Could pooling insurance help solve advisers’ PI problems?

The professional body’s solution – a savings and investment monetary protection and education levy – was put forward to the Financial Conduct Authority and HM Treasury in May last year.

Keith Richards, chief executive of the PFS, warns that as the PI market continues to harden it is likely to compound the level of liability placed upon it, resulting in poor outcomes for clients and the market as a whole.

Mr Richards also worries the FCA’s proposals to double the Financial Ombudsman Service compensation limit – from £150,000 to £350,000 in April 2019 – will increase advisers’ PI premium costs further.

Pooled solution

To protect advisory companies, and clients, from potentially devastating consequences, the PFS recommends a fundamental overhaul of the FSCS – to replace the compensation funding system with a protection and education levy, collected centrally by the government, with advisers also contributing, thus pooling the risk.

Mr Richards describes the mechanics behind the levy solution as “an alternative funding mechanism to the FSCS”, one which incorporates “an answer to PI”, addressing “the untold level of liability that now sits in the FSCS”.

A priority should be to ensure that the well-run and well-governed advisers are not made to pick up the tab for the poor conduct of those on the fringes of the industry.Sir Steve Webb

He says: “If adviser contributions went into the same fund to pool the risk, the current need for PI insurance would be disposed of.

“While excesses could still apply, over time, the build-up of the fund could reduce contributions and help mitigate financial failure.”

Key Points

• As the PI market hardens, it is likely to compound the level of liability placed on it
• The FCA has put forward its own plans for the FSCS, suggesting a number of changes to the PI market
• The Personal Finance Society's Keith Richards has put forward an alternative, which creates a pooled fund for investments

The FCA has put forward its own plans for the FSCS, suggesting a number of changes to the PI market, such as forcing insurers to cover some of the costs of compensation by allowing the body to claim against a defaulted company’s insurance.

But this has led to concerns that PI insurers will simply leave the market, or that the FCA’s overhaul of the FSCS will amount to no more than what Mr Richards calls a “reshuffling of deck chairs”.

Instead, he suggests the necessary funding could be achieved, on the premise that most in the market accept the need to contribute to regulation and protection, without forcing the burden on any one sector.

He explains further that if total funds under management in the UK retail sector amount to several trillion pounds, FSCS and regulatory fees could be adequately covered by a few basis points each year, collected centrally, and combined with sector contributions to provide fairer funding and a more sustainable long-term solution.

Industry collaboration

Andy Kirby, managing director of Money Alive – an adviser portal supporting advisers with the defined benefit transfer process – agrees it is becoming more difficult for companies to obtain PI cover, which, in turn, compounds transfer risks.

But Mr Kirby warns there is “always going to be the argument that, ‘If I am not involved in the high-risk area, why am I ending up subsidising other advisers in the marketplace?’”

While he believes in “collaboration and getting the right people around the table, exactly like what the PFS is doing”, he also suggests “you’ve got to look at the equality aspect of it as well, and that will always come into these types of conversations”.

If a company can demonstrate to an insurer that it has a robust risk management process in place, it will ensure it then has a better PI conversation, he recommends.

“There are two elements of risk that an advisory firm should be looking at – first, is it ticking all the regulatory boxes, and, when it comes to PI, is it looking at it from a commercial risk point of view?”

Importantly, he suggests advisers must understand exactly what PI covers because “too often people buy the insurance based on premium, get the policy documents, and then stick it in the drawer”.

If you’re a good firm then the theory goes you get decent PI cover at an affordable rate, and that’s fair – if not, you pay more.Damian McPhun

“This is why we involve PI brokers and lawyers really early on in the process because when you look at the claims that go through when things go wrong, a large percentage are based around clients saying they didn’t understand what they were doing,” he explains.

“Anything that we can do collectively as an industry, and with the various regulators and professional bodies, to actually look at helping reduce risk in the marketplace, has got to be a good thing.”

He agrees “the whole system needs to be looked at”, but suggests it is just as important to not forget “the many good things happening in the industry”.

Looking ahead

Sir Steve Webb, director of policy at Royal London, says these issues are too often looked at in a piecemeal way when what is really needed is a system-wide review.   

Mr Webb says: “A priority should be to ensure that the well-run and well-governed advisers are not made to pick up the tab for the poor conduct of those on the fringes of the industry.

“A system that lowers costs for those who place less risk on the system and who put their clients’ interests first would be a big step forward.”

Indeed, Damian McPhun, specialist financial services litigation lawyer and partner at Beale and Company Solicitors LLP – who often deals directly with cases for advisers when they go wrong – says leaving it down to the individual PI arrangement of the company is, in a sense, “the most equitable way of doing it”.

He explains: “If you’re a good firm then the theory goes you get decent PI cover at an affordable rate, and that’s fair – if not, you pay more.

“In principle, while a solution like a mutual fund sounds like a good idea, and people do it already by funding the FSCS, there’s always going to be complaints from those firms who are well run and doing the right thing about having to compensate those doing the wrong thing.”

However, he recognises a continued perception that the PI market, for IFAs, is not working.

“But to lay all of that at the PI insurers’ door would be unfair,” he says.

“It is true that in some respects, the PI market for [independent financial advisers] is stacked towards the insurers in terms of them declining cover, but at the same time you need to look at the market PI insurers are being asked to cover.”

Victoria Ticha is a features writer for Financial Adviser and FTAdviser