Professional indemnity insurance (PII) providers are starting to ask specific questions about the agreements advisers have in place with discretionary fund managers.
They are also asking whether these tie in with the agreements advisers have with their clients.
Before renewing your PI cover, it’s essential you fully understand the agreements you have in place, and are confident that you have mitigated any unnecessary risks.
One issue causing some concern among PI providers relates to the Agent as Client (AAC) arrangement.
If you're relying on agreements with investment managers that haven't been reviewed recently, it's worth taking the time to review these.
Otherwise, you may find yourself facing a significant hike in PI premiums or, in the worst case scenarios, not being able to renew them at all.
From conversations I’ve had with advisers, it’s clear many are operating under agreements that were drawn up years ago, and many of those agreements are based on AAC.
If you're an adviser without discretionary permissions, and you have an advisory agreement with your client, it’s highly likely an AAC agreement is unsuitable for you.
When reviewing agreements, the following questions are useful to work through:
AAC agreements between the adviser and discretionary fund manager (DFM)
- How aware are you that you are acting as the client, rather than for the client?
- How aware is the DFM that acting as the client is what you have prepared for?
- How has this awareness been established?
- How aware are you that acting as the client means the DFM can treat you as a professional investor?
- Do you have a good understanding of what you are required to do when acting as the client and the potential consequences if you get it wrong?
AAC agreements between the adviser and clients
- Do you have the appropriate authority from your clients to appoint a DFM?
- Have you made the necessary changes to your client agreements that allows your client to give you this authority?
- Have you explained to clients they will not be a client of the DFM?
- Have you explained the implications of this to your clients?
- Have you outlined the appropriate complaints procedure by explaining to clients that, under AAC, they are prevented from accessing the Financial Ombudsman Service (FOS) standard compensation scheme and what their options are instead?
- Is this clearly documented in your client agreement?
It's worth stressing here advisers who have signed an Agent as Client agreement are exposed to any complaints from their clients about their investments, and this may extend way into the future.
The DFM is only accountable to you, the adviser, who as a professional client should be aware of what investments are being made and the subsequent risks attached to them.
Diminimis is an independent consultancy that aims to minimise regulatory and contractual risk for advice firms when using DFMs.
Founding director David Gurr says: “If you don’t have discretionary permissions and you operate with DFMs under Agent as Client agreements, there is a strong chance that you and your firm are at serious risk of being hit with compensation claims should something happen to make your clients question the investments in their model portfolio.
“When it comes to PII to cover the cost of compensation claims, it’s essential to consider the proposal form very carefully to make sure you provide accurate and complete answers and disclose everything that's relevant to the insurer."
He adds: "This is especially important at renewal, as this is when insurers reassess the risk and set premiums in line with the risk they are agreeing to cover.
"Insurance coverage disputes frequently arise due to failure by advisers to disclose issues accurately and fully to insurers at the outset.
“Unless you fully understand the agreements you have in place, it is possible you will misrepresent the position to your insurers and could be left exposed should a claim be brought against you by a client.”
There is an alternative arrangement known as Reliance on Others.
Under this kind of agreement, the adviser remains responsible for establishing whether the DFM mandate is suitable for the client, but responsibility for the actual investment management lies with the DFM.
Reliance on Others also means clients can bring a FOS case against the DFM directly.
Reading it and acting on its recommendations will give you the peace of mind that your PI cover is fit for purpose.