure that we can provide a consistent offering to the market year in and year out – and that’s why we’ve taken the action that we’ve taken.”

Another reason insurers are running scared is that financial planners are exposed to systemic risks, meaning they cannot insulate themselves from the market, according to Gribbin. In the event of a market failure, a host of planners are likely to be affected, he adds.

Further, if clients sustain market losses they can’t afford to absorb, it’s likely they are going to try and recover them and blame somebody else for them, says Girard.

Gottlieb agrees, adding that planners are the first port of call and a disproportionate amount of blame can be shifted in their direction. This is “made more difficult” by “consumer friendly” external dispute resolution schemes.

In addition, the failure of investment schemes prior to the market’s downward turn has meant insurers are likely to be concerned about another round of failures or being “plunged into a bare market”, according to Gribbin.

Product failures, such as Great Southern, and the ramifications of Storm Financial, have also contributed to claims experience, says Franklin. He adds that several insurers make their money on their investment returns – a negative investment return and negative underwriting position means “that’s a double hit on them and fares badly for advisers”.

Getting it right

Despite what might appear to be a gloomy outlook, many insurance brokers have indicated there are promising options available, particularly for those who have a conservative risk profile and a clean claims history.

“For those planners that have gone through the GFC and haven’t had a claim ... they represent an excellent risk for an insurer,” says Hughes. “It’s not all necessarily doom and gloom.”

Gottlieb adds that if a planner is a ‘preferred risk’ with no previous claims history and is above the minimum premium, there is “competition for the business and you should get a good result from the insurance market”.

“Because of the loss ratios of a number of insurers being 150 per cent-plus, it’s created an opportunity whereby ... some of the risks with attractive claims histories are able to move insurers, and obtain materially the same premium and not really get increases,” he says.

To secure these benefits, a planner’s risks needs to be properly promoted and represented to an underwriter, according to Hughes, who says it’s important to deal with a broker who knows this type of insurance.

Given this risk “is not everybody’s cup of tea”, according to Girard, for planners to optimise their position, it’s important they are very detailed with the information they supply to insurers.

“It takes time to do that, but it’s [an] indication of professionalism,” he says. “Your insurer can read that submission and get a lot of comfort around the qualities of the activities of the planner and how well they manage their business and their risks.”

Regulatory concerns

With a wave of regulations about to hit the financial services industry, industry associations have some concerns around the impact of the changes on PI insurance for planners.

These concerns include whether pre-existing insurance policies will cover planners once the Tax Agent Services Act (TASA) comes into force on July 1, particularly if the practitioner’s service offering doesn’t change.

“If [planners are] going to start doing tax returns ... then that’s a completely different service offering and a different level of coverage,” says Dante De Gori, general manager of policy and standards at the Financial Planning Association (FPA).

“If they’re doing what they are doing today [after] TASA starts, how is the risk any different to the PI provider?

“We would say that financial planners are already covered for [tax] advice within the context of financial advice.

We’d be disappointed if our providers came out and said that wasn’t the case.”

While admitting there has been no indication so far of any “drastic” changes, De Gori says it’s an issue that the FPA is watching closely.

Philip Anderson, chief operating officer at the Association of Financial Advisers (AFA), says that while it is most likely that existing cover will be adequate, “it’s another factor that might highlight to insurers that there’s a greater risk, a greater exposure”.

“If it’s covered under the existing policies, then presumably it will have limited impact immediately on cost, but it does open up a new avenue of complaint by a client to go through the Tax Practitioners Board,” Anderson says.

In addition, the government has accepted recommendations made by the Parliamentary Joint Committee (PJC) on Corporations and Financial Services on the collapse of Trio Capital, as well as the report by Richard St. John on Compensation Arrangements for Consumers of Financial Services.

The reports’ recommendations include legislative changes to strengthen the PI insurance requirements of providers of financial services that deal specifically with retail consumers.

However, the FPA is concerned with some of the recommendations which suggest a “ramp up” of PI insurance criteria. Using the Trio example, Mark Rantall, chief executive officer of the FPA, says there is “no evidence” that PI insurance has fallen short of what is needed to protect consumers.

“It was a matter of fraud within a product … if and where there were advice failures, then consumers have already got the avenue through the Financial Ombudsman Scheme (FOS) to lodge a claim,” Rantall says.

“So to make a [broad brush] statement which looks at PI cover without evidence is probably just a bit premature at this stage,” he says.

The FPA is not hiding from client compensation as a result of shortcomings in an adviser’s professional conduct, De Gori says; rather, the association is saying there needs to be “proportional liability” for another person’s role in a consumer’s complaints.

De Gori adds that the Future of Financial Advice reforms (FOFA) aim to deal with the influence of commissions, something Treasury raised as a “question mark” in another report regarding the Trio inquiry.

“FOFA has to commence still … I think we should be in a position to wait and see and allow the new regime to take place,” De Gori says. “Before you start looking at additional potential changes, you’ve got to allow the changes that have been on foot to actually [start] working the system.”

FOFA: divided opinions

The spectrum of views regarding the impact of the Future of Financial Advice (FOFA) reforms on PI insurance ranges from those who believe it could improve the way insurers see planners to those who think the reforms will contribute to an already uncertain market.

AIG will be “closely monitoring” the impact FOFA has on losses in its portfolio and Clarke says that, as with any new legislation, there are concerns on how it will impact the industry.

“FOS has done some great work with the insurance industry in trying to allay any fears insurers may have, but until those first matters go through FOS, we don’t really have that certainty,” he says.

AIG’s concerns include the best interest principle and how that will be determined, particularly by FOS. Clarke agrees that AIG is concerned there are potentially more grounds for a client to take action based on the best interest provisions.

However, he adds that AIG has not made any changes to its policy in respect to the FOFA reforms, and doesn’t feel it’s necessary to make changes at this stage.

Speaking more broadly, Brad Fox, chief executive officer at the AFA, says when a level of regulation increases, the number of duties an adviser has to meet increases too. “The more things there are to meet, the more risk there is potentially of failure,” he says.

Boutique advisers suggest FOFA has already had a negative impact on PI insurance for their market, with Gillett saying PI underwriters are “pricing out the risk” they are taking on, particularly in relation to best interest.

Despite these concerns, Claire Wivell Plater of The Fold believes if the FOFA reforms have the desired effect and financial planning moves further towards a “true profession” in which planners truly act in the best interest of their clients, it’s likely that insurers will become interested in insuring this risk again.

Franklin says he believes FOFA will, in the long term, remove some of the claims that get lodged because of a lack of transparency and understanding between financial planners and their clients.

“Because of [FOFA] driving the fee for service model ... planners will position their value to clients and the costs associated with it, so it will remove the misunderstanding between what the planner is there to do and what the client actually wants,” Franklin says.

Coming off the bench?

Some practitioners are quietly hopeful that in the next few years, the market will return to equilibrium.
Others are not so sure.

“Remember James Bond – ‘Never say never again’,” says Gribbin. “If the perception becomes generally accepted that planners have improved their performance and reduced their claims, hopefully you will see some insurers come back into the scene.”

Some insurers on the bench are taking a “wait and see” approach, according to Franklin, who believes there will be more players entering the market – those that have not had the losses the ones currently in the market have seen.

“They’ll be able to potentially price at a more competitive level; it’s just a question of whether they come in before the portfolios are balanced up of the existing players,” Franklin says.

The industry is 24 months off seeing a “real, meaningful change” in pricing, according to Franklin. “We may be in a world that has a new standard when it comes to financial planners, given what insurers have seen,” he says.

Girard, meanwhile, points out there are rumours of new entrants coming into the marketplace, with the perception that the “worst is behind everyone”.

However, Girard believes there is still instability in the investment market, and this difficult environment will remain into the foreseeable future. “Everybody involved, including the planners, is going to have to tread carefully,” he says.

Keeping it competitive

THERE HAS been talk that price increases in the insurer’s market could be due to a lack of competition.

However, several practitioners oppose these suggestions, with Claire Wivell Plater, financial services and insurance lawyer and managing director of The Fold, saying even three providers in the marketplace would be “reasonable”.

“There’s no gouging ... insurance doesn’t work like that,” Wivell Plater says. “Yes premiums are high... they’re high because it is high-risk business and insurers have been burned, and that’s why they’ve exited the market,” she says.

Insurers have lost “a lot of money”, and “won’t want to come back in until they can be satisfied that is a risk that they want to pick up again,” Wivell Plater adds. “Nobody insures Florida for hurricanes.”

In addition, it’s not necessarily a lack of competition which is linked to price increases, but rather lack of capacity, according to Enrizen Financial Group’s Trent Franklin.“[The] losses that those underwriters have on their books don’t allow them to do it any cheaper,” he says.

Further, even if new insurers come into the market, “they’re not going to be wanting to insure risks that have bad practices, they’ll be wanting to insure good risks,” according to Strathearn Insurance Brokers’ Stephen Hughes.