The Financial Conduct Authority (FCA) has been conducting a review of the operation of the Financial Services Compensation Scheme (FSCS), seeking views as to how to reduce the number and value of claims falling to the FSCS and assessing how the scheme is funded, including the impact of professional indemnity insurance (PII).
Do you have any views on our proposal to prevent personal investment firms (PIFs) from buying PII policies which exclude claims when the policyholder or a related party is insolvent?
The proposed change is "to ensure that more consumer claims are paid by insurers which could help to reduce the cost of the FSCS to other firms." There is a prohibition on the use of insolvency exclusions in PII for other professions: for example solicitors and accountants and the FCA's concern is that an otherwise covered claim, which has been notified correctly, could be denied if there is an insolvency exclusion in a PIF policy and the insured or a third party is insolvent.
This was the case in the 2017 case of Crowden v QBE  EWHC 2597 (Comm). The insured financial adviser had provided investment advice to the claimants, after which the claimants invested £350,000 in bonds issued by Keydata and securities issued by Lehmans. Following their collapse, the claimants suffered significant losses. With the insured having entered liquidation in 2013, the claimants sought to pursue the insured's professional indemnity insurer under the Third Parties (Rights Against Insurers) Act 1930.
The insurer applied for summary judgment or strike out, on the basis that the claim had no reasonable prospects of success, as the insurer was not liable to the insured under its professional indemnity insurance as a result of the application of an insolvency exclusion in the policy which excluded cover for any Claims, liability, loss, costs or expenses “arising out of or relating directly or indirectly to the insolvency or bankruptcy of the Insured or of any insurance company, building society, bank, investment manager, stockbroker, investment intermediary, or any other business, firm or company with whom the insured has arranged directly or indirectly any insurances, investments of deposits” (the 'Insolvency Exclusion').
The Court held that the Insolvency Exclusion was “clear and unambiguous”. For the Insolvency Exclusion to apply, insolvency must be “specifically accountable as a cause” of, and “stand out as a contributing factor” to, the claim, liability or loss - which was the case on these facts. Summary judgment was accordingly granted.
In the context of the FSCS, when it pays compensation, the consumer's claim is usually assigned to the FSCS. The FSCS has a duty to pursue recoveries that are "reasonably possible and cost effective to pursue",1 for the benefit of the scheme as a whole. As PIFs are required to maintain PII which provides an adequate level of cover and meets certain limits of indemnity,2 the pursuit of recoveries under PII is a common route for the FSCS. However, the FSCS would be hampered from recovering under the PII in circumstances where there is an insolvency exclusion contained in the policy (some policies also have express clauses preventing claims by the FSCS). If the proposed change comes into force, PIFs will be obliged to have PII policies that do not limit claims, where the policyholder or a third party is insolvent, or where a person other than the PIF (e.g. the FSCS) is entitled to make a claim on the policy.
The responses that the FCA received to the question raised in CP17/36 were largely in support of the proposal and the FCA invites more comment on the issue. In CP18/11 it has proposed the following further question, to which it would like to receive comments by 1 August 2018:
Do you agree with our proposed approach to ensure that PIFs have PII policies that do not limit claims, where the policyholder or a third party is insolvent, or where a person other than the PIF (e.g. the FSCS) is entitled to make a claim on the policy? If not, do you have an alternative proposal?