confusion / claude nakagawa

Inflation, more claims against advisors and higher legal costs have pushed up errors and omissions (E&O) insurance rates for financial advisors. The Canadian Securities Administrators’ (CSA) proposal for binding dispute resolution could, if implemented, also increase rates.

Last year, E&O insurance rates increased by 10%–20% on average, said Joanna Reid, senior vice-president and national financial and professional lines affinity leader with Marsh Canada Ltd. in Toronto. Premiums for E&O programs with few claims rose by 2.5%–5% just from inflation, but premiums for riskier pools rose by up to 22%, she said.

Premiums for Marsh’s E&O program range from $500 to $1,240 a year before add-ons for policies beginning between July 2023 and July 2024.

Advisors are costly to insure. For example, provincial regulators in B.C., Saskatchewan and Ontario require life insurance agents to hold E&O coverage of at least $1 million per claim. Thus, if an insurer covers a program with 1,000 advisors, it’s providing $1 billion in coverage, Reid said.

To calculate E&O insurance premiums, insurers consider factors such as the licences held by the advisor, the policy limit, the complexity of products sold, frequency and severity of claims against other advisors in the program pool, and legal fees. Advisors who sell only basic products have a lower likelihood of complaints, but more complex products present a higher chance of complaints with increased severity, said Reid Irwin, senior vice-president and executive risk and financial institutions practice leader with Chicago-based Hub International Ltd. in Toronto.

Clients are more likely to lodge complaints against advisors during a market downturn even if the complaints are baseless. The increased likelihood of a complaint drives up premiums, Reid said.

And claims have become more expensive to defend as the hourly rates for lawyers and legal associates have gone up. “I had one carrier tell me that in the last 10 years, the cost to manage a claim has gone up three times,” Irwin said. “The biggest [reason] that stares you in the face is just legal fees.”

One factor that could hike E&O insurance rates is the CSA’s proposal to make investment-related disputes binding. The proposed framework would designate the Ombudsman for Banking Services and Investments as the binding dispute resolution service for complaints up to $350,000.

Most E&O insurance policies will pay out only if the advisor is found legally liable in a case. As the CSA’s proposal also would make binding resolutions enforceable by courts, it may increase the number of claims lodged against advisors, resulting in higher E&O insurance premiums, Reid said.

Advisors can purchase E&O insurance through their dealers, professional associations and provincial regulators. Given the complexity of claims management, only a handful of underwriters offer E&O insurance for financial advisors. The number of advisors that Hub and Marsh underwrites in Canada are each in the five figures.

“It’s not an area that insurers can just dip their toe in. You have to be in for a penny, in for a pound,” Irwin said.

Although advisors usually can choose which E&O program to use, firms are easier to underwrite as they have compliance departments, Irwin said. Insurers can interview compliance teams to evaluate their complaint escalation process, compliance safeguards and technology.

Firms with clear processes to fix issues and address complaints quickly are likely to have lower premiums. Advisors should know how to use the technology their firms provide to prevent non-compliant behaviour. “We’ve seen losses where people say, ‘I never got training,’ but the dealer says, ‘Here was the training session. You missed it,’” Irwin said.

To mitigate rising premiums, insurance brokers encourage advisors to keep meticulous records and sell only products they understand.

Advisors should keep records of conversations, Reid said, including the client’s rationale for investment decisions. This protects advisors when clients refuse to follow investment recommendations and complain later about losses.

A well-documented file helps protect and defend them, Reid said, and advisors “should see the benefit in their insurance premium.”

And as investment options grow more complex, advisors should sell only products they understand. Reid has seen an uptick in the past two years of cases where a single advisor received multiple complaints about one product. “It’s not inconceivable to think you could have 50 complaints lodged against you at the same time,” she said.

E&O premiums should stabilize in 2024 barring a market downturn, Reid said. “But if there’s a shift, with respect to market conditions and interest rates, we’re probably going to see another influx in losses.”

This article appears in the March issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.