When the UK Financial Ombudsman Service revealed it would increase its compensation limit to £350,000 ($458,725, € 405,759) from £150,000, financial advisers were left to carry the burden of skyrocketing professional indemnity (PI) insurance premiums.
If that wasn’t bad enough, they were given less than a month’s notice between the announcement and the implementation of the higher limit, which came into force on 1 April 2019.
To understand more about the impact this is already having on advisers’ PI cover, International Adviser reached out to over a dozen insurance firms.
None of which were willing to speak to the press.
However, Matthew Whinney, managing director of Whinney insurance Brokers, agreed to shed some light on the repercussions of the latest regulatory changes.
Cost is up but applications are steady
“There hasn’t been a drop in PI applications; because, in order to trade as an IFA, you need to have PI insurance,” Whinney told IA.
“We have seen an increase in the cost IFAs are paying for PI cover; and, over the last few months, we have seen advisers looking to be more cautious around defined benefit (DB) pension transfer advice, because advising in that area has had a significant impact in the premiums they pay.”
There have been a number of incidences where investors have pulled their money out of DB schemes and lost it by investing in high risk, esoteric funds.
Firms had already started to feel the pressure after the collapse of British Steel and Carillion, but this is now pushing them over the edge.
To advise or not to advise?
This is why firms who advise clients on pension transfers risk paying almost double the insurance than firms who do not, Whinney said.
Between DB transfer advice and the higher compensation limit, financial advisers are being hit with higher PI covers.
“We’ve seen increases of circa 40% in cost in some cases,” Whinney admitted.
Worst-case scenarios could see PI premiums go up by 200% to 500%, the Financial Conduct Authority (FCA) said.
How is PI cover calculated?
According to Whinney: “PI insurance premiums are based on the advisers’ revenue, but most importantly on their claims record and the areas of work they are advising on – a big focus at the moment is on DB pension transfers.
“Certainly, the increase in compensation has made a difference for those advising in high risk areas, such as DB transfers.
“I think it’s going to take some time for the market to adjust to this change, insurers are still coming to terms with it and reacting because there was quite a short time between the announcement and when the change became effective.”
Firms that could not upgrade their PI cover ahead of the 1 April changes will need to maintain higher levels of capital adequacy.
What can firms do?
Firms can try to mitigate their insurance premiums in two ways though, Whinney told IA.
First, financial advisers need to be extra cautious when (or if) they advise on high-risk areas and do as few as possible.
“The greater the risk in the insurer’s eye, the greater the premium they will pay,” he said.
Second, firms need to be able to show they have robust procedures they follow every single time.
“They should demonstrate that those procedures have been through a compliance process – usually through an external compliance adviser experienced in DB transfers – covering matters such as the clients’ attitude to pension transfer risk and critical yield.
“Ultimately, the onus is on the IFA to ensure they make an extremely strong case when advising a client to transfer a DB pension,” Whinney added.
Input from the regulator
The FCA received feedback from over 130 firms and individuals prior to its policy statement on the increase in compensation limit.
All of the ones sent by industry professionals argued against it.
Although the limit is now fully in effect, the industry is looking for more clarity from the regulator about what best practice looks like.
At the end of the day, “if firms cannot afford PI insurance cover and cannot raise capital adequacy, they don’t really have much of a choice but to close their DB pension transfer business”, Whinney told IA.
“We understand that FCA modelling expects around 1,000 firms to stop advising on DB pension transfers. Because if those firms can’t find the cover they can’t trade.”
IA reached out to the FCA to ask whether it intends to hold a consultation on how to deal with the aftermath of the compensation limit increase, but the watchdog said it did not plan anything more than what was set out in its policy statement.
