Safety First

Few prudent drivers would take to the road without having their cars adequately insured, even if it were legally permissible. In these days when a medical catastrophe has the potential to wipe out a lifetime of savings, no one who can avoid it goes without healthcare insurance. Most people grumble about the premiums paid for such protection and pray they never need the coverage but don’t feel they can afford to gamble on going without. Often the peace of mind that comes with coverage is well-worth the premium. Most financial planners and investment advisors have come to feel the same way about errors and omissions, or E&O, insurance.

“It’s a necessary evil,” says Lisa Kirchenbauer, CFP, only partly in jest. Kirchenbauer has a small practice ($32 million in AUM) in Arlington, Virginia, and purchases E&O coverage for herself as well as the firm’s other CFP.

Two years ago, after 17 years with a broker/dealer, Kirchenbauer went completely independent and launched Kirchenbauer Financial Management and Consulting. “For the first time I had to get my own coverage; that was a rude awakening,” she recalls.

Her first shock was that as a sole practitioner she didn’t have the size to make her an attractive risk for one of the major E&O insurers. She says that the staff at one major carrier politely explained that they didn’t offer coverage to advisors with less than $100 million in assets under management. Seeing she wasn’t getting what she needed as a small independent, Kirchenbauer decided to see if her membership in the FPA gave her any leverage, which it did with two insurers.

“I got two completely different quotes, and neither would cover my hedge fund of funds business,” she says. “And they still won’t.”

One of the quotes was twice as much as the other, and even the low one was twice what she had been paying through her broker/dealer. “Because I’m a smaller firm, it’s been a big challenge,” noted Kirchenbauer. “I’m getting about half as much coverage for twice the price.”

Other independent advisors with relatively small practices would be wise to take a page from Kirchenbauer’s book and investigate E&O policies that may be available to them as members of professional associations such as FPA or NAPFA.

A Changing Market

For advisors affiliated with broker/dealers, as Kirchenbauer belatedly discovered, E&O coverage under a massive policy has long been one of the cost benefits of that association. While that still remains the most viable route for many advisors, coverage under such policies is not as inexpensive as it once was, according to a comparison of data collected for the Investment Advisor independent broker/dealer directories in 2000 and again last year.

In 2000, some 83% of the broker/dealers listed in the directory offered E&O insurance to their reps. Five years later, with a greater number of firms participating, that figure had dropped to 73%. What’s probably more alarming to advisors is the increase in E&O premium costs (see “I’ll Get It From My B/D” sidebar ). Five years ago, there were two B/Ds in the directory offering their reps E&O coverage for less than $100/year. Last year one of those companies, Prospera, noted that the average cost per rep had gone from $88 to $2,160. While that was the greatest upward spike of the broker/dealers listed in both directories, triple-digit increases since 2000 have been the rule rather than the exception.

Surprisingly, perhaps as a “loss leader” strategy, the number of broker/dealers that offer the coverage to their reps without charging for it has increased at the same time that overall premiums have escalated. Only one of the B/Ds that offered E&O at no charge in 2000–SII Securities–still did so in 2005. Two other firms that didn’t pass along the cost of coverage in 2000 are now asking for more than $2,000/year from their reps for coverage.

Mark Connell is a CFP with Capital Advisory Group in Dallas, a firm that actively manages about $64 million and advises on another $70 million. Both he and the firm’s owner/president, who is also the firm’s other advisor, get E&O coverage as registered reps through their broker/dealer. In addition, Connell also has coverage as an investment advisor. The firm president, a 30-year industry veteran, chooses not to purchase any coverage, Connell notes. Contrary to the experience of some other advisors, when Connell made a survey of coverage available on the open market last year, he found that in a few cases he could actually purchase coverage for slightly less than he was currently paying.