The prudential rules of the UK financial services regulators require that certain regulated firms maintain professional indemnity insurance (“PII”) and provide certain minimum criteria to be met (depending on the size and type of regulated activity which the firm undertakes). However, the regulated financial services sector is not currently required to maintain mandatory PII subject to standardised terms in the way that other professions are (for example, solicitors).
In December 2016, the Financial Conduct Authority (“FCA”) published two documents regarding PII held by regulated financial services firms. The motivation behind the FCA’s reengagement with PII issues appears to be the strained funding position of the Financial Services Compensation Scheme (“FSCS”) and comments in last year’s Financial Advice Market Review’s final report on the efficacy of the PII market for smaller advice firms . The FSCS has had to foot a considerable bill in recent years arising out of the collapse of a number of insurers and also firms who have given unsuitable investment advice to customers.
Thematic Review: General Insurance Intermediaries
The FCA’s thematic review of the effectiveness of the PII market for general insurance intermediaries (TR16/9) evaluated the individual policies purchased by a sample of 200 firms (from a population of approximately 6,000) to assess whether they complied with the FCA requirements.
The FCA found there is sufficient breadth within the market to provide choice, and that firms were able to obtain cover for high limits of indemnity. However, concerns were raised regarding exclusion clauses within policies which could reduce the level of cover below that required by the FCA’s relevant prudential rules (the “MIPRU”). Those types of exclusion clause were: (i) suitability of insurer; (ii) unrated insurers; (iii) non-admitted insurers; and (iv) insurer insolvency.
The review also identified a high level of inaccuracies or gaps in coverage, which indicates that the policies have not been subject to appropriate review. Examples include a lack of clarity as to whether policies provided cover for awards by the Financial Ombudsman Service (“FOS”) and out of date language.
Following the review, the FCA raised clear examples of noncompliance with the firms at issue and ensured that corrective action was taken. Those insurance intermediaries that were not included in the review are expected to review their own PII policies to ensure that they meet the relevant requirements. Similarly, the FCA expects insurers that provide such policies and managing general agents to review their products in light of the FCA’s findings, to ensure they are consistent with the needs of the intermediaries and meet the necessary requirements. Where the FCA has identified issues, they are considering whether there is a need for further regulatory action.
Consultation Paper: Funding of the FSCS
The second publication touching on PII is the FCA’s paper regarding the funding of the FSCS (CP16/42). The FSCS is the UK’s statutory compensation scheme of last resort, compensating individuals and small businesses for losses when authorised financial services providers are unable to pay claims. The paper includes a section dedicated to a consideration of PII for “personal investment firms” (including financial advisers and other intermediaries). In particular, the FCA has sought views on the current and future interaction between a firm’s PII and FSCS cover.
The paper follows a statement by the FCA chief, Andrew Bailey, in November 2016 that PII is not always performing reliably in the financial advice sector, as insurers were frequently writing contracts that excluded losses in this area, leaving the FSCS to make payments. He called on the insurance industry to put forward ideas as to how to make the PII market work more effectively.
The consultation puts forward various proposals regarding how PII in the financial services industry ought to be revised. The FCA has raised concerns with the impact that existing PII requirements appear to have on the FSCS such that the FSCS has become the “first line of defence” in many instances where a firm fails. The FCA is seeking views with a view to improving the reliability of PII so it acts as a “front stop” ahead of firms failing and resulting claims being made on the FSCS.
The paper invited submissions on whether the FCA should introduce more comprehensive mandatory PII cover, such as requirements to have run off cover in place and additional requirements for legal defence costs. The FCA recognises that defence costs can often be high in the event of a claim and the current Handbook guidance says it is not considered reasonable for a firm’s policy to treat defence costs cover as part of the limits of indemnity if this reduces the cover available for any individual larger claim. The paper questions whether the PII market is working, acknowledging that there are few providers in the market and some firms find it hard to purchase appropriate cover.
The paper identifies a number of issues in the PII market in the personal investment firm arena, and the FCA’s desire to address indications that PII is not functioning as effectively as it should. Some firms have reported to the FCA that they find it difficult to purchase appropriate PII cover or, in some cases, any PII cover at all. Moreover, the FSCS and other industry stakeholders have provided evidence to the FCA that not all PII policies respond adequately to claims made. In particular, some polices exclude the insolvency of the policyholder or the FSCS as a claimant. The paper focuses, in particular, on exclusions, recognising that Insurers can find it hard to price the risks inherent in the financial advice market but that, for example, product exclusions can leave firms unprotected if they chose to provide certain types of advice. In the FCA’s view, the analysis shows that there is justification for strengthening PII, particularly for personal investment firms through the use of, for example, mandatory terms.
Clearly the FCA views PII as an important protection for firms and customers. However, the prevailing view of the regulator appears to be that too much is falling to the FSCS and if FSCS funding reforms are to be successful, reforms will also need to be made to PII cover in the financial services sector.
Part of the problem with financial adviser’s PII is as a consequence of changing expectations of the regulator, unpredictable FOS outcomes (which decides cases on a “fair and reasonable” basis, and not strictly in accordance with established legal principles) and the associated uncertainty as to exposures that these practices bring for insurers.
Enforcing standard wording and extending the level of cover required will undoubtedly raise the overall cost of PII cover through the imposition of higher premiums (and so, cancelling out if not exceeding any savings for firms in terms of reduced FSCS levies). It may also lead to some insurers withdrawing from the already relatively small market.
The consultation period closed on 31 March 2017 and it is currently expected that the FCA will publish a further consultation paper on proposed rule changes in autumn 2017.
R (Aviva Life & Pensions (UK) Ltd) v Financial Ombudsman Service  EWHC 352
When determining a complaint, the FOS must do so by reference to what is fair and reasonable in all the circumstances, taking into account all relevant law, guidance and practice.1 It has been accepted as the law and referred to in decisions for many years that the FOS can depart from the relevant law, guidance and practice provided the ombudsman explains its reasoning to do so. However, this successful application for judicial review, where the High Court quashed the FOS’ decision, highlights the importance of the ombudsman to take relevant law, guidance and practice into account when making decisions and give full reasons for its decisions when departing from it.
Mr and Mrs McCulloch took out a 23-year joint life policy in 2006 which they cancelled, in 2013, when they separated. In November 2013, Mr McCulloch applied for a single life policy on his own from Aviva, but failed to disclose on the application form: that he had been consulting his GP in relation to possible mental health issues since September 2013, that he had been referred for psychiatric assessment, and that he was awaiting a CT scan. He later sought to claim for terminal illness benefit following being diagnosed with a rare terminal form of earlyonset dementia identified by the CT scan. Aviva declined the claim on the grounds of misrepresentation, and avoided the policy owing to negligence or careless, rather than innocent, non-disclosure. Aviva stated that it would not have offered the policy if disclosure had been made.
The FOS decided that special consideration had to be given to Mr McCulloch’s illness as he could not be expected to make the same disclosures expected of a reasonable person and, accordingly “[i]n cases of innocent misrepresentation, the appropriate remedy is to disregard the information that wasn’t included in the application form. So Aviva should reinstate the policy on its original terms and consider Mr McCulloch’s claim”. Aviva sought judicial review of the decision.
The High Court decided that the Ombudsman had not given sufficient reasons for its decision nor had it followed the relevant law, guidance and practice. The FOS’ jurisdiction was derived from the Financial Services and Markets Act 2000 and when exercising its compulsory jurisdiction, a complaint had to be determined with reference to what was, in the opinion of the ombudsman, fair and reasonable in all the circumstances and this included taking into account relevant laws and regulations and, where appropriate, good industry practice at the relevant time. When the ombudsman did not follow the relevant law, guidance and practice (as it is entitled to do so), it is incumbent on the ombudsman to explain why it had not.
It was not disputed that Aviva had followed the relevant law, guidance and practice and so, as a result, its decision was not prima facie unfair or unreasonable. At the same time, it would not be unreasonable for the FOS to hold the insurer to its contract given the unusual circumstances of the case. However, if it did, careful reasons had to be given for any lawful decision to uphold a complaint
In light of its conclusions, the High Court quashed the Ombudsman’s decision with the effect that the FOS had to reconsider the complaints.