Crisis strikes at heart of industry

Robin Yates has an unblemished record as a financial adviser. He has been awarded the International Quality Award for financial planning five times. He is a director of the Association of Financial Advisers (AFA). He has never had any claim made against him in almost 25 years as a financial planner.

He is also a reasonable man. That is why he is prepared to admit that the $480 he paid for his professional indemnity insurance in June 2000 was far too cheap.

But nothing could have prepared Yates, who runs two successful financial planning offices in Tasmania under the Business Life Group banner, for the professional indemnity insurance premiums he was quoted when his cover came up for renewal this June.

From the $480 he paid in 2000, Yate’s premium jumped to more than $13,500, an increase of almost 2,800 per cent.

The quote could have been brushed aside as a cruel hoax had it not been typical of the crisis in the professional indemnity insurance market that has engulfed financial planners along with many other professionals over the last six months.

The crisis now looms as one of the biggest threats ever to the financial planning industry, with few left in any doubt that it will force some financial advisers out of business.

“We will have situations where people will be looking at the professional indemnity crisis, along with a more vigorous compliance regime [under the FSRA], and reassessing whether they want to stay in business,” Financial Planning Association (FPA) chief executive Ken Breakspear says.

While the potential impact of rising professional indemnity insurance premiums on financial planners is resoundingly clear, the cause of the crisis is still very much the subject of intense debate.

On the one hand, financial planners like Yates are arguing the premiums being quoted by insurers are totally baseless and therefore utterly unwarranted.

They say, regardless of the uncertainties facing insurers post September 11 and the collapse of HIH, which dominated the professional indemnity market in Australia, the reaction of insurers is at best ill-informed about the risks presented by financial planners.

At worst, they say insurers have reacted opportunistically to situations such as the absence of HIH, which was famous for undercutting its competitors in the professional indemnity market, to push premiums beyond what could ever be justified.

“It would appear on the face of it that the demise of HIH has been the catalyst for a lot of insurers to try and recoup the losses they had previously accumulated,” Yates says.

Such claims are not entirely without vindication.

In one case recently brought to light by the FPA, a financial adviser who had previously paid $1,800 for professional indemnity cover, was quoted a premium of $80,000 when trying to renew his cover this year.

But when that same financial adviser sought separate quotes from two different insurers for the life and financial planning sides of his business, he was quoted $30,000 for the life component and $5,000 for the planning portion.

The $45,000 difference between the $80,000 originally quoted to the planner, and the $35,000 he eventually paid, does not suggest an insurance sector that is pricing the risk associated with financial planning in an obviously rational way.

Insurers on the other hand are arguing that not only is it a different world for insurers in Australia following September 11 and the demise of HIH, but that the premiums being quoted to financial planners are deserved.

Far from accepting that they are ill-informed about the risks presented by the financial planning industry, insurers, such as the AIG group’s regional manager Timothy Powell, say the rise in premiums are an accurate reflection of a mounting history of claims against the professional indemnity insurance of financial advisers.

“Professional indemnity insurance premiums in general have risen. AIG’s premiums for the financial services industry have risen as well. Not in any small respect, that is a result of claims from financial planners in particular,” Powell says.

It is only when insurers are asked to detail these claims that things can get contentious.

There is of course the much celebrated Hartley Poynton case, where the stockbroking firm was ordered to pay $1 million in damages to a Perth taxi-driver who lost $300,000 that he had invested with the group.

After that, however, details of a growing claims history by financial advisers, particularly over the last year when professional indemnity premiums have risen dramatically, are not exactly forthcoming.

Whatever it is that is spooking insurers about professional indemnity cover for financial planners, the bottom line is that the impact has been immense.

Of the 37 insurers who the FPA says were willing to provide professional indemnity insurance to financial planners last year, only four remain.

And those that are left — QBE, Dexta, the American International Group (AIG) and Macquarie Underwriters — have totally changed the way they are assessing financial planners looking to renew their indemnity insurance.

By and large, the days of insurance brokers organising large numbers of advisers together and then presenting them as a group for insurers to cover en masse, are gone.

Indemnity insurers in Australia are now insisting on assessing all financial planners on an individual basis, leading the FPA to publicly claim recently that delays in finalising insurance cover could leave up to 50 per cent of advisers whose insurance is up for renewal without any cover, even if for short periods.

Those financial planners who do manage to find an insurer willing to cover them are also likely to find themselves faced with more than just an inflated premium.

It has become common practice for insurers still offering indemnity insurance to financial advisers to insist on excluding their cover from the advice given by financial planners on areas such as tax-effective schemes and margin lending products, potentially restricting planners from recommending such products.

The situation has put the providers of products to financial planners directly in the firing line of the professional indemnity insurance crisis.

So serious do some of Australia’s largest margin lending products providers view the circumstances that they have taken the unprecedented step of lobbying insurers directly in an attempt to ensure planning groups are able to recommend margin lending products.

The head of margin lending at the Commonwealth Bank, Paul Johnson, says he has personally met with insurers on a number of occasions in an attempt to have margin lending exclusion clauses lifted from the insurance contracts of financial planning groups.

Such action appears to have produced some results.

AIG’s Powell says margin lending exclusions have now become a standard clause in the insurance cover the group provides to financial planners. But he says AIG is prepared to waive the clause for planning groups that can demonstrate appropriate experience with margin lending products.

However, Powell has also issued a dire warning to financial planners, saying that such exclusions, as well as higher premiums, are now a permanent part of the landscape for financial planners.

“Financial planners whose insurance cover is coming up for renewal are going to find it pretty difficult,” he says.

With the crisis over professional indemnity insurance managing to impact on groups one step removed from financial planners, it is no wonder that it has had an enormous effect on financial planning dealer groups and their attitudes to advisers.

It is understood some dealer groups, like the Lifespan group, are now trying to insist financial planners who leave the group take with them the liability for the advice they gave while they were part of the dealer group.

This would require advisers to personally take on the liability for the advice they gave while part of a group, even though the advice was given under the group’s licence, its recommended list of products and other structures set up by the dealer group.

It is understood other planning groups, like the Queensland-based Strategic Joint Partners, are trying to insist departing advisers transfer the liability for the advice they gave while part of the group to their new dealer group.

All this is not to say financial planners, and their representatives, have been sitting idly by while the crisis engulfs them.

The Association of Financial Advisers (AFA), for one, has just negotiated insurance cover for 600 of its members with the London-based Lloyd’s group through a Sydney-based broker.

The association was expecting the premium paid by each of the advisers to be vastly below what they would have expected to pay if they sought cover through a local provider.

The FPA has also put forward a string of proposals in an attempt to solve the crisis.

The proposals include a plan to impose a statute of limitations on the advice given by financial planners. The statute would limit to a fixed term the time frame in which investors can make a claim in regards to advice they receive from a financial planner.

The association is also exploring the potentially controversial proposal of establishing proportional liability for the advice given by financial planners.

The proposal would push some of the liability for the advice given on any investment products by financial planners back on to the providers of those products.

The proposals are aimed very much at keeping the few remaining insurers that are still providing professional indemnity cover to financial planners in the market.

The proposals, which could require some legislative backing, are also aimed at capturing the imagination of federal and state governments.

The fear is that with governments making concrete attempts to lessen the risks for insurers in the equally troubled public liability market, insurers will be attracted to that market at the expense of the professional indemnity market.

Whatever the solution, the priority for financial planners is to have the issue resolved quickly, particularly as they transition across to the new regulatory regime under the Financial Services Reform Act (FSRA).

There is currently no requirement under law for financial planners to have professional indemnity insurance.

But the Australian Securities and Investments Commission (ASIC) has made it a condition under the new licensing requirements of the FSRA that financial planners need to provide their clients with adequate compensation arrangements.

The financial planning industry is still seeking clarification from ASIC over what the term ‘adequate compensation arrangements’ actually means.

If it does mean, however, that all financial planners must be covered by professional indemnity insurance, then planners will need access to affordable and easily attainable insurance arrangements.

At the moment, that is not an option for the majority of financial planners.