• ASIC to increase surveillance to monitor compliance with PI insurance requirements
• AFS licensees should check their PI policy to determine whether cover is adequate
• Insurers should review their PI offerings to ensure cover is compliant with RG 126

Following an eight month review, ASIC has released its findings on the PI insurance market and areas of regulatory risk for AFS licensees providing financial product advice to retail clients on Tier 1 products (referred to as ‘advice licensees’).

While the availability of PI insurance cover has improved, ASIC found that not all advice licensees have adequate cover.

ASIC detected compliance issues in five key areas and signalled an intention to increase surveillance of advice licensees to monitor compliance. ASIC’s position is that these issues should be addressed by the industry.

Availability of PI Insurance

ASIC noted that the PI insurance market is cyclical with premium increases and reduced market capacity when insurers experience poor profit ratios.  ASIC is of the view that there is currently stability in the market with a sufficient number of active insurers and flattening premiums.

However, it also noted that insurers continue to be more selective and cautious in offering PI insurance cover.

Adequacy of PI insurance

In its review, ASIC analysed the policies issued by what it considered the four most active PI insurers.  Generally, it found that the cover purchased by advice licensees did not meet the requirements set out in RG 126 – Compensation and insurance arrangements for AFS licensees in the following areas:

Defence costs should be above the limit of indemnity

ASIC found that almost 14% of the small advice licensees in the sample had their defence costs included in the limit of indemnity. RG 126.54 requires the defence costs to be covered in addition to the limit of indemnity.

Inclusion of at least one automatic reinstatement

This requirement is set out in RG 126.  ASIC found that not all insurers provided one automatic reinstatement in their policy.

Cover for claims caused by fraud and dishonesty by directors, employees and other representatives

Of concern, ASIC found that half of the insurers in the sample excluded cover for loss or damage caused by fraud or dishonesty of directors, employees and other representatives. These insurers covered over 300 advice licensees.

Aggregation clauses and EDR scheme sub-limits

ASIC detected variation in policies as to whether aggregation applies and, if so, how claims are aggregated.  In some cases, multiple claims may be aggregated under a single limit of indemnity if they result from the same event, which may be failure of a financial product. In other cases, claims may be aggregated if they arise out of the same circumstances or acts, such as multiple parties relying on a common piece of advice.

Of particular concern to ASIC is the operation of aggregation clauses in policies combined with EDR (External Dispute Resolution) scheme sub-limits.  EDR scheme sub-limits are often significantly below the policy’s full limit of indemnity. As a result, multiple claims may be subject to a single EDR scheme sub-limit.

ASIC has made known its view that advice licensees are unlikely to be compliant with RG 126 without additional financial resources if their PI policy contains both aggregation clauses and EDR scheme sub-limits.  ASIC expects that a significant number of advice licensees are in this position.

Lack of aggregation of claims resulting in multiple excesses being payable

Conversely, ASIC also outlined its concern that where aggregation clauses do not apply multiple excesses may need to be paid.  The ability of an advice licensee to meet all excess payments when there are multiple claims is a consideration when determining whether the licensee has sufficient financial resources for the PI insurance to work in practice.

Where to from here?

ASIC expects the industry to address the issues it has identified and intends to increase surveillance to monitor compliance.

As a result, AFS licensees providing financial product advice should reassess whether they have adequate PI insurance cover to ensure they are meeting their obligations under RG 126.

Furthermore, it is timely for insurers and brokers to review the PI policies marketed to AFS licensees to ensure that the industry is meeting the need to provide RG 126 compliant policies and the compliance of existing policies is not misrepresented.