article
The pension switching review
15 April 2009
Most professional indemnity (PI) insurance policies contain a
‘condition precedent’ clause prohibiting policyholders from
admitting liability or making any offer in respect of any claim or
possible claim. That condition does not sit happily with certain
regulatory obligations upon IFAs, which arise under the Financial
Services Authority’s review of pension switching business (the
“Review”). This article seeks to provide some helpful tips for
avoiding the many insurance pitfalls that could lead to pension
switching claims not being covered and explores, too, the possible
impact of the Review on the PI market.
Key features of the pension switching
review
On 5 December 2008 the FSA published its report “Quality of
advice on pension switching: a report on the findings of a thematic
review”, which set out the results of its assessment of advice
given to customers since 6 April 2006 to switch their existing
pension arrangement(s) into a personal pension plan (PPP) or
self-invested personal pension (SIPP).
The FSA immediately followed that up with a “Dear
Proprietor/Compliance Officer” letter on 9 December 2008, in which
it asked firms to assess the advice given to customers to switch
their pension(s). In its letter, the FSA stated what action it
expected firms to take and, from a PI insurance perspective, the
two most important “expectations” were:
· to consider the approach taken to the firm’s relevant pension
switching business and if necessary, look at a sample of individual
files of past sales as well as the sales process, and systems and
controls that apply; and
· to take appropriate remedial action if failings are
identified, including providing redress to customers where
necessary.
The FSA has stated that it intends to undertake follow-up work
in the third quarter of this year and has made clear that if firms
have not undertaken appropriate action in response to the Review,
they may be subject to regulatory action. Those are the important
regulatory obligations, but what about the obligations upon firms
under the terms of their PI insurance?
Key features of your professional indemnity
insurance
The vast majority of insurers offer cover for IFAs on a “claims
made” basis. For these types of policies, provided the insurance
does not exclude claims that arise from advice given before a
particular date (sometimes called a “retroactive date”), it does
not matter when the advice was given - underwriters will indemnify
the policyholder against claims made and notified during the policy
year, subject to the firm having complied with all the other terms
and conditions of the policy.
Although all policies are different, “claims made” policies
usually contain terms and conditions of the following sort:
The policyholder must not admit liability or make any offer deal
or payment without the prior written approval of underwriters;
Once a claim is made or the policyholder becomes aware (or ought
to have become aware) of any circumstances likely to give rise to
claims, the policyholder must notify the insurer “as soon as
possible” or “promptly” or “within 21 days” or similar. If a
circumstance is correctly notified and a claim subsequently arises
from it (even after expiry of the policy) the insurance will
usually provide cover.
The critical question therefore becomes: how can firms meet the
FSA’s expectations under the Review, whilst at the same time ensure
that their insurance cover won’t be jeopardised for any claims
payments that have to be made as a result of the Review?
Notification considerations
One of the first issues to consider is what, when and how the
firm should go about notifying its professional indemnity
insurer.
What should a firm notify?
Where a firm’s insurance policy requires claims to be “likely”
to arise from a particular circumstance, before the insurer is
obliged to accept the notification, it is highly arguable that
claims cannot be said to be “likely” to arise from a firm’s entire
population of pension switching cases. This argument arises because
under the current Review, the FSA considered 500 IFA files
(approximately 10% of all pension switches since A-day) and in
total found unsuitable advice in only 16% of cases. If that review
covered a population representative of the market as a whole (and
the FSA says it was representative) then there is arguably a 16%
chance of a firm having given unsuitable pension switching advice.
In those circumstances, PI insurers arguably would be entitled to
say that a 16% chance of a claim does not cross the “likely”
threshold.
It follows that where the relevant policy allows circumstances
that are “likely” to give rise to claims to be notified, it will
probably be necessary for the firm to have undertaken its own
investigations into its population of cases that fall within the
scope of the Review and have identified specific files where the
pension switching advice was deficient. Given what the FSA has said
about its expectations on firms taking appropriate remedial action,
notifying actual cases where remedial action might be required is
prone to form the basis of a notification that has a much better
chance of being accepted by an insurer.
When should a firm notify?
This question turns on the precise wording of the PI insurance
policy in question. However, the most common obligation is for
notifications to be made as “soon as possible” or “promptly”.
Therefore, it would be prudent for firms to exercise great care to
comply with the specific requirements of their policy as soon as
the firm believes it has grounds to notify. The notification clock
might start ticking once the firm has identified those cases in
which it considers deficient advice was provided.
However, in all cases, firms should contact their insurance
broker for guidance as to the precise notification obligations
under the terms and conditions of their policy and consider taking
specialist legal advice in the event of any doubt.
How should the notification be framed?
This is an important question in the current climate of the PI
market (a subject to which I return later). Whilst firms will
understandably be very keen to avoid notifying insurers of matters
that could very well lead to an increase in premium in the next
insurance year, there are real dangers of “playing down” the
seriousness and breadth of any problems identified.
Recent case law demonstrates that if a notification is too
circumspect about what precisely is the subject matter of the
notification, insurers might not be fixed with liability to
indemnify the firm for the claims that might ultimately arise. If
subsequent insurers exclude cover for matters a firm mistakenly
believed had been notified to a previous insurer, a gap in cover
could be created that would leave the policyholder with uninsured
claims and losses.
Firms may wish to consider the following factors when
approaching notifications to PI insurers:
What requirements must be satisfied for a notice to be valid and
effective for the purposes of the relevant condition in the policy
and are those relevant requirements satisfied?
Can the relevant communication objectively be said to “give
notice” (i.e. can it objectively be regarded as intended to be a
notification of circumstances as distinct from – for example – an
update describing the insured’s response to the Review that is
stated to be provided to underwriters “for information”)?
The following questions should be asked:
What does the communication reasonably convey to the reasonable
recipient?
Is the notification fair, comprehensive and comprehensible?
Is there a statement in the heading of any of the letters, or in
the body of the communications, to indicate that the firm is in
fact, by means of those letters/communications, notifying
circumstances which are likely to give rise to claims?
Offer making
The FSA has informed firms that it expects them to take
“appropriate remedial action” if failings are identified. However
the FSA has not given any clear guidance of how firms should go
about taking any remedial action. To the extent that a firm’s PI
insurance policy includes a condition precedent to the effect that
no admissions, offers or payments must be made without
underwriters’ approval, it is vital that firms comply in an attempt
to ensure that nothing is done to invalidate cover.
It is still too early to say how the PI insurance market will
react to requests from firms for approval of letters and so forth
to clients offering redress without a claim having been made.
However, the prudent course would arguably be for firms to attempt
to engage with their PI insurer at an early stage and certainly
before any offers are made/redress paid.
The Review’s impact on the professional indemnity
market
Due to the severe declines in global asset prices over the last
12 months has led to an increase in the number of claims being made
against IFAs. The increase in claims frequency has been compounded
with insurers realising less investment profit with the premiums
they collect. The net effect of those two factors means that
premiums and excesses are very likely to increase for most firms
this year. Unfortunately, whilst it is still too early to say with
any certainty what the impact of the Review will be, it is almost
inevitable that the cost of appropriate PI insurance will
increase.
Conclusion
The stakes are undeniably high. On the one hand there is the
risk of enforcement action if the FSA’s expectations are not met.
On the other, there is the risk of insurers rejecting
claims/notifications due to breaches of policy terms and
conditions.
Obviously the precise obligations on firms will be governed by
the specific wording of the relevant insurance policy. Although the
points set out in this article might help firms safely traverse the
tightrope, ultimately, there is no substitute for having a good
understanding of your own firm’s PI insurance policy’s terms and
conditions. If you have any queries or are unsure about any of the
firm’s obligations, your insurance broker should be able to help.
Otherwise, given the perils that could await the unwary, firms may
wish to consider taking specialist legal advice.
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