Buying errors and omission (E&O) insurance for a registered investment advisory practice is something that has many advisors scratching their heads in confusion. At its base level, E&O insurance covers you for a wrongful act, error omission or breach of fiduciary duty in rendering professional services to a customer or client. But in reality, many factors go into determining which policy is right for your practice. Read on for the answers to some frequently asked questions about E&O insurance.
Why should I buy it?
While there is no regulatory requirement for an advisor to carry E&O insurance, it’s a good idea to have it. Some advisors choose not to buy E&O because they perceive it to be expensive in a cost-benefit analysis. But others prefer to pay for the comfort of knowing they are protected. It also puts clients at ease. “Just like when the plumber comes to your house. You like to know he’s insured,” says David Blain, president and chief investment officer of D.L. Blain & Co. LLC in New Bern, N.C.
How do I buy coverage?
While some insurance companies allow you to buy direct, you’re probably better off working with a reputable broker who knows the ins and outs of the industry and can find you the policy that best suits your needs. To find a reputable broker, ask your custodian or other advisors for references. Industry groups such as the FPA or NAPFA also may be a good source of insurance broker leads.
How much should I buy?
How much you need depends on the type of business and how much you manage. You need to choose a level that allows you to sleep at night. “You’re always better off with a higher deductable and a higher limit. That way, you keep your price down, but you have enough coverage that it won’t put you out of business in the event of a catastrophic loss,” says Andrew Fotopulos, senior vice president in charge of investment industry practice group in the Westwood, Mass., office of Starkweather and Sheply, an insurance brokerage firm.
When looking to buy insurance, consider also what types of services you plan to provide in the coming year, but may not be providing now, says Gary B. Sutherland, chief executive of North American Professional Liability Insurance Agency in Framingham, Mass. “Have a good sense of what that is, because without telling your agent, we might not be providing you with the right coverage,” he says.
Know also that, depending on your practice, other insurance beyond a traditional E&O policy may be advisable.
What factors should I consider in how much to buy?
While there’s no black-and-white answer as to how much is enough, there are certain factors to consider, according to Tom Orrico, managing director of Marsh USA in New York City, whose practice focuses on financial institutions.
For starters, consider your assets under management. Also, consider how much you can absorb from a loss perspective, your historical lawsuit experience and the industry-wide regulatory climate. Market conditions also will come into play because, in a downturn, you should anticipate more claims. Another thing to look at is peer benchmark data provided by your insurance broker to make sure you’re in line with companies of similar size, Orrico says.
Also consider your risk profile—what could go wrong with respect to each product and service you offer, Orrico says. In addition, consider what’s happening in the market with rates and coverage, and determine whether it makes sense to buy more insurance when the cost is lower.
How much does an E&O policy cost?
Cost is based on the amount of assets under management, the type of professional services offered and the types of investments offered. It also varies by carrier. You should expect to pay at least $2,000 a year for $1 million limit of liability for the year—and that’s for the more restrictive policies and smaller RIAs, Fotopulos says. You’ll pay more as your assets and coverage go up.
You also should expect to pay more every year because premiums increase due to the additional years of liability exposure.
Ask your broker about premium-saving opportunities. Certain designations, for example, will lower your premium. Also, when applying for insurance, it’s a good idea to provide documentation to show why you’re a good risk, says Sutherland. Maybe, for example, you’ve been in business for 10 years and never had a claim, or maybe you’re just starting as an RIA, but you’ve been a CPA for 10 years. “We’ve seen a well-drafted letter save $500, so it does make a difference,” Sutherland says.
While shopping around is a good idea, remember that cost alone should not be the deciding factor. Rather, it’s what you’re actually getting for your money.
What acts are covered in an E&O policy?
It depends. Basic coverage is designed to protect the advisor for mistakes while managing money. But every carrier has a list of exclusions.
Make sure the definition of “insured” properly reflects how your organization is structured, says Orrico of Marsh. Also, make sure the definition of “claim” suits your needs, he says.
“Never accept a policy right off the shelf from an insurance company because it’s never going to be broad enough to address all of the exposures faced by a registered investment advisor,” he says.
Some carriers also will tack on additional enhancements for little to no extra charge, so make sure you talk to your broker about what’s available, says Fotopulos of Starkweather and Sheply.
When should I start researching coverage?
You can get a quote early on as you explore independence; if there are no changes by the time you actually start up the business, you can just re-sign and re-date the paperwork. “I get a lot of calls Friday at 4 p.m. saying I just started a business and need E&O insurance by 5 p.m.,” Sutherland says. But without an application, he can’t provide a ballpark quote and may not have time to research multiple carriers. “It just makes things more difficult.”
Can I switch carriers once my policy expires?
Sure. But if you do, make sure the new carrier covers your practice retroactively. “Make sure you have that because if you switch carriers and you don’t transfer the starting date, the old carrier’s not going to cover you,” says Blain of D.L. Blain & Co.
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