The days of $1,500 errors and omissions insurance with a $5,000 deductible are quickly coming to an end.
Today, it’s more typical to see annual policy costs in the $3,000-$4,000 range, with deductibles running as high as $350,000. Reasons for the increases vary, as Jim Eccleston, president of Eccleston Law Offices, explains.
“Regulatory actions and arbitration claim filings are increasing,” Eccleston argues. “Arbitrations claims may be ‘group’ type claims involving multiple investors and may involve products sold to numerous investors. And product-based class-action filings alleging lack of due diligence are increasing as well.”
Jodee Rager, chief compliance officer at Geneos Wealth Management, believes that securities attorneys are a primary cause of the current E&O insurance dilemma.
“Attorneys are making a lot of money with their boilerplate statement of claims and in my opinion, are a major factor in the number of claims that result in the E&O increases,” according to Rager. “These law firms are going after insurance money and perhaps don’t realize that insurance coverage is dwindling thanks in part to the investors they’ve convinced to file a claim. It’s true that not all attorneys are banking on insurance money, but we do know that one of the selling points in getting investors to sue is that it won’t cost the advisor any money.”
Rager adds that clients who are still doing business with their advisor are filing arbitrations through these law firms who solicit complaints because they are led to believe there will be no splashback to the advisor as they won’t be named in the complaint, which is simply not true — the advisor doesn’t need to be a named party for the complaint to be reportable.
Another development in this Dodd-Frank era of reform is how E&O deductibles are being determined — based on product, compliance history and outside business activities.
Alternative investments: It’s getting tougher to find coverage
If you have alternative investments as part of your product mix, you may see your deductible at a much higher threshold and/or a higher premium. As deductibles go up, you may also see coverage being cut back to levels as low as $50,000, while other product coverage remains at normal levels of $1 million to $2 million per incident. We are hearing from many firms how difficult it is becoming to get coverage for alternative investments, especially for direct participation programs and hedge funds.
Dodd-Frank suitability rules have made oftentimes frivolous claims proliferate over liquidity and risk level issues, especially when senior citizens are involved in a claim. Broker-dealers have been quick to settle such claims through their E&O insurance, resulting in more carriers less willing to offer coverage and much higher rates for those that do. Fraudulent alternative investment products such as Provident Royalties, Medical Capital and DBSI originally drove the rate increases. Now, suitability litigation from securities attorneys capitalizing on products they perceive as an easy target is exacerbating the problem.
Fixed insurance: It may cost you to go outside the BD network
If you do fixed insurance through an outside insurance marketing organization rather than an IMO networked through your broker-dealer, you may incur a higher deductible. The reasoning is this: doing fixed insurance as an outside business activity is harder to supervise and exposes the firm to more liability, hence the higher deductible. Broker-dealers make 30 to 50 basis points on the fixed insurance business you run through their networked IMOs — and that’s in addition to any payout grid that may be applied to fixed production. Reps going outside the insurance network cut into the broker-dealer’s profitability and raise potential liability. A growing number of firms are removing coverage from their fixed insurance policies if advisors handle it outside of the broker dealer, and only maintaining this coverage when purchased through their network.
“Why should we offer freebie insurance on something that is outside of our supervision and profit center?” commented one compliance staffer.
Compliance: One mark can drive rates up