From November 2014 to June 2015, ASIC conducted a review of professional indemnity (PI) insurance for AFS licensees that provide financial product advice to retail clients on Tier 1 products (advice licensees).

Specifically, the review concentrated on small advice licensees (those with around 20 authorised representatives or fewer, and revenue of $2 million or less). It does not appear to have included review of general insurance brokers.

The review specifically looked at:

  • the availability and cost of PI insurance for advice licensees including how those variables have changed over the past few years; and
  • the adequacy of PI insurance issued to advice licensees as against ASIC’s Regulatory Guide 126 ‘Compensation and insurance arrangements for AFS licensees’ (RG 126).

The review follows concerns raised by:

  • advice licensees as to the availability of insurance on terms which comply with RG126 or the cost of such insurance; and
  • the Financial Ombudsman Service (FOS) as to the high level of unpaid external dispute resolution scheme determinations made in its Investments, Life Insurance and Superannuation stream.

The Report’s findings

In respect of the availability of PI Insurance, the Report provides that the current, post-Global Financial Crisis market is stabilising with sufficient capacity and flattening premiums. However, while the market conditions have improved, insurers continue to be ‘selective and cautious’ in offering PI insurance to advice licensees. The report noted that the exit of Axis Specialty Australia from the market may have an impact which would need to be monitored.

The Report also identifies five areas where the PI insurance policies that are generally available in the market have not met the requirements under RG 126, namely:

  1. Defence costs – RG 126 requires defence costs to be covered over and above the minimum limit of indemnity (being $2million). ASIC’s findings provide that 14% of the sample advice licensees reviewed held policies where defence costs were included in the minimum limit of indemnity.
  2. Automatic reinstatements – RG 126 requires at as a minimum, PI policies should include one automatic reinstatement. One insurer involved in the review advised ASIC that its policy does not include a reinstatement and it was unclear to ASIC how that was addressed by the advice licensees. i.e. through a write back into the policy or if the limit of indemnity was double the minimum requirement.
  3. Fraud and dishonesty cover – RG 126 provides that PI insurance for advice licensees must not exclude cover for fraud and dishonesty by directors, employees and other representatives. The review found that two of the four insurers reviewed did not provide policies that met this requirement.
  4. Aggregation of claims and the limit of indemnity – RG 126 identifies that policies may include an aggregating clause for related claims so that it is treated as one claim under the policy with a single limit of indemnity and that a sublimit may apply for external dispute resolution (EDR) scheme determinations.   In the event an aggregation clause is triggered and a sublimit applies to that claim, then there may be a significant gap in cover. The review found that this may stem from a misalignment between how insurers and EDR schemes define a claim.
  5. Lack of claim aggregation and the impact of payable excesses – the review also raised concerns regarding insurers not properly aggregating claims made on the PI policy, resulting in advice licensees having to pay multiple excesses, which in turn could be unaffordable for the advice licensees.

What does this mean for Licensees and their insurers?

ASIC has indicated that it will continue to monitor the industry as to ensure compliance with RG 126. It is unclear whether such surveillance will eventually lead to amendments to the minimum requirements for PI insurance for Licensees as set out in RG 126, or conversely whether this will lead to investigations of and fines for Licensees as a result of noncompliance with RG 126.

There is also the possibility of enforcement action in the event that insurers (or brokers/agents) make misrepresentations regarding the ability of their products to meet the requirements in RG 126.

It is therefore important for Licensees, brokers and insurers to check whether their PI policy meets the minimum requirements for Licensees as set out in RG 126.

A copy of RG 126 can be found here.

A copy of ASIC Report 459 can be found here.