Licensees have been forced to become risk management professionals in order to comply with the new professional indemnity (PI) insurance requirements.
Regulation 126 (R126) has seen financial planning businesses all around the country update their financial services guide, assess their businesses to define adequate PI cover, update risk management and compliance plans and communicate with external resolution schemes about new PI limits.
And while there has been added work, in many cases the compliance process has simply paralleled the renewal of existing PI cover.
"It is onerous. But it's something we've always done," Goodman Private Wealth Advisers chief executive and senior adviser Brad Church says.
The Money Managers chief executive Rob Jones says: "We've had a seamless transition. We had our new application in two months ago."
Even the legal fraternity reports a calm transition.
"It's been nothing new for my clients," Alexis Insurance Brokers managing director Christina Kalantzis says.
"The boutique groups already had cover over and beyond the regulation."
Yet despite this feedback, the industry is awash with tales of woe.
The prospect of increased premiums, sourcing an insurer in a shrinking market and the prospect of self-insurance has dominated coverage of the issue.
"I have been surprised to hear how hard the industry is finding it. I think the new regulation is very sensible," Church says.
And Jones says: "My peers around the country, we are not seeing them freaking out."
But with ASIC now conducting what it calls "routine surveillance activity" on whether licensees have the correct PI insurance in place to comply with the law, the seriousness of the compliance task should not be underplayed.
But apart from compliance headaches, what has been the real impact of R126 and, indeed, has it fully played out?
While the new regulation has certainly added extra work and worry to financial planning businesses' compliance, it seems it has not been the main concern.
"With PI being mandated, we could be seen to carry the can for poor performance," says a principal financial adviser keen to remain anonymous for fear of attracting attention from the regulator and the business's own insurer.
"It [R126)] will feed the pockets of [law] firms like Slater and Gordon."
Investment performance, adviser responsibility and market downturn have all become wrapped up with R126.
The close scrutiny by insurers of approved product lists (APL) has helped fuel this concern, making some in the industry hold greater concern over what other financial advisers in the industry are recommending.
"I would question as an industry whether we are recommending things we shouldn't be," Church says.
These concerns come despite legal advice to the contrary.
"PI insurance is there to protect the AFSL (Australian financial services licence). It's not about product failings," Kalantzis says.
Where did R126 come from?
Prior to the Financial Services Reform Act 2004, there was a requirement for AFSL holders to have adequate compliance arrangements in place.
However, this requirement was in no way defiant.
At this time, financial planning businesses had two options. They could lodge a $20,000 bond with ASIC or undertake to source their own PI insurance.
However, in late 2007, R126 was born, which dictated the terms of PI insurance.
"There were a number of factors behind this development," explains Kalantzis.
"There needed to be clarification of what adequate compensation was. Also the planning industry knew that other professions such as accounting had PI insurance."
Further, she says Westpoint highlighted that perhaps many licensees were in fact underinsured, and with the huge growth in debt product innovation, regulators and licensees were concerned further problems could arise.
However, R126 does not satisfy all those involved.
"Regulation 126 provides the end consumer with protection," Vero Profin executive director Alex Green says.
Contrary to what financial planning businesses may want, insurance houses are not going to wear all the liability either.
"The insurance industry has said it's not going to provide blanket cover that takes all responsibility from both ends," Green says.
Compliance easy accept for paperwork
Financial planning businesses report insurers focused on a range of issues to ensure adequate compliance.
They wanted to know how long the business had been in operation, who the principals were and their experience, the revenue sources of the business, customer profiles, the business's involvement in products, such as tax schemes and hedge funds, and what products were on the recommended list.
Given many businesses were no longer able to go through their previous PI insurer, QBE, preparing this information took some time.
"We started three months ahead of our existing policies maturity date," Church says.
"We had to attach evidence and a supporting schedule of 30-40 pages and we submitted it to our insurance broker one month prior to maturity date."
Planners say they have noticed a steady increase in what paperwork has been required from them by their insurers.
Jones says: "Five to six years ago there was not the same volume of paperwork. It was really a compliance audit of the licensee and the reps."
A renewed scrutiny of APLs
Thanks to R126, APLs and investment processes have been thrust into the spotlight by both financial planning businesses themselves and insurers alike.
"We have a robust investment committee process with our APL. But insurers are definitely taking more interest in APLs," Jones says.
One of the reasons Jones and Church believe both businesses had an easy experience getting adequate cover for R126 from their insurer, Vero, was because of the nature of their investment menus.
"We have a very narrow investment process. We don't invest in any kind of projects," Jones says.
Church says Goodman Private Wealth does not offer tax-effective investments, discretionary accounts or hedge funds.
He says R126 raises the question over just what products financial advisers should advise on.
"I would question whether as an industry we are recommending things we shouldn't be," he says.
Even if financial planning businesses did have existing PI cover, there are benefits of compulsory industry-wide cover not only to the consumer, but for the industry as well.
"Often PI policy requires businesses make improvements to their process," Church says.
"For example, because you have your own licence, there is no big brother telling you what you can put on your recommended list. But there are often restrictions around tax schemes."
For insurance groups such as Vero, the existence of APLs actually makes their job easier.
"Most of the people we talk to have got rigorous systems in place. They have APLs," Vero Profin national underwriting manager Cathie Thompson says.
"But they [the businesses] are not as confident underwriting fraud or dishonest reps. We will cover straight dishonesty such as stealing money."
Who is providing advice?
Another issue R126 has brought sharply into focus is the range of professions that provide advice.
"We had always assumed it was not an opportunity for new business. There's not a great deal of new business for those businesses with previous cover," Thompson says.
"But it [R126] has hit a host of licence holders who are not financial planners, such as super trustees or people giving financial services advice, so those falling into the grey area like the corporate advisory work."
The key issue for insurers is identifying the business its clients are primarily are in.
"So, [we have to ask] what is this commercial enterprise? What do they actually do?" Green says.
"And the question comes down to when does it come down to actual financial advice?
"There are still people scratching their heads about whether they should be picked up on this or not."
Kalantzis says this also becomes an issue when financial planning businesses expand into areas such as mortgage broking or with a law firm.
"It makes it more difficult to get PI insurance. Some PI underwriters won't quote if a business is giving general insurance," she says.
Of particular concern to her is the declining number of underwriters available to licensees.
"It [R126] is a big deal because there are only four to five providers in terms of underwriters and if they do decide to leave, how are licensees going to get PI?" she says.
"In other professions there could be up to 30 underwriters."
What premium increase?
Planning groups around the country report negligible increases in premiums, and if they have in fact increased, this is attributed to the businesses' own desire for greater coverage than what is required.
"We had a minimal increase with our premiums. It was the same if not lower than the same scenario as last year. Our increase was due to an increase in the amount of coverage. We had some larger clients with larger amounts," Jones says.
For Goodman Private Wealth, premiums increased by 5-10 per cent.
Church says historically the group sourced its PI insurance from QBE, but with it out of the market, its insurance broker suggested Vero.
"Several years ago, our premiums went up significantly after the collapse of HIH. For a couple of years, premiums skyrocketed. But QBE halved premiums a couple of years after and they have steadily increased since," he says.
Vero wanted information on a range of issues, including how long Goodman Private Wealth had been in business, who its principals were and their experience, where the businesses revenue came from and a typical customer profile, he says.
The insurer also asked questions over its use of tax schemes and hedge funds and wanted to see the recommended product list.
According to insurance provider Vero, premiums have been going up due to a greater level of claims in the financial planning industry and the desire by the industry to have more cover.
However, Jones says a more litigious client is not what's driving the increase in complaints.
"It's more uncertainty," he says.
He says in times such as these where markets are providing investors with disappointing returns, it's a case of simple re-educating clients about the investment process and market cycles.
How much is enough?
Under R126, the onus is on the licensee to determine the amount of cover they need.
"Eighty per cent of the industry had PI insurance before the legislation but how much was adequate cover?" Kalantzis says.
This can be difficult to calculate, so it is not surprising financial planning businesses admit to being insured over and above the minimums set out in the regulation.
"Our cover is substantially above the minimums in the regulation because we have larger client balances and we want protection," Church says.
The group also goes beyond its requirements in that it has its clients sign a service agreement, which has a section explaining its PI cover.
"No-one would ever be told they have adequate insurance," Thompson says.
"ASIC's not going to sign off. They might have bought $20 million in cover and get a $25 million claim.
"The onus is back on the insured to determine what they need."
The other big issue with how much PI is enough is legacy issues. R126 requires businesses to have a minimum of one-year's run-off cover, which means if an authorised representative leaves a financial planning business, it still has PI cover for this adviser for a further 12 months.
And given the revolving door of the financial services industry, this is an important requirement.
"Legacy lives on for a very long time," Thompson says.
"If a life product is sold, a client might not claim on that product straight away. The act is not activated until a claim is made."
With ASIC now sending letters to licensees asking them if they are insured as required by law, the future implications of R126 are not clear.
What will ASIC do if licensees are not adequately insured?
Green says the case is clear cut: "If they can't get the insurance, it stops them from operating."
It will be interesting to see the response of the insurance industry to adapt product and innovate new products to accommodate the likely increases in cover that will be needed.
