Professional indemnity insurance (PII) experts say the current market is the hardest they have known, handing financial planning and advice firms a significant financial headache. According to figures from the FCA, PI premiums (as a percentage of revenue) were above 4% for the smaller independent businesses (with a turnover of up to £100,000) in 2019, and 5% in 2020.
Chris Davies is executive director and co-lead of the financial and risk adviser’s division at Howden Insurance Brokers, and a former founder of advice firm 2plan Wealth Management. He says, “The PII market, across all professions, is the hardest market we have seen for decades.”
At the heart of the matter is a collision between the FCA requirement for all advisers to have PII and the limited appeal of an unprofitable market that is therefore served by a relatively small number of insurers.
In a policy statement published in March 2019, the FCA reports that 62% of Lloyd's of London's "syndicates writing non-US PII have made an aggregate loss over the last six years, and several have left the market". It also says that PII for personal investment firms (PIFs) is a "relatively concentrated market", and adds that an insurer says there are over 60 PII insurers, but fewer than ten provide cover to PIFs.
More generally, insurers are also looking for a degree of certainty, reflected in which advice firms an insurer will cover, and what risks it will insure. Yet the advice sector as a whole suffers from frequent shifts in regulatory policy.
The FCA has accepted that its policies can impact prices and that it could cut adviser and financial planner numbers. On 1 April 2019, the FCA increased the maximum amount the Financial Ombudsman Service (FOS) could pay out to £350,000, from £150,000.
"We thought the advice market on that scale could lose a few [advisers] without damaging access to good quality advice to consumers"
The FCA consulted with insurers who had warned about the implications. Its subsequent policy statement PS19/8 says: "A membership body representing PII insurers told us that that the proposed increase to the award limit would make an ‘already unattractive’ class of business ‘even less attractive’. They felt it would cause an already limited PII market to shrink further."
Nevertheless, the regulator pressed ahead with the change.
Speaking at a press conference following the FCA annual general meeting in July 2019, Megan Butler, at the time FCA executive director of supervision, said: "There are around 9,000 financial advisers [meaning firms], and we were conscious that when we changed the FOS limit that insurance would come under pressure. We thought the advice market on that scale could lose a few [advisers] without damaging access to good quality advice to consumers."
The regulator can also be optimistic that its actions can improve a situation.
In March 2021, in a statement accompanying new guidance on defined benefit (DB) transfers, the FCA states: "We hope that, going forward, firms can demonstrate higher rates of suitable advice and that this guidance can help the market in achieving good advice on a consistent basis. This should eventually be reflected in the PII rates that are charged."
Regulatory actions driving the gap?
At times, the FCA accepts a connection between PII costs and its regulatory actions. In other often more broad-based work and research, the language it adopts is more cautious as some of the following remarks by FCA bosses and quotes from reports demonstrate.
In a report evaluating both the Retail Distribution Review (RDR) and the Financial Advice Market Review (FAMR) published in December 2020, the FCA refers to a Personal Investment Management and Financial Advice Association survey in which 30% of firms report that PII premiums had risen by 100% or more in the preceding five years.
It adds: "It is unclear whether the cost increases reported by firms are linked directly to FAMR and RDR, wider regulatory interventions or non-regulatory reasons such as investment in technology or changes in market practices."
"It’s a perfect storm. Supply and demand get out of kilter, premiums go up, excesses go up and it becomes harder for everyone"
While PII policies still cover most mainstream advice, a more direct impact has been on the availability of DB transfer advice, according to a policy paper from insurer Royal London and pension consultancy Lane Clark & Peacock, published in September 2020. It includes a survey of 762 advisers who had advised on transfers in the previous three years. It finds just under a third are no longer active in DB transfers with 82% citing issues with PII.
The survey finds "high levels of concern about the future of DB transfers", with more than 40% saying they are "unsure if they will be in the market in a year’s time, and most cite a mix of regulatory uncertainty, hostility to DB transfers and rising PI costs as key factors. Around one third operate a minimum transfer value below which they will not provide advice, with floors of £100,000 and £250,000 being quite common".
Changes to the landscape
Practitioners are keen to make the connection between regulation and premiums.
Phil Billingham CFP™ Chartered MCSI, director of financial planning firm Perceptive Planning, says: "I honestly don’t think the regulator understands what impact its actions have on the PII market, often indicated by the lack of consultation with the PII insurers themselves. There is a lack of trust in future regulation with insurers almost pricing in future shocks. The arbitrary raising of FOS compensation limits is an example. The regulator also argues it didn’t change its tone on pension transfers, but it did. It was maybe done for good reasons, but I don’t think it always fully thinks through the impact."
Phil is referring to a consultation paper and speeches from FCA officials in 2017 in which the FCA looked set to change its position on transfers from an assumption that a DB transfer would be 'unsuitable' for a client to a softer statement in the Handbook that in most cases it would be 'likely' that retaining safeguarded benefits would be in the client's best interests. That suggested change was subsequently ditched. Indeed, the regulator then toughened a range of rules including banning contingent charging on transfer advice.
Jon Barham, head of directly authorised (DA) consultancy at Bankhall, a firm offering bespoke compliance support solutions to DA firms, says: "While the PII market for financial services is relatively small at £120m in premiums per annum, it’s highly regulated and potentially high risk from an insurer’s perspective. The role of claims management companies in generating complaints is well documented, as is potential bad advice relating to DB transfers. It has led some insurers to either add exclusions to their policy cover or withdraw from the market."
"The market goes in these cycles every 10 or 20 years. It has been worse this time, driven in part by Lloyd's of London"
Jon explains that around five years ago, firms were able to secure "more competitive longer-term cover, such as 17-month policies", but PII costs have increased for a number of reasons. "Insurers are seeing rising claims and market forces ultimately dictate that if they can’t make money or the risks are too high then they could withdraw," he says. Some insurers have stopped accepting new business and are concentrating on their existing clients, and some want to reduce their book of business further, he says. "The impact is higher prices, narrower policy cover, and increased excesses. We’re also seeing exclusions on specific risks and business written previously, a recent example being interest-only mortgages," says Jon.
Chris Davies says the Lloyd’s of London review caused some insurers to withdraw and others to limit themselves to writing a set amount of premiums per annum. Separately, there was nervousness about the economic effect of the pandemic in addition to the associated market falls.
He adds: "We have DB transfers still in the system, there is the political intervention around the British Steel Scheme and the FOS award maximum has gone up. It’s a perfect storm. Supply and demand get out of kilter, premiums go up, excesses go up and it becomes harder for everyone."
Consultant and former managing director with support services business Threesixty and more recently chair of the Sense Network, Phil Young says: "The market goes in these cycles every 10 or 20 years. It has been worse this time, driven in part by Lloyd's of London. The only solution anyone, including the FCA, has deployed so far is to pray to the gods of market economics and hope high premiums equate to new entrants in the market and market forces naturally equalise things."
Jon says that as PII is a compulsory insurance for financial advisers, if there is "little appetite for insurers to offer terms then further down the line it could lead to consumers not getting access to professional advice they need".
Phil Billingham says advisers are reaching fewer people and they will tend to be better off because they need to set aside significant sums per client due to uncertainty about future bills, something exacerbated by regulatory restrictions on firms’ borrowings.
Phil Young doesn’t quite agree, and he doesn't see the direct impact on the cost of advice. "Most firms picked a price and pricing model well before the current mess. Few have really changed it up or down since," he says.
What's the solution?
What would a sustainable reform look like? Are there answers from other markets? Events in Australia suggest regulation remains a major driver across the world especially in the wake of financial scandals.
In Australia, financial planners have seen PII become more expensive and harder to obtain following the Royal Commission into Misconduct in the Banking, Superannuation, and Financial Services Industry, according to the Financial Planning Association of Australia. Among other reforms, a new Australian Financial Complaints Authority was set up in 2018 with higher compensation limits amid debates about legacy compensation and its impact on the PII market for financial planners and advisers.
An Aon report into the PII market in Australia published in Q3 2020 notes that regulatory activity is ongoing with significant price increases for those seeking cover.
"The PII sector has traditionally operated on a claims-made basis, which allows it to wriggle off the hook every time a scandal emerges"
In Europe, Paul Stanfield, CEO at the Federation of European Independent Financial Advisers says: "It doesn’t seem to be the same issue across Europe in terms of the ability to obtain cover and the cost of cover. There appears to be less of a litigious culture with regards to financial advice. Maybe people feel there is less recourse and, in some countries, more caveat emptor."
However, he suggests directives such as Markets in Financial Instruments Directive II and the Insurance Distribution Directive are more likely to bring the EU into line with the UK than the reverse.
Is there a domestic policy solution?
Independent compliance consultant Adam Samuel MCSI says: "What the public needs is every financial adviser being insured fully against losses caused by their adviser's defaults. However, that cannot happen in the absence of a mutual scheme run by the regulator."
Even that may not be a panacea. The English Bar has such a scheme, Bar Mutual, but the solicitors' version demutualised many years ago.
Adam adds: "The PII sector has traditionally operated on a claims-made basis, which allows it to wriggle off the hook every time a scandal emerges by declining to accept a possible future claim relating to something that has already happened."
He says it would help if the FCA changed the Dispute resolution: complaints in the FCA Handbook, which prevents claims made by small firms against insurers from going to the Financial Ombudsman Service. Advisers could then challenge insurers’ decisions not to pay out on certain claims. Otherwise, he says, "it is a permanent game of cat and mouse".
"Insurers could help by risk-rating firms sensibly by insisting on proper compliance checks and training for firms. However, they have always steadfastly refused to do this, landing themselves up with often unsustainable levels of claims." Besides consistent and simpler regulation, Phil Billingham suggests the regulator could require more permissions for advisers offering complex advice and solutions which could, in turn, free up the broader market.
"The key to finding the best premium is engaging earlier. We suggest three months before you come to renew your policy"
Simon Goldthorpe, joint executive chair of the Beaufort Group, a financial advice and investment management firm, says: "There are suggestions PII and Financial Services Compensation Scheme (FSCS) should be rolled into one central account. There is some merit in that. It would give a proper safety net and one thing the FSCS has is vision on where complaints are coming from early on."
In the absence of radical solutions, Simon says that advice firms have been good at keeping in contact with their insurers, "even where they are not specifically asking for it". He adds: "If firms are going to take on new projects or areas of new business, talk to your insurers first. Are there any additional controls they would like to see? Insurers want to see you have control over that process and some sort of risk management."
Chris says: "The key to finding the best premium is engaging earlier. We suggest three months before you come to renew your policy. Think of the application process as the firm’s CV, disclose the key processes and how you integrate compliance. In such a hard market where insurers can pick and choose, you want to give them the confidence that you are the risk you want to take on."
There may even be solutions from regulation technology (regtech) to bring down costs.
Founder and managing director of Model Office, a regulatory benchmarking regtech platform, (also named) Chris Davies says: "We have an agreement in principle that can allow PII underwriters to take a closer look at firms through regtech. The tech data allows the insurer to look under the bonnet and show where firms believe they are against the algorithm, showing where they really are, where the problems lie and what they need to do. What it is doing is producing lots of analytics, evidence and management information to see if they are walking the talk on PII and compliance.
"This could provide more favourable renewal rates based on firm ongoing risks."
Phil Billingham sounds a final more upbeat note. He adds: "I am reasonably optimistic the firms that are still around have learnt to control what we can control. We face paying 5% of turnover, but if we can survive this and make things simpler then the number and quantum of claims will fall. Existing insurers or new insurers will then respond if they can see a predictable risk."