Professional Indemnity Insurance considerations regarding MDAs
If you are considering providing an MDA service the purchase of professional indemnity (PI) insurance will be one of your largest expenses and hurdles that you will face. Most PI insurers exclude any cover for operating an MDA and you need to apply to the Insurer for this exclusion to be removed. It is not automatic cover so the first point is you need to be very careful when purchasing appropriate PI insurance for the MDA. Secondly, some Insurers will automatically decline to insure you with an MDA so that does narrow the ‘pool of insurers’ available to approach for a quote on your PI insurance.
The financial advice industry has seen many regulatory changes of late which means the advice business needs to have a clear and concise business model with regards to how you intend to integrate your MDA into your advisory. When it comes to PI insurance when providing an MDA the Insurer will need varied information depending on the model you intend to operate under. There are three common models that we see that I will touch on to help you decide which path is best for your business.
1. Outsourcing the Investment Manager
2. Limited Advice
3. Traditional
When outsourcing the Investment Management, the Adviser usually provides strategic advice. This is the preferred model with many PI Insurers. The PI Insurer will often ask (and likes the idea) that the Investment Manager has a contract with the end client in addition to the contractual relationship with the financial planner. The PI Insurer likes how both roles are well defined and direct with the client (it’s clear and transparent on who is doing what). The insurer will want to know who is the Investment Manager and what are their credentials. They are likely to look at the Investment Managers website for information on expertise, investment philosophy and to have a look at the returns/performance of their investment portfolios. All of this information will assist in getting the best result when seeking PI insurance.
The MDA brought to the client by the Investment Manager and provides limited advice. Many PI insurer’s will not offer insurance for this model so it can be problematic when it comes to purchasing PI insurance. It’s not impossible just more challenging to place cover. It is often separate Insurers who will cover a Fund Manager (under what is known as an Investment Managers Insurance package) and then those PI Insurers happy to cover retail/personal advice risks of financial planners. Where it is general advice only it is an easier PI insurance placement. The key here is a really good description to the Insurer of what the Investment Manager is doing and what is involved in the ‘limited advice’ and is there any retail/personal advice exposure that they need to cover.
The traditional model where the adviser is both the MDA provider and Investment Manager and integrates their own ongoing portfolio advice. This is also a model which has been problematic when it comes to placing the PI insurance. More insurers prefer the first model described above. Sometimes under this traditional model a third party is still used for certain activities (for example a Morningstar or an Investment Committee with external consultants/advisers involved). Insurers generally like the MDA using independent third parties so a good explanation of whose services are being used and for what purpose is useful. If no third parties are being used the Insurer is trying to then assess if the MDA has the appropriate expertise to carry out all roles requiring cover. The Insurer will also be concerned if they believe there is any potential conflicts of interest (possibly related parties doing different functions) and how this is being managed.
The key to purchasing PI insurance under any of the above models is being able to explain that the appropriate expertise is being utilized and what are the checks and balances in place to ensure that the appropriate advice is in the client’s best interests.
The cost range for PI insurance has a lot of variations with the starting point being the annual fees, income and the types of model you are using. It is very difficult to get any PI insurance covering MDA/SMA’s under $20,000. The insurance payment becomes more complex if you need cover for financial planning activities as well as investment management activities as these are typically written by different Insurers using different insurance products.
Seek advice from an insurance professional who has experience in the sector and where possible arrange a meeting directly with the Insurer because ultimately, they are the ones pricing your risk.
Greg Hansen is an associate with MDA Guru and a Director and partner of Austbrokers Countrywide who is a General Insurance Broker that specialises in the placement of Professional Indemnity and Directors Liability Insurance for AFSL Holders. Greg has expertise in understanding the MDA process and explaining this to the Insurers so that appropriate Professional Indemnity Insurance can be arranged which complies with RG126. He also has great insights into the particular areas where financial planners are caught up in costly disputes and litigation. Greg can assist with ensuring your compliance regime and procedures align to the professional indemnity insurance that has been purchased.