The head of the Financial Conduct Authority has said professional indemnity insurance is failing to “reliably” act as the first line of defence to prevent advice firms from failing.
Speaking at the Association of British Insurers’ (ABI) annual conference today (22 November), Andrew Bailey said PI insurance should serve as a ‘front-stop’ to prevent financial firms from going out of business, much like commercial insurance works for lawyers.
However, he said shortcomings in the PI cover market have meant it has become the ‘back-stop’, meaning the Financial Services Compensation Scheme is now one of the primary lines of defence, and its levy payers have ended up footing the bill as a result.
“PI cover is not by experience always reliably performing the role, particularly in the IFA and investments world – the contracts are framed often in ways that rule out loss absorption in the context we are dealing with here when the firm fails,” Mr Bailey said.
The FCA chief said this ‘front-stop’ mechanism “requires further thought”, and pointed to the two forms of pooling: through private insurance like PI cover, or through “mutualised industry risk” cover through the FSCS.
He said, however, the “important difference” between the two is that the FSCS does not currently charge a risk-based premium.
“The front-stop problem in the [IFA] model is really caused because there is no risk-based cost. This creates a very marked incentive problem.”
The Financial Conduct Authority is currently conducting a review of FSCS pooling, and Mr Bailey said this is focused on how the “burden” of the pooled risk should be shared.
He said there are two tensions and “no easy answer”, with the first tension focused on how to divide the provision of risk cover among the various sub-sectors of the finance industry.
“The tension is between spreading the cost enough to avoid seriously damaging other firms, versus spreading it so much that firms are paying the price for failures that are a long way from their area of activity."
The second tension, he said, is how to spread the cost between the creator of the product and those who sell and advise on it.
“But these tensions would be at least less pointed if they were not trying to cover a world where there is no risk-based pricing of insurance in the front-line.”
Mr Bailey added: “This is rightly a public policy issue, but it is also a private issue too because many advisory firms are meeting substantial bills for FSCS pay-outs.
“With all this in mind, my request today to the insurance industry is to help us to think through how we might solve this problem.”
Marlene Outrim, managing director of Uniq Family Wealth, said in many ways she agreed with Mr Bailey.
"With PI Insurers now, you virtually have to be conducting business with little risk.