PROTECTING YOUR PRACTICE – Key considerations when purchasing Investment Advisor E&O insurance

Ken Golsan and Brian Francetich article excerpts from PlanAdvisor Magazine – May/June 2013
Errors & omissions (E&O) insurance is a risk management tool. It is particularly important to retirement plan advisers since Employee Retirement Income Security Act (ERISA) liabilities are personal, meaning that advisers’ personal assets are at stake if a claim is brought against them.

E&O insurance protects against alleged negligent acts, errors, omissions or breaches of duty arising out of advisers’ professional services. It protects advisers against losses by paying for all or part of attorneys’ fees, claims and judgments against the adviser.

Plan advisers are increasingly recognizing the need for comprehensive insurance to cover these risks, experts say. Underwriters, however, are seeing more retirement plan lawsuit claims and fear the greater possibility of plan lawsuits, says Brian K. Francetich, vice president of Golsan Scruggs, an insurance and risk management firm in Portland, Oregon. This has led to a trend of rising prices over the past 18 months. The marketplace is also narrowing as underwriters stop insuring new plan advisers, Francetich adds.

A discord has developed between the insurance and investment worlds, agrees Kenneth R. Golsan, president of Golsan Scruggs. While the investment world is charging into alternative classes within the retirement plan investment portfolio, the insurance underwriting world is retreating, he says. This makes it a challenge for advisers to get adequate coverage at a good price.

When shopping for an E&O policy, here are some key questions an adviser should consider:

1) Does the insurance broker/agent have experience with retirement plan advisers? Ask if the insurance broker/ agent understands the plan advisory business and pension consultants’ exposures. “An insurance agent/ broker should fully grasp the animal [he is] being called to insure,” says Golsan. Many insurance agents, he says, are unaware what the registered investment adviser acronym RIA means.

“It’s not unusual for plan advisers to have to explain their businesses to the agent/broker.”

“It’s not unusual for plan advisers to have to explain their businesses to the agent/broker,” Francetich says.

2) Does the insurance agent/broker have good underwriter relationships and an understanding of the marketplace? Securing an agent/broker who has good relationships with underwriters can make a substantial difference when it comes to premium payments. Golsan’s firm is working with a new client who previously had another agent submit an E&O proposal a year and a half earlier. The market responded to Golsan’s proposal with premiums that were 40% lower, a lower deductible and broader terms than the other agent’s.

“Underwriters know we properly vet our accounts, so there is a higher degree of confidence that it will be a profitable underwriting for them,” says Golsan. His firm also has a large volume of this business, so underwriters give his firm preference, he says.

3) What are the differences between underwriters’ policy provisions? Unlike property/casualty insurance, there are no standard terms for E&O policy provisions, says Golsan. Property/casualty insurers have a governing body that writes the standardized contracts, forms and policies. So, if a business buys commercial, automobile or property insurance, the actual contract is standardized, he says. This makes it easy to do a comparison based just on limits, deductibles and premiums. To analyze an E&O insurance contract, though, an adviser must look into the contract terms, he says.

That is where an adviser must proactively get endorsements and tailor coverage to meet his practice’s needs, says Francetich.

4) What are the most common coverage loopholes and ambiguous terms? Advisers need to ensure they are covered for any claim that could be asserted against them, says Joseph C. Faucher, an attorney with Drinker Biddle & Reath LLP in Los Angeles. For example, fiduciary claims can still be asserted against a nonfiduciary broker, says Faucher, so E&O coverage needs to be broad enough to cover any fiduciary claims brought.

Additionally, advisers who discover an error and decide to circumvent the insurer—telling the client about the mistake and making good on it themselves—might want to think twice. If their policy covers the error, they could be forfeiting future coverage if that error occurs again. Many policies exclude coverage for claims that advisers volunteered to cover, says Faucher. Therefore, advisers should contact their insurance carriers and negotiate with them prior to offering to make good to a client. “Speak with your insurance carrier first, and get them on board,” he says.

Also review which investment products and categories are covered and which are excluded, Francetich says. And beware of ambiguous terms that can greatly expand the definition of excludable investments. Often a contract will contain a list of excluded investment vehicles with wording at the end that opens up the definition to whatever the insurer deems unacceptable. Golsan’s firm recently had a client referred to them with a pending claim where the underwriter was denying coverage based on such language.

5) What types of claims are most common? One of the biggest exposures, says Francetich, is when advisers recommend third-party service providers. If the third party makes a mistake, the adviser may have done nothing wrong or improper, yet he may still be drawn into the claims. “This risk cannot be managed away by best practices,” Francetich says. —Elayne Robertson Demby