Compensation beyond PI

With a third of FOS determinations going unpaid the efficacy of Professional Indemnity insurance as a compensation mechanism is under question and, as Mike Taylor reports, change seems inevitable. 

Professional Indemnity (PI) insurance may cease to be the primary mechanism via which financial planning firms deliver compensation to clients who are deemed to have received inappropriate advice. 

No one is suggesting that the legal requirement to hold PI will be removed for financial planning firms, but it is likely to become part of a broader suite of compensation remedies. 

The Australian Securities and Investments Commission (ASIC) has acknowledged that, to a significant degree, the regime under which all financial planning firms are compulsorily required to carry PI insurance has ceased to function as it was originally intended. 

It was a point driven home by ASIC deputy chairman, Peter Kell who earlier this month told a Parliamentary Joint Committee (PJC) that the reality of the current regime was that around a third of Financial Ombudsman Service (FOS) claims against financial planners did not get paid. 

His point was later emphasised by the chairman of ASIC, Greg Medcraft, who suggested that admitted that there were limitations to the effectiveness of professional indemnity insurance when it came to ensuring investors were compensated for bad advice.  

“PI is at its weakest when it is most needed - that is, when you have multiple claims coming through at a single point in time,” he said. 

It was in these circumstances that while ASIC acknowledged that there existed problems with respect to conflicts of interest inherent in the vertical integration which has occurred under the umbrella of the major financial institutions, this was offset by the capacity of those institutions to compensate clients impacted by the provision of poor advice. 

As Kell pointed out to the PJC, from the number of the unpaid disputes at FOS involving financial planners, “none of them involve vertically integrated companies, because they [the vertically integrated companies] have the money behind them to ultimately pay if something goes wrong”. 

The facts of the matter are that before financial planning companies were compulsorily required to hold PI insurance, there existed security bonds. Some of those bonds still exist and it is axiomatic of the challenges facing the industry that claims have been mounted to gain access to that money. 

The problem for both ASIC and those making claims against the still existing security bonds is that most amount to little more than $20,000 and, as Kell told the PJC, “trying to establish and work through who might have what sort of claim against what at the end of the day is a limited amount of money is a far from straightforward exercise, which is one of the reasons there has been a move away from such bonds as a compensation device”.  

All of which points to the fact that the regulator is pushing for a move away from bond security bonds and PI and towards a larger, last resort compensation scheme. 

It is something that ASIC has argued for in its submission to the Financial System Inquiry in which it argues that such an arrangement could stand beside the continuation of PI arrangements and more onerous requirements being imposed on financial planning firms and individual advisers. 

Discussing the implemention of a last resort compensation scheme, the ASIC submission described it as something which would be accessed “only to provide compensation where all other options have been truly exhausted”. 

“We support consideration of the introduction of a limited last resort statutory compensation scheme as part of a suite of measures to improve standards in the financial advice industry,” it said. 

It listed those measures as being: 

(a) improve competency and standards among financial advisers;  

(b) address conflicts of interest; and  

(c) increase access to safe and appropriate financial advice. 

With ASIC urging for at least some change and with a number of influential members of the Government arguing for a new regime in the wake of the issues which have confronted some smaller advice firms, advisers and dealer groups should brace for a set of new requirements.