Compulsory PI insurance for financial advisers: the new compensation arrangements

Transcription

1 Compulsory PI isurace for fiacial advisers: the ew compesatio arragemets Followig chages to the Corporatios Law o 1 July 2007, fiacial advisers are ow required to hold adequate professioal idemity isurace (PI isurace). The iteded beeficiaries of the chages are the retail cliets of fiacial advisers with the aim beig that through compulsory PI isurace mum ad dad ivestors will be able to regai losses associated with egliget or illegal advice. But the burde of this ew regime falls squarely o fiacial services licesees ad isurers. Stefa Sudweeks is a Parter at Jackso McDoald ad leads the Professioal Idemity Practice. ssudweeks@ jacmac.com.au Richard Viciullo is a Solicitor i the Professioal Idemity Practice at Jackso McDoald. rviciullo@ jacmac.com.au Traditioally, the fuctio of PI isurace was simply to protect the assets of the isured. But the July 2007 chages to the corporatios law sigificatly altered this. They mea that the beefit derived by mum ad dad ivestors is ow the primary driver, ad o loger merely a positive cosequece of PI isurace cover. I this paper we provide a overview of the chages from a legal perspective ad idetify the major issues stemmig from the ew compesatio arragemets as they relate to fiacial services professioals ad those i the isurace idustry. The paper examies the law as it ow stads ad the issues that fiacial services liceses (Liceces) licesees should be aware of whe reewig a PI isurace policy or cosiderig cover uder the ew laws. We also provide some predictios o the future of PI isurace ad fiacial advisers i this evolvig area of law. Chages to the law Sectio 912B(1) of the Corporatios Act 2001 (Act) provides that a licesee that provides services to retail cliets must have arragemets i place for compesatig them for loss or damage suffered as a result of a breach of a obligatio of the Licesee imposed by Chapter 7 of the Act. This sectio was dormat prior to 1 July 2007, whe it commeced i cojuctio with a amedmet to the Corporatios Regulatios 2001 (Regulatios) by which reg AAA was itroduced. That regulatio sets out i detail what is etailed i the compesatio arragemets. Licesees must ow have compesatio arragemets, ad this geerally meas that they must hold professioal idemity isurace cover that is adequate. For a licesee with a curret Australia jassa the fisia joural of applied fiace issue

2 Fiacial Services Licece (Licece), (that is, a Licece that commeced before 1 Jauary 2008), the iitial requiremet for adequate PI isurace takes effect o 1 July 2008 (or 31 December 2008 for those licesees who have a existig policy i place due to ed betwee July ad December 2008). For licesees who gai a ew licece o or after 1 Jauary 2008, the iitial requiremet takes effect from the date of commecemet of the licece. A more oerous euciatio of what costitutes adequate PI isurace will take effect from 1 Jauary There are two exclusios to the requiremet for PI isurace. First, it is ot required where the licesee is a exempt licesee (a geeral isurace or life isurace compay regulated by APRA; or a authorised deposittakig istitutio regulated by APRA). Secod, it is ot required where ASIC has approved i writig a adequate alterative compesatio arragemet. The requiremet that licesees PI isurace cover be adequate is the greatest source of difficulty with the chages, ad we cosider its practical implicatios i detail i this paper. The regulatios direct ASIC to determie whether PI isurace cover is adequate with regard to: 1. the maximum liability that realistically has some potetial to arise uder the licesee s exteral dispute resolutio (EDR) scheme; ad 2. relevat cosideratios i relatio to the fiacial services busiess carried o by the licesee, icludig: a. the volume of busiess; b. the umber ad kid of cliets; c. the kid, or kids, of busiess; ad d. the umber of represetatives of the Licesee. The questio of what will costitute adequacy uder the ew laws is also the big issue addressed i ASIC s Regulatory Guide 126 (which was released i November 2007). The guide sets out the basis o which ASIC will determie what is adequate cover. I the ext sectio we will cosider some of the sigificat aspects of adequacy from the perspective of a licesee comparig PI isurace policies. Comparig PI isurace policies Uder the ew regime, the ous is o licesees to assess what is adequate PI isurace i their circumstaces. ASIC has give extesive guidace o what it cosiders to be adequate. The key priciples guidig ASIC s approach to adequacy are: that a licesee s PI isurace is fit for achievig a reductio i the risk that a retail cliet s losses (due to breaches by a licesee) caot be compesated by a licesee due to lack of fiacial resources ; ad that the type of PI isurace practically available at ay give time is a relevat cosideratio. As ASIC has ackowledged, the role of PI isurace is to protect the isured agaist certai risks, ad it does ot exist to protect or compesate cosumers. It is for this reaso that the two priciples above seem at odds. ASIC s policy objective is to protect cosumers, while admittig that commercial realities may ot (curretly) allow for this. Recogisig these difficulties, it is perhaps usurprisig that licesees, ad ot ASIC, have the difficult task of determiig the questio of adequacy. The upshot of this is that licesees ad applicats must ow thik very carefully about their PI isurace, or risk ot fulfillig these compesatio requiremets. Geerally, cover will eed to be from a APRA-regulated isurer. But the requiremet of adequacy goes much further tha this. Below, we idetify the most importat ad cotetious aspects of the compesatio arragemets to provide some idicatio of what licesees should be lookig for whe obtaiig or comparig PI isurace policies or cosiderig alterative arragemets. The upshot of this is that licesees ad applicats must ow thik very carefully about their PI isurace, or risk ot fulfillig these compesatio requiremets. Geerally, cover will eed to be from a APRA-regulated isurer. But the requiremet of adequacy goes much further tha this. Iitial assessmet Before plugig ito the deep ed of isurace that is the PI market, it may be worthwhile for licesees to take stock iitially of their eeds ad resposibilities. The startig poit is to cosider the two factors that determie whether PI isurace is adequate. First, what is the maximum liability uder the EDR scheme? Secod, what kid of busiess does the Licesee coduct? As a geeral rule, the higher the potetial EDR liability, the higher the level of required cover. The broader ad more volumious the busiess that is coducted, the greater breadth ad scope of cover required. After coductig this iitial assessmet, licesees should compare the various policies offered by isurers to determie which best suits their specific eeds ad resposibilities. 30 jassa the fisia joural of applied fiace issue

3 Cover The most importat cosideratio for licesees i comparig PI isurace policies is the cover provided. ASIC has set out miimum requiremets for adequacy i the followig areas (amog others): amout of cover; scope of cover; exclusios; excess/deductibles; EDR scheme awards; ad ru-off cover. Amout of cover The most seemigly straightforward of the compesatio requiremets is that a licesee should hold a amout of cover which is adequate to satisfy possible claims. This ivolves two factors: the limit of liability uder the isurace policy per claim (for each idividual claim); ad the limit of liability i the aggregate (for all claims). I the licesee s circumstaces, both will be required to be adequate. ASIC s miimum adequacy requiremet is that licesees with total reveue of $2 millio or less have cover to a aggregate claim limit of at least $2 millio. For licesees with reveue higher tha $2 millio, cover should roughly match the licesee s actual or expected reveue to a limit of $20 millio. Scope of cover A licesee s amout of cover may be adequate, but the PI isurace policy may still be iadequate if it does ot have sufficiet scope. While all PI isurace policies provide cover for breaches of professioal duty, the maer i which this is achieved ca vary from policy to policy. The logical coclusio of this is that certai claims will be covered uder the terms of oe policy, but ot uder aother. This is where it becomes essetial that licesees uderstad the differet ways that various aspects of policies provide cover. The best way for licesees to protect themselves is to always egotiate a policy that goes had-i-glove with the services that they provide. This is ot always a possibility, especially for smaller licesees costraied by fiacial pressures ad lack of bargaiig power. But the poit here is that i isurig a professioal busiess, it is importat to be midful of the ature of that busiess. If, for example, the policy is to be limited to certai securities dealigs, the licesee should be aware that it will ot be covered for a claim allegig egliget fiacial plaig advice. With these cosideratios i mid, licesees should esure that their PI isurace policies have sufficiet scope to ecompass the followig miimum requiremets (subject to what is available i the market). The policy must cover: loss suffered by retail cliets due to breaches of the Corporatios Act; breaches ad fraud by both the Licesee ad its represetatives; ad EDR scheme awards. I cosiderig the scope of cover applicats ad licesees should also be aware of exclusios. Exclusios All PI isurace policies have exclusios, but the exclusios ca vary from the arrow ad obscure to exclusios that may seriously limit cover. Whe lookig at a potetial policy, licesees should carefully cosider whether ay of the exclusios will limit cover to a ureasoable extet cosiderig the ature of their busiess. ASIC requires that policies do ot cotai exclusios for, amog other thigs: The best way for licesees to protect themselves is to always egotiate a policy that goes had-i-glove with the services that they provide. This is ot always a possibility, especially for smaller licesees costraied by fiacial pressures ad lack of bargaiig power. But the poit here is that i isurig a professioal busiess, it is importat to be midful of the ature of that busiess. EDR scheme awards; fraud ad dishoesty by agets ad represetatives; ad claims for misrepresetatio about services. Curretly, may PI Isurace policies cotai a exclusio where the isured has acted kowigly frauduletly or dishoestly. That is, if a isured is iadvertetly fraudulet, the exclusio will ot apply ad the claim will be covered. Give that the exclusio for itetioal fraud is so widespread, ASIC isistece upo PI Isurace coverage for such acts may prove problematic. jassa the fisia joural of applied fiace issue

4 Excess/deductibles There are three issues that licesees should be wary of whe it comes to cosiderig the excess uder a potetial PI isurace policy uder the ew provisios. First, cosiderig that excesses ca be as high as $250,000, licesees should have regard to whether the excess is at a level that the licesee ca cofidetly sustai as a uisured loss, takig ito accout its fiacial resources. If ot, the PI isurace cover will ot be adequate. Secod, the licesee should cosider the differece betwee costs iclusive ad costs exclusive excesses. Practically speakig, there is a higher risk of beig required to pay a costs iclusive excess. Other factors to be cosidered are whether the excess ca be sustaied as well as the licesee s obligatios to cover ay shortfall payable from its ow resources. Third, the licesee should closely cosider the policy wordig i relatio to the applicatio of multiple excesses. For example, there is a sigificat differece betwee 10 claims arisig out of the same ivestmet, but caused by 10 differet acts of egligece, ad 10 claims caused by oe act of egligece. A $250,000 excess may thereby be coverted ito a $2.5 millio excess i the former case. EDR scheme awards A less obvious aspect of PI isurace policies tha excess is cover for exteral dispute resolutio schemes such as the Fiacial Idustry Complaits Service (FICS), which have traditioally bee provided for i policies. PI isurace for licesees must ow cover claims made via EDR scheme awards such as FICS to the limit of its jurisdictio to be cosidered adequate. Cosiderig that FICS proposes to icrease the moetary limit of its jurisdictio, this may prove a difficult requiremet for isurers ad licesees. Ru-off cover Aother requiremet that may have licesees sweatig by late 2009 is the obligatio to hold ru-off cover. PI isurace policies are geerally claims made policies. This meas that cover is grated for claims which are made or otified to the isurer withi a period of isurace (without regard to whe the cause of actio accrued), but ot for claims that emerge after a period of isurace. Ru-off cover provides a remedy to this situatio by coverig a isured for claims made after the isurace period. But ru-off cover is ot widely commercially available, ad ASIC has attempted to deal with this difficulty by providig for a relatively maageable miimum of oe year. Lookig ahead It may be worth briefly lookig at what the future may hold for fiacial services professioals ad PI isurace i the followig areas: implemetatio period; iadequate cover; alterative arragemets; A licesee that failed to hold $2 millio PI isurace cover i February 2009 would ot have adequate compesatory arragemets i place. Iadequate cover is a serious problem. ASIC has suggested that if a licesee caot obtai adequate cover or approval for a alterative arragemet, it might eed to cease operatig as a licesee. ogoig assessmet/compliace systems; disclosure i Fiacial Services Guide (FSG); ad ew liceces. Implemetatio period The ew laws took practical effect for ew licesees from 1 Jauary 2008, ad take effect for existig licesees o 1 July 2008 (or 31 December 2008 for those licesees who hold iadequate PI policy cover, which is due to ed betwee July ad December 2008). These dates begi the implemetatio period, durig which some of the elemets of adequacy outlied above will ot be required. The full rage of adequacy elemets are required by 1 Jauary The policy for assessig adequacy durig the implemetatio period (kow as the implemetatio period policy ) is essetially a bare boes versio of the fial adequacy policy. For example, durig the implemetatio period, licesees must have the full amout of cover, but will ot require ru-off cover. Iadequate cover A licesee that failed to hold $2 millio PI isurace cover i February 2009 would ot have adequate compesatory arragemets i place. Iadequate cover is a serious problem. ASIC has suggested that if a Licesee caot obtai adequate cover or approval for a alterative arragemet, it might eed to cease operatig as a licesee. It should be bore i mid that iadequate cover will costitute a breach of sectio 912B of the Act, which may have serious repercussios. I the Cosultatio Paper that preceded the release of its Regulatory Guide o the subject, ASIC suggested that where PI isurace cover is iadequate, licesees will have the choice to make up the shortfall with their ow fiacial resources. The iitial proposal reeked of self-isurace, ad ASIC appears to have backed dow from such a approach. Self-isurace will presumably still be a optio for licesees, to be 32 jassa the fisia joural of applied fiace issue

5 approved uder the protocol for alterative arragemets set out below, but it is a uappealig optio. Practically speakig, licesees should take a threestep approach to esurig that their PI isurace cover is adequate by: 1. egotiatig a policy that is appropriate to the ature ad extet of their busiess, havig regard to the ASIC miimum requiremets ad market availability; 2. implemetig quality cotrol to esure that represetatives are ot actig beyod the Licece or givig egliget or fraudulet advice; ad 3. developig ad applyig for the approval of a alterative arragemet where PI isurace is iadequate or iappropriate, i circumstaces i which the resultig cover will be iadequate. Alterative arragemets While this paper focuses o PI isurace, techically, the law oly requires arragemets for compesatig cliets. This is where alterative arragemets may fill the gap betwee PI isurace ad adequate cover. ASIC requires that Licesees apply for approval of ay alterative arragemet. The test is that a alterative arragemet will oly be approved where it provides o less protectio tha adequate PI isurace cover. Selfisurace, for example, for highly capitalised licesees or a idustry member fud, has bee floated as a possible alterative arragemet. Alterative arragemets have their difficulties. Self-isurace is realistically available to few, if ay, licesees, while idustry member fuds require a great deal of orgaisatio ad support. Furthermore, idustry member fuds ca become expesive, ad are ot subject to the coditios of the Isurace Cotracts Act 1984 (Commowealth). O the other had, the market for PI isurace ca fluctuate, ad a market correctio i the medium term could see the adequacy of PI isurace policies o offer deteriorate through reductio of the scope of the risk or a icrease i premiums or excesses. I such circumstaces, licesees may be forced to seek alterative arragemets to cover some or all of their potetial liability, ad it is thus importat that licesees thik outside the box of PI isurace. Ogoig assessmet/compliace systems Whe thikig iside the box of PI isurace, ASIC expects licesees to review their PI isurace for adequacy at least aually, ad may require licesees to provide it with relevat iformatio to coduct its ow compliace reviews. Iteral review is also expected where major chages are made to a licesee s busiess. I the same vei, ASIC expects that a seior officer or maager of a licesee will oversee the compesatio requiremets, esurig regular reviews ad maiteace of PI isurace policies. Disclosure i FSG Aother ew requiremet is that a licesee s compesatio arragemets must be disclosed i their FSG, with a explaatio as to how the isurace cover or the alterative arragemet will provide cover for the licesee s ad its represetatives work. ASIC is empowered to take actio agaist a misleadig disclosure. Coclusio PI isurace will soo be difficult to avoid for fiacial services professioals. It should ow be clear that for licesees this is ot simply a case of hoppig dow to the local broker ad sigig up. The burde of iterpretig ad applyig the ebulous cocept of adequate PI isurace is o the Licesees themselves, ad it should be take seriously. But licesees should ot lamet this situatio. Though the compesatio requiremets are oerous, havig adequate cover for potetial breach of duty claims is i the iterest of all licesees. To this ed, licesees should begi the process of aalysig their busiess, their potetial liability ad their isurace with a view to fidig adequate cover ad, i the process, satisfyig the ew laws. If the ew law results i PI isurace protectig both licesees ad ivestors, it will have proved a success. The trick will be to protect ivestors without drivig isurace premiums prohibitively high. jassa the fisia joural of applied fiace issue