Wealth managers, as much as any other form of professional, need to be aware of the issues surrounding professional indemnity insurance. This article explores the outlines of this important topic.

Practitioners working in the wealth management industry in countries such as the UK need to be aware of the issue of professional indemnity insurance. In this article Simon Hogg, an insurance broker of Tysers, the insurance and reinsurance firm, and Dennis Govan, co-founder of Private Captive Insurance, discuss the issues. The editors are pleased to share these views with readers; as ever, the views expressed are not necessarily shared in full by the editors of this news service, and readers are invited to respond.

Professional indemnity insurance, or PII, provides financial protection to businesses by protecting against claims of negligence in the performance of that business’s services. It can essentially be viewed as the product liability insurance of the service sector. In today’s ever more litigious society and with cross-border activities becoming commonplace, PII provides invaluable balance sheet protection.

Types of PII
There are two main types of PII insurance: civil liability and negligence insurance. Civil liability insurance is intended to cover any non-criminal claims lodged against businesses on account of its services; negligence insurance states that such claim must be based on a negligent error or omission on the part of the business.

In the world of trusteeship and managed assets, the services provided by industry professionals are often personal and involve sensitive and high-value assets. Therefore potential liabilities can be enormous.

What’s normally covered?
A typical policy will provide indemnity to the insured against loss arising from any claim or claims for breach of duty which may be made and reported to the insurers during the policy period by reason of any neglect, error or omissions committed in the conduct of the insured's professional business.

The type of coverage varies widely between the professions. Exposures also vary between global, national, and local firms. Specific policies do, however, exist for the legal and accounting professions and for financial institutions.

The actual scope of coverage is very difficult to define as each industry has its own set of issues and coverage, however the main areas of cover are:

- Negligence: or breach of duty of care to your client;
- Intellectual property: unintentionally infringing on others’ copyrights, trademarks, broadcasting rights, or any act of passing off;
- Loss of documents/data: damaged, lost or stolen data and documents belonging to your clients;
- Dishonesty: liability arising from the theft of your clients’ money;
- Defamation: libel or slander, lowering a client in the public’s estimation;
- Breach of confidentiality;
- Breach of warranty of authority.

You may even be sued by a client who is merely dissatisfied, but has no valid claim, leading to substantial legal costs and time away from contracts.

What can the policy be extended to cover?
PII policies are flexible and are often negotiated on a case-by-case basis. To this end there are other aspects of exposure that can be at least partially covered by the policy which include:

- Mitigation costs, where no claim has yet been made but the insured is aware of the problem;
- Data Protection Act liability;
- Outside directorship liability;
- Breach of statutory or fiduciary duty and breach of contract or regulatory rules.

What’s not covered?
Certain risks are generally not covered under a PII policy either because they would be against the public interest or more commonly because they are better covered under other forms of insurance such as employer’s liability insurance.  

The main areas excluded are:

- The insured's lost profit or opportunity;
- In-house costs incurred in defending a claim;
- Injury to an employee – which should fall under employers’ liability insurance;
- Death, bodily injury or property damage unless arising from negligent design, advice specification – these should fall under public liability insurance.

Claims-made basis
PII insurance generally operates on a "claims-made" basis. This provides cover for claims made (and reported to the insurer) during the period of insurance only. In contrast, other liability covers normally provide indemnity for “losses occurring during the policy period". This is not the same in all jurisdictions. For example, in Europe PII has historically been written on a "losses-occurring" basis, but the trend worldwide is towards claims made. It is almost impossible to obtain anything else in the UK.

A claim is generally notifiable under a PII policy (a notification) when the insured first becomes aware of circumstances that could lead to a claim. The interpretation of when this situation occurs is the source of frequent policy disputes between the insurer and insured. It is essential that there is a robust internal process for reporting all indications of a potential claim and most good insurance intermediaries can assist with the creation of an effective claims reporting and management protocol.

There is often a lot of confusion as to how a change of insurer at renewal may affect a claims-made policy. While in theory there should be no issues, it is important that certain key policy covers are maintained and also that any continuity dates are maintained.

The continuity dates refer to any date in the past stipulated in the policy as being a cut-off date where any acts committed before such date (a retroactive date) or outstanding litigation as at that date (a prior and pending litigation date) is not covered. In the UK the laws regarding the disclosure of information to insurers are both difficult to interpret and generally in favour of the insurance company.

To this end, unless the contract is being conducted and concluded under an alternative legal framework it is imperative with a claims-made policy to ensure that there is full and transparent disclosure. This is particularly important prior to a policy renewal, as a change of insurers may occur which could subsequently result in a potential non-disclose of a notifiable event.

Limit of indemnity
Cover can be offered on an annual aggregate limit for all claims (but often comes with reinstatements), or it can be applicable to each and every claim or any one claim without aggregate limit. Where the limit is not aggregated, careful attention needs to be paid to the definition of a "claim". For example, a series of linked claims is normally deemed to be one claim for policy purposes.

Excess
This is also referred to as “the deductible”, and is the first amount of every claim that is uninsured. It generally applies to each and every claim, but it can occasionally be aggregated.

It is important to consider very carefully what excess levels are appropriate. While a low excess allows for almost full risk transfer, there is generally a cost attached to this and it also means that even for very small issues, a third-party insurance company has the right to take control of the claim.

Conversely, while higher excess amounts generally equate to lower premiums, accurate assessment of the business’s cash position is essential so that in a worst case scenario, the business has adequate cash at bank to avoid other funding. Most insurers/intermediaries will assist in providing comparative excess scenarios.

What is the correct level of cover?
The key question is always: “How much PI insurance do I need?” There is no industry formula or magic rule to answer this. Many businesses rely on the levels offered by their advisors, or small scale peer reviews. Neither is really adequate. Each firm will have its own dynamics and market risks.

A client base which is largely domiciled in areas of high litigiousness may warrant higher limits and while it is unlikely that the limits are either available or affordable to cover the largest asset exposure to any one client, taking an average across all managed/advised assets and then ascertaining where the main risks of error lie and how this relates to those asset values is a good starting point.

Past claims and complaints may also be a valid criterion, as will the contractual limitations used by the business. There is no set answer to the limit question, but there are lots of questions to be asked and talking this through with your intermediary or legal advisor is essential.

Why can’t we disclose our PII?
The existence of a firm’s PII insurance is a key factor in not only its own internal risk management and risk transfer policy, but is also a key part of general consumer protection, where the responsibility for financial indemnification to aggrieved clients is passed away from the trust sector into the insurance sector, which is much more capable to deal with this financial responsibility.

Communicating the existence of a PI policy is therefore a key part of any firm’s marketing strategy. Indeed firms have amended their "limitation of liability" clauses to "insurance-backed guarantees" as a marketing tool.

Most good insurance brokers will also create certificates for their clients detailing the level and scope of cover without revealing other more sensitive information (for instance the premium paid). Any insurance policy that precludes an insured from disclosing the existence of an insurance policy is rather antiquated and is not acceptable in today’s market environment.

Box out – an alternative way of managing the risks
The use of a captive insurance company can result in a potential reduction in overall insurance costs, improved risk management, efficient administration and potential tax benefits in some cases. Captives, through direct access to the reinsurance market, allow the owner to save on brokerage and effectively share in the underwriting profit on its own insurance.

The reinsurance market can also offer additional capacity and a willingness to insure more difficult risks. The captive may also reduce insurance premiums by charging a premium reflecting its owner’s individual claims history as opposed to the generic market.

There are, however, regulatory challenges and operating cost disadvantages of running your own captive and therefore they have typically been the reserve of major corporations. An alternative structure offering very similar benefits but at a substantially lower cost is to use a protected cell company (PCC). A PCC is a company consisting of a core and an indefinite number of cell entities owned by the individual insured parties, which are completely legally separate from each other.

Each cell has its own dedicated assets and liabilities, and the assets of an individual cell cannot be used to meet the liabilities of any other cell. The same cell can be used for several categories of insurance, including PII, and therefore “bundling” can significantly ease the burden of administration and benefit from the PCC core’s overall market pricing.