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:
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- 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.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.