There could be more fireworks than usual for independent financial advisers (IFAs) in November, as they try to renew their professional indemnity (PI) insurance.
With premiums rising by as much as 60 per cent and underwriting capacity at low levels, City regulator the Financial Services Authority (FSA) says about 10 per cent of IFAs who need PI cover - because they lack the financial reserves to meet any claims - don't have any.
PI is important because it is used to compensate clients when there has been mis-selling, negligence or improper advice from their IFA. Between 400 and 500 IFA firms are without PI insurance, and that number could grow significantly as an estimated 30 per cent of policies are up for renewal on 1 November.
"The problem is going to get worse over the next couple of weeks because of the high number of renewals due," warns Gary Dixon, managing director of Compliance Solutions, a firm which helps those working in the financial services sector to establish "best practice" procedures.
The problem began to take hold last year, and is a result of fewer underwriters either being willing to offer PI cover or increasing premiums to IFA firms because of the rise in mis-selling.
Previous mis-selling scandals like pensions, endowments and split-capital invest- ment trusts have been added to recently by precipice bonds.
Increases in PI premiums of 50 per cent have not been unusual, says Neil Pointon, director of PYV, a provider of the cover. In addition, some underwriters are raising the excess that has to be paid by IFA firms before they can make a claim, or extending the number of investments excluded by PI policies.
As a result of the lower capacity in PI insurance, the FSA has allowed some IFAs to operate without it. Those firms granted a waiver, says the regulator, must have sufficient capital to meet the risks of the business on which they are providing advice.
The FSA, says Mr Pointon, has also changed the rules over the level of excess that IFAs can have on their policies. Previously it was 3 per cent of turnover, but it is now a maximum of £5,000.
The FSA adds that, as a back-up, consumers can use the Financial Services Compensation Scheme. But this only provides compensation of up to £48,000 for investments, 90 per cent of the policy valuation of long-term insurance and a maximum of £31,700 for savings on deposit.
Such has been the difficulty for IFA firms in obtaining and being able to afford PI cover that some have liquidated their old companies and set up new businesses. In this way, says one adviser, they discard their historical liabilities and their premiums plummet.
Alan Steel, managing director of Steel Asset Management, says it is a "farce" that IFAs can simply liquidate old firms and establish new ones to reduce their PI cover.
Paul Smee, director general of the Association of Independent Financial Advisers (Aifa), admits there has been some "corporate activity which has been primarily driven by PI". He says it is difficult to evaluate the level of this but would expect more if underwriting capacity is not increased during the November renewal season.
"There are some signs that the market is twitching back into life through greater capacity and more underwriters basing policies on the risk of the IFA business," says Mr Smee. "This has been helped by IFAs trying to offset PI cover against cash in the business."
Mr Steel is critical of the City watchdog for failing to help IFAs obtain PI cover. "The FSA said 15 months ago that it was aware of the problem and was looking at it. But it has done nothing about it. Surely the FSA and the insurance industry could have sat down together to sort out the problem? I would like to know what the FSA has been doing for the past 15 months."
That the regulator is allowing IFAs to continue to operate without PI cover, says Mr Steel, suggests that these firms are capable of meeting any potential liabilities from their cash reserves.
But while the FSA is concentrating on existing business, Mr Steel argues that the liabilities are likely to come from historical cases.
"It is easy for a firm to have had rogue advisers over the past 10 years. You cannot monitor everyone for every minute of the day. Even if an IFA is running a tight ship today, a case could easily pop up from 10 years ago. The problem is that the adviser responsible can leave to join another IFA firm and not have any liability even though he sold the case."
Mr Steel adds that with underwriters raising the level of excess and excluding such products as guaranteed bonds, split-capital investment trusts and pension transfers, "it is unlikely IFAs would ever be able to make a claim against their PI cover.
"What is the point of IFAs spending £100,000 on PI insurance when it is unlikely they will be able to claim against it?"
Even underwriters admit that the number of IFA firms without PI cover is likely to increase over the next couple of weeks. And it is questionable whether longstanding firms would have sufficient cash reserves to meet a number of substantial claims for mis-selling, negligence or inappropriate advice.
This makes it more important than ever to ask your financial adviser whether he has PI insurance.