The growing PI conundrum at the centre of financial advice
While financial planners accept the reasons they are required to hold Professional Indemnity insurance, there are signs the system needs a review.
Few people would argue with the underlying reason the Corporations Act requires financial planning practices to carry professional indemnity (PI) insurance - the compensation of clients who suffer losses as a result of bad practices or bad advice.
However, when the PI requirement was first inserted into the Corporations Act and translated into Australian Securities and Investments Commission (ASIC) regulatory guide RG126 in 2008, there were more insurance providers in the Australian market actually prepared to service the market - something which created a very different commercial dynamic for planning practices and individual planners.
Indeed, ASIC's pre-2008 analysis of the PI market painted a picture dramatically at odds with that which pertains in 2013.
According to that nearly five-year-old ASIC analysis: "the market for professional indemnity insurance is well supplied with a wide choice of providers, policies and special schemes.
It is highly competitive on price, with few concerns about affordability or premium levels".
"It is not expected that licensees who are not presently insured will experience difficulty in obtaining [professional indemnity insurance] unless they have a poor track record or present unusually high risk exposure."
The simple facts of life now confronting financial planning practices are that there are limited sources from which Professional Indemnity insurance can be obtained, and that events such as the collapse of Westpoint, Storm Financial, Trio Capital and a raft of Managed Investment Schemes have seen those few remaining providers tighten their rules.
That tightening has been reflected in asset allocation ratios, with the insurers making it clear that they are not well-disposed towards excessive exposures to asset classes such as property trusts, real estate investment trusts (REITs) or mortgage funds.
From an insurance point of view it is hard to argue with an approach adopted by PI providers based on minimising/containing exposure to allocations they regard as being unduly risky - but such an approach, in turn, must inevitably impact the manner in which planners provide advice.
Quite simply, there is evidence that some planners are deliberately steering their clients around exposure to particular asset classes in the interests of maintaining their PI cover.
This, in turn, raises the question of whether they are then acting in the best interests of their clients as required under the Future of Financial Advice (FOFA) legislation.
Some might even ask whether there is a difference between a planner being influenced by PI considerations or being influenced by the payment of commissions.
What seems clear is that the background to ASIC's rosy pre-2008 analysis of the PI market has changed dramatically - and this has given rise to some serious unintended consequences and possible conflicts with respect to the underlying objectives of the FOFA legislation.
Given all the circumstances, it is probably time for regulator to review the current regime and whether it is actually working as intended.
Recommended for you
In this episode of Relative Return, host Laura Dew is joined by Andrew Lockhart, managing partner at Metrics Credit Partners, to discuss the attraction of real estate debt and why it can be a compelling option for portfolio diversification.
In this week’s episode of Relative Return Unplugged, AMP’s chief economist, Shane Oliver, joins us to break down Labor’s budget, focusing on its re-election strategy and cost-of-living support, and cautioning about the long-term impact of structural deficits, increased government spending, and potential risks to productivity growth.
In this episode of Relative Return, host Laura Dew chats with Mark Barnes, head of investment research, and Catherine Yoshimoto, director of product management, from FTSE Russell about markets in Donald Trump's second presidency and how US small caps are faring compared to their large-caps counterpart.
In this episode of Relative Return Unplugged, we examine the push for superannuation tax reforms aimed at saving $10 billion annually, as well as the immense pressure being placed on Treasurer Jim Chalmers ahead of the budget and Deloitte’s warning of a $26.1 billion deficit.
