INSURING THE RISK – Why every adviser needs insurance for fiduciary breaches

The following is an excerpt from the article:

Beyond Basic E&O

The usual route for retirement plan advisers to cover liability for fiduciary breaches is through their E&O policies, says Kenneth Golsan, president of Golsan Scruggs (see sidebar). However, a basic E&O policy may not adequately cover the adviser’s potential risk. Insurance companies want to sell more insurance, as well as identify the risk, notes Faucher, so it may be necessary to purchase additional riders to be fully covered. Advisers should determine how much potential risk they have and add on riders accordingly. And they have to ensure that the insurance they buy provides the coverage they need, Faucher says.

Advisers also need to review policy exclusions. A policy may exclude the sale of certain products, so if an adviser sells those, that risk is inadequately insured. Insurance contracts also may not cover certain types of investments, says Brian Francetich, vice president of Golsan Scruggs. For instance, there may be exclusions for foreign exchange or alternative investments. Some contracts do not cover investments in collective investment trusts (CITs), he says. If the insurance contract does not provide coverage for hedge fund investments but the adviser helps retirement plans invest in hedge funds, that adviser needs more coverage, Golsan says.

E&O policies can sometimes also exclude services such as third-party administration, adds Faucher. It is imperative that advisers get an ­insurance contract with language that matches the business they perform. So, when purchasing or reviewing insurance, advisers need to ask, “What am I doing for retirement plan clients?” and find out whether any of those activities fall within the exclusions, says Faucher. Advisers should never take for granted that the policy covers what they need. Faucher says he once reviewed a policy with an RIA only to discover the policy excluded claims for investment advice. “His core business was providing investment advice, but his insurance policy didn’t cover it,” he says.

Sometimes standard language must be amended or tweaked to make sure coverage is complete. Golsan recalls seeing a contract that excluded not only alternative investments but “anything similar,” as well. Language that broad, he says, could be used to deny coverage for breaches related even to more traditional investment classes.

To complicate matters, unlike with other business insurance, no industry standard insurance contracts exist for the investment advisory world. Every insurer has its own form for E&O, which makes it difficult to compare different insurers’ policies. So when purchasing insurance, every policy should be examined thoroughly, says Francetich.

In the absence of industry standard contracts, advisers should work with specialist agent/brokers who understand the investment industry, when buying coverage for fiduciary breaches, Golsan says.

Contracts that are not standardized, with their many little nuances, can also create problems should a claim arise, says Francetich, giving yet another reason to work with someone knowledgeable about advisers’ business practices. Advisers should also understand the extent of the coverage they are buying, he says. For instance, some insurance contracts will pay the entire expense of a suit, even if five allegations are made and the policy only covers two. Other policies­ merely will pay two-fifths of the defense.

Increased coverage for fiduciary claims has become more popular in recent years, Panskep says, but not ubiquitous yet.

However, getting the insurance they need may prove difficult for advisers in the current climate. In the last two or three years, the underwriting industry has pulled back from writing policies on investment advisers who work with retirement plans, says Francetich. The insurance industry became nervous due to the uptick in litigation in this area, so it has pulled back on writing new business, he says.

This is a ­challenging environment for securing good, solid insurance coverage, says Golsan. It can be done, he says, but it’s tricky.

According to Kenneth Golsan, president of Golsan Scruggs, advisers may find it unnecessary to purchase separate fiduciary liability insurance to cover their client transactions, though they may still need it for their own plans. Technically, fiduciary liability insurance covers plan sponsors only for breaches in fiduciary duty caused by their own staff, he explains. Most errors and omissions (E&O) policies exclude fiduciary breaches by the adviser when acting as a plan sponsor regarding any ERISA [Employee Retirement Income Security Act] plans they themselves sponsor, he says.

By way of illustration, if an adviser with 15 employees installs an ERISA retirement plan for them, the adviser has personal liability for any fiduciary breaches relating to that plan. Those breaches are not covered by his E&O policy. To cover that exposure, Golsen says, the adviser would have to purchase fiduciary liability insurance.

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Golsan Scruggs is an insurance brokerage firm operating throughout the United States specializing in investment advisor E&O errors & omissions insurance (aka professional liability insurance) for RIA registered investment advisors. As one of the largest insurers of RIA firms in the U.S., we have a dedicated staff that understands the risks of the financial services industry and delivers superior results.  We make the underwriting process painless.

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