As I sit on my return flight to the United States from Italy, it saddens me to report that I was not successful in becoming the securities commissioner of Positano or Venice, the Italians insisting that no such position exists. Thus, I must devote my energies to the many challenges that continue to face U.S. advisors. One such challenge is E&O insurance: Should I have it and, if yes, how much?
There is no regulatory requirement that an investment advisor maintain E&O. So, should an advisor purchase E&O insurance? My answer is absolutely yes. I have heard many reasons not to purchase, including that it makes the firm more susceptible to claims or it doesn’t cover claims for client-alleged negligence. Nonsense! Over the past 25 years, I can point to far too many examples of such errant judgment, the unfortunate result of which is an advisor facing a claim (regardless of the merits thereof) without any coverage. It is at this point the advisor realizes how mistaken he or she was to not obtain coverage. Legal defense fees can be substantial, even in cases where the advisor insists that the claim is spurious. Having been engaged by advisors and their insurance carriers for many years, I can assure you that it is emotionally difficult enough for an advisor to defend him- or herself against a claim (especially a meritless claim), without compounding the situation by having to fund the defense and potential settlement and judgment costs.
I often review insurance policies to determine if the scope of coverage is appropriate for an advisor. Who should it cover, and how much coverage should the advisor have? In general, the policy should cover the firm and all of its employees and representatives. As for how much coverage an advisor should have, unfortunately there is no specific benchmark to point to. Generally, most standard policies will cover claims for at least $1 million during any coverage year (although some may cover less, depending upon the carrier and advisor). I strongly recommend that the advisor annually review and adjust such coverage amounts as the advisor increases his or her assets under management and scope of services. I also often recommend that an advisor consider using insurance dollars to obtain more coverage with a higher deductible, recognizing that a claim in excess of the advisor’s coverage can be potentially disastrous (for example, $2 million of coverage with a $25,000 deductible versus $1 million of coverage with a $5,000 deductible).