Michael* is a Sydney-based financial planner who admits he is not terribly experienced when it comes to his PI insurance. About to become a certified financial planner, he is reeling after being badly burnt by his policy last year.
Ten of Michael's 200 clients invested in an income fund from failed property group Westpoint. When it collapsed, Michael notified his insurer, QBE, which immediately referred him to its lawyers, Phillips Fox.
The lawyers informed him QBE will not honour the causality terms in his policy, which states that there is a single deductible for all claims relating to one product. Instead, the insurer is claiming he needs to pay one excess for each client on the basis that each one was given an individual statement of advice. Michael now faces a $50,000 bill based on an excess of $5000. "When you pay your premiums, you think you're covered. But that's the start of the battle," he says. "We did as much due diligence as possible on the income fund - we relied on KPMG. We had face-to-face meetings with [Westpoint boss] Norm Carey, who assured us of the financial stability of the company two months before it collapsed. To me, QBE is trying to wriggle out of payment."
From the corridors of power in Canberra to smaller planners like Michael, PI insurance is again rocking the foundations of the Australian financial planning industry. Premiums have stabilised, insurance is affordable and the market is competitive. According to a recent report, over 80 per cent of planners say they have enough cover. So why are planners still getting a raw deal? The short answer: Westpoint. The industry is facing echoes of 2002 when the majority of insurers exited, spooked by HIH, and planners were forced to take desperate measures to get affordable cover. The industry's resources and reputation had just recovered when another blow hit in the form of Carey's disgraced property scheme. The state of play
The history of PI is a history of under-regulation. Licensed advisers are not required by law to hold insurance. PI does not come under the radar of the Insurance Ombudsman. ASIC records based on 2004 data show only about 60 per cent of Australian licensees hold PI policies.
Canberra powerbrokers want to clamp down on this laissez-faire arrangement and force the 40 per cent of Australian financial services licensees who do not have PI to pay for an adequate amount. The idea is that ordinary mum and dad investors will no longer have to differentiate between those that have PI and those that don't. The current plan can be traced back to a hazy definition under the Corporations Act of licensees needing adequate compensation arrangements. Wrangling over these arrangements has continued six years after the introduction of financial services reform. Federal Treasury has released a five-option plan and called for industry feedback. Treasury's preferred plan, option two, is to make PI compulsory but to refrain from prescribing a limit. The FPA supports this.
In a recent survey of 450 planners, just over half were behind the Government's plan to make PI mandatory. According to financial research house brandmanagement, 56 per cent agree with the proposal and 21.1 per cent disagree (see graph below).
Brandmanagement says the issue does not appear to be a major problem as four out of five (80.7 per cent) believe they have sufficient cover in place (see pie chart on page 21). But such is the disagreement among industry players about the five options that the Government has been forced to extend the transitional period for another six months until July.
Parliamentary Secretary to the Treasurer Chris Pearce is continuing negotiations while everyone is using transitional arrangements to get by and hoping they are adequately covered.
Divisions run deep
A roundtable of 32 industry participants and decision makers in government held last month ended in a stalemate. "As far as I'm concerned, it's a witch hunt against financial planners," Association of Independently Owned Financial Planners (AIOFP) chief executive Peter Johnston says.
"There [is] a lot of indecision and a lot of grey areas. I don't really think [ASIC] have thought it all the way through. Financial planners are the poor suckers who are selling the product and get the heat while the fund managers hide behind their lawyers."
Insurers tighten their policies
In the past five years there has been a major movement in the underwriting market towards restrictions and exclusions in policies. When HIH, the nation's largest PI insurer, collapsed it took two-thirds of planners down with it. In 2002 and into the 2003/04 cover periods, planners were slugged with 30 per cent to 100 per cent rises in premiums. Then in 2005 PI costs began to drop an average of 9.7 per cent. According to a Dealer Group Advisers survey at the time, they were down from an average of $433,000 per $1 million of cover to $391,000 per $1 million.
In the past 12 months, premiums have lowered still further. Dealer groups are enjoying a competitive insurance market, where limits and excesses differ from underwriter to underwriter as insurers cut prices to stay on top. Premiums are around 0.5 per cent or 1 per cent of the cover limit, which averages about $1 million. Exclusions are now a permanent fixture of a range of produce classes. They include margin lending, tax-effective schemes and mezzanine finance. At least one insurer, Macquarie Underwriting, has decided to exit the market altogether, while another has introduced a special Westpoint exclusion and another, Dexta, has excluded mezzanine finance.
The market has since dwindled from 37 insurers before HIH to a small but powerful group of just five. AIG is the dominant player in the market through an FPA deal brokered in 2005 for members, together with CGU, QBE, Dexta and Dual. Those remaining are clambering to insure financial planners in the current bull market.
Insurers are waiting out a time lag before Westpoint litigation begins to bite, Dexta boss Tony Wheatley says. "We are currently still seeing reductions in premiums and I don't for the immediate future see any change to that. I'm not convinced they will dramatically rise because of Westpoint if FICS [Financial Industry Complaints Service] are reasonable. But I would have to say they'll level out a bit," Wheatley says.
The Westpoint exclusion combined with increased competition has cut Dexta's portfolio of planners by 20 per cent. "We're working through it at the moment. At the end of the day we'll try and retain the book," Wheatley says.
"[Dexta has] aggregated all my potential claims into one $10,000 excess - which I have paid to their lawyers," one planner says. "It's a great result for us. Of course, my premiums have more than doubled, but our good practices will lower these over time." Different groups propose different solutions to ramp up consumer protection.
IFA understands listed litigator IMF and Slater Gordon, the law firm acting for it in a Westpoint class action, want planners' PI cover exclusions to be in the financial services guide (FSG). This is on top of the Government's proposal that licensees need to provide a summary of cover in the FSG.
Insurers warn PI premiums will rise if the FICS limit is raised, and the scheme has come under fire for providing no recourse for planners to appeal a complaint.
FICS has hit back at its critics, saying PI is not an adequate compensation mechanism anyway and understands Dexta has granted indemnity claiming insurers are deliberately frustrating the process of compensating Westpoint investors. A last resort safety net?
The idea of an industry levy, administered by FICS, to pay for a compensation pool in addition to PI insurance is doing the rounds of Canberra, the financial media and consumer lobbyists. Stockbrokers have a safety net called the National Guarantee Fund, managed by the Securities Exchange Guarantee Corporation. Lawyers have a similar scheme, as do travel agents.
"The experience of Westpoint demonstrates that PI insurance - without prescription - will fail comprehensively to deliver any effective consumer protection," Australian Consumers' Association senior policy officer for financial services Nick Coates says.
Coates says the fund could follow an existing model in the United Kingdom and would involve an initial charge of $5000 across 3500 licensees, raising $17.5 million in the first year. But financial services lawyer Mark Halsey says a levy would hurt non-institutional licensees because it would exempt certain groups - those under the watch of the Australian Prudential Regulation Authority.
"This would mean there would not be a level playing field because of the artificial cost burden on only part of the industry, and the threat of reduced competition in the industry," Halsey says. In the second half of last year, ASIC commissioned former Insurance Council of Australia head Alan Mason to report on the current state of the marketplace. He turned up results that point to a fundamental lack of understanding in the industry about what level of indemnity is required and the way it is structured. One insurer interviewed for the report said 90 per cent of individual claims ever lodged would be covered by a limit of indemnity of $2 million.
The industry average is only half of that at $1 million. Another noted its clients were generally unaware premiums did not increase in the same ratio as limits - doubling the limit would usually see a premium increase of 30 per cent. Brokers sound out warnings
BMS Austpac insurance broker Schuyler Elia says affordability has increased but expects a market correction before the renewal period in March to cushion the blow from the Westpoint collapse. "I don't think they're going to be sizeable increases - they'll be raised over a period of time," Elia says.
Perth-based broker Stephen Hughes agrees premiums will remain favourable through 2007. "The pricing is excellent at the moment for financial planners," Hughes says. Hughes, who works for Strathearn Insurance Brokers, says PI insurers are fairly sophisticated and as such have not had to put a Westpointstyle levy on policies, preferring to define their policies on the basis of picking through a dealer group's approved product list (APL). "Most now will only insure what is on the APL," he says.
The dealer group is effectively out on its own if one of its authorised representatives decides to sell a client one of these products, or sells something off the APL. The collapse of former Financial Wisdom subsidiary Sentinel is a case in point. The current owner of Financial Wisdom, Commonwealth Bank of Australia, was sued for millions after the Victorian Supreme Court found it was responsible for the failure of Sentinel's taxeffective investments despite the products sold not being on the APL.
"Dealer groups really need to consider what their exposure is to a particular product, particularly high-risk products," Hughes says. The collapse of Westpoint in November 2005 has not yet forced insurance up to unjustified levels and it is too early to lay too much weight on the impact it will have. The potential impact is unclear. The stock market continues to rise at record levels, buoyed by happy investors. But the mood is wary.
