Financial advisors saw steep increases in both the number and the financial severity, of liability claims paid out by their insurers last year, according to proprietary data collected by Golsan Scruggs, an insurance brokerage firm catering to financial services companies.
Golsan Scruggs, which collected the data from an aggregated pool of 2,042 U.S.-based independent RIA firms with an average AUM of $400 million, found a 213% increase in paid errors and omissions claims against RIAs in 2023. The severity of the claims increased by 85%.
Contributing to the spike: Paid investment suitability or breach of fiduciary duty claims were six times higher in 2023 than the prior year, and paid wire fraud claims jumped four times higher, according to Golsan Scruggs data.
Suitability claims often jump following a market downturn, such as the one investors experienced in 2022, according to the firm’s co-founder and Managing Director Kenneth Golsan. But suitability claims also tend to have higher payouts and accounted for most of last year’s jump in the total value of all claims.
For years the standard in the industry has been that advisor shops with $250 to $300 million in assets under management would buy insurance with about $1 million limit per claim, Golsan said. But that $1 million includes defense costs, and when markets tumble and one client files a successful breach of fiduciary duty claim, other clients follow suit, quickly racking up costs for the RIA.
“You have one case that’s going on, it takes two years to arbitrate, and you’ve now spent $200,000 in defense costs, you only have $800,000 left,” Golsan said. “You can easily, especially in these market turns, pierce that $1 million liability limit.”
Still, the growing number of underwriters and volume of insurance capital flowing to RIAs has kept a lid on premiums RIAs pay for insurance, despite the spike in claims in 2023.
“Pricing has stayed very stable,” said Brian Francetich, shareholder and director of GSRIA with Golsan Scruggs. “One component is the capital that has come in."
Another is how advisor E&O insurance is generally pooled into the broader market of insurance for executive directors and officers. "The public D&O marketplace has really stabilized in 2023, so there was not internal pressure at insurance companies, because they are pooling all of these risks,” Francetich said.
Paid claims stemming from trading errors, regulatory actions or cybersecurity breaches stayed relatively flat in 2023. That clashed with the expectations. The brokerage firm’s 2023 RIA Risk Survey named those as the top three risks that concerned advisors.
Increasingly, RIAs are aware of cybersecurity risks, and between 80% and 90% of Golsan Scruggs clients currently carry insurance to cover it, said Golsan.
However, when a cybersecurity incident involves a financial loss it gets classified as a wire fraud claim under insurance policies, meaning the covered digital breaches likely contributed to the dramatic increase in wire fraud claims seen last year.
“Wire fraud saw a big jump,” said Francetich. “If it starts with a cyber breach, but it leads to a direct loss of dollars that makes it covered from an insurance standpoint under a crime policy and not a cyber policy. It’s usually some kind of a hack of a client account or even an internal email hack. No doubt the risk of cyber is real. But it’s not so much the privacy, the information they are going after. They are going directly after client funds."