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BD/IA Risk Review – June 2020

Risk & Analytics
Insurer Solutions

By Brian Cavanaugh , Jack Jennings and Jeremy Sokop | June 2, 2020

Risk and insurance considerations and approaches

COVID-19 and claims frequency

Huge thanks and appreciation to Lilian Morvay’s IBDC/RIAC Alliance for allowing us to participate with the Bates Group on May 12 in the panel discussion: Risk Management in the Time of COVID. Lilian does such a great job supporting our clients and prospects; we are truly thankful for her partnership.

On the call, we discussed various risk management techniques during COVID, including rep communication, cyber risk management, product mix exposure and various insurance-related issues. Joining Lilian was a host of experts, including Judith Knudsen of Avantax Wealth Management, Bob Reidy of Bates Group, Brian Nally of Reminger, David Baugh of Kaufman Dolowich and myself representing Willis Towers Watson.

On my portion of the call, we discussed how FINRA arbitrations are up 14% over 2019 as of March. That number is now at 12% as of April (FINRA Data). We also discussed the case frequency through the 2008 financial crisis where new filings jumped from 3,238 in 2007 to 7,137 in 2009 (a 120.41% increase). We then discussed the hypothetical impact to policyholders in 2020 – 2021, if that frequency held true for the current crisis. We asked policyholders to think about how their firms would fare with such an increase in frequency below their retentions. Specifically, we touched on the impact to net capital. We discussed all of this against the backdrop of the current insurance market where rates are rising at historic levels.

When faced with substantial premium increases, the first instinct might be to increase your policy retention to offset the premium increase and stabilize the cost to your reps and firm. For 2020 – 2021 we are asking clients and prospects to consider the alternative. That is, decreasing or maintaining their current retention levels as much as possible.

Unfortunately, underwriters are pushing 10% – 20% across their BD/IA E&O books this year, which may exaggerate the premium impact associated with decreasing or maintaining your retention levels. Notwithstanding, we think it makes perfect sense to follow this strategy.

One way to think about it is this: if your anticipated losses over the next 12 months will exceed 10% – 20% from a frequency standpoint, and considering FINRA case activity through the financial crisis represented an increase of 120% — a very real scenario, then it makes perfect sense to not only renew with the same carrier for this renewal cycle (where claims may already have been noticed), but to also capture that frequency activity by decreasing or maintaining your retentions.

Preservation of the existing self-insured retention may also be an asset to combat more severe price increase in 2021.

Consider a scenario where you change carriers in 2020 and increase your E&O policy retention. Academically, the immediate premium benefit would be two-fold, a non-incumbent competing for your business and the increase in retention level creating a large price efficiency, right? But by how much? Say your average loss history for the prior 12 months is $250K (within the retention) and $250K in above the retention across five unrelated claims at $100K each. Your expiring program structure carries a $50K SIR (per claim/per rep) for $1M total premium with insurance carrier X (we will omit policy limits for sake of simplicity). You renew with insurance carrier Y with a $150K SIR (per claim/per rep) for $800K premium. If you were to renew with Y, in an average year, you are now incurring $500K in claims within the retention while saving $200K in premium, a net negative (again, only in an average loss year). Now imagine if your loss frequency were not five claims, but 11 totaling $1.1M all within the SIR — and that’s not to mention any increase in severity (the pure dollar amount of the claims). If you had stayed with carrier X your premium may have gone up to $1.2M but, assuming you maintained your retention levels at a frequency of 11 unrelated claims of $100k each, you would have incurred only $550K beneath the SIR paying $200K more in premium. That’s $150K better off (the difference between $750K and $900K — $1.1M minus the $200K cost savings) with carrier X than carrier Y.

In reality, the premium benefit may be even less by switching to carrier Y and the loss history more varied. We offer this hypothetical only for the sake of advising firms to carefully consider significant retention adjustments especially moves over the next 12-months. We always recommend working with a qualified insurance professional in the placement of your program, and risk retention appetite should also be carefully considered in all cases.

Coverage for packaged retail/institutional investment products

In last month’s newsletter, we discussed steps to confirming E&O coverage for ETN products. We discussed how, even though the products may fall within the general definition of “securities,” they may still be excluded absent express wording otherwise. The reason these products may be excluded is that they can sometimes include a structured or derivative component (or both in some cases), therefore triggering certain exclusions. Underwriter perspectives may also differ with respect to how coverage may and may not apply complicating the issue. We then discussed the application of the structured products and derivatives exclusions and how they may not be readily identifiable.

A more general discussion may also be warranted with respect to other packaged retail/institutional investment products in your portfolio. Generally, BDs and RIAs should always confirm coverage with their insurance brokers before selling packaged products. We will avoid providing specific examples here out of concern for our clients and prospects; however, since we have already discussed ETNs, let’s use them as an example.

Generally, the definition of “security” in BD/RIA policies tracks with the definition of “security” in the 33’, 34’ and 40’ Acts and may include exempli gratia, such as “stocks, bonds, mutual funds, annuities, variable annuities and etc.” The word “securities” is typically included in the definition of “professional services” which is, in turn, included in the definition of wrongful act (the “claim” trigger under the policy). The definition of “security” seems straightforward, right? After all, it is right there in the Securities Regulations. Well, not so fast. Take ETNs for example, which may be publicly traded and highly liquid “securities.” These securities would be excluded because of the exclusionary language of most policies just as we discussed in April. Further, the underwriting markets are seemingly at odds as to which exclusion might apply and whether they are even “securities” to begin with. The argument seems to be that ETNs, and certain of their components, involve the use of strategies rather than the sale of a “security.”

You may be asking, well, what about my other packaged retail/institutional investment products? Do I need to conduct diligence on every investment my firm is selling? The answer is unequivocally “yes,” but rest assured, the process should be much easier than it sounds. Begin by submitting a list of approved products to your insurance broker asking them to compare this with the prior year. Take the time to discuss with them and educate them on new products year over year. This applies especially to any products that have become problematic or given rise to one or more investor complaints. The result will likely be that you, your firm and your insurance contract are no worse off than the prior year, and furthermore, you will have the additional peace of mind you expect from your insurance products.

As we discussed above, and in this volatile market more than ever, our recommendation is to invest the time with your broker to conduct a diligent, product-by-product review, to confirm coverage if so desired. Communication is key, not only with the insurance brokers, but also with the underwriters. We encourage and advocate for full transparency, not only in the renewal process but in all communications with our partners.

Buying separate coverage for specific IARs

Some RIAs may be asking: “What do I do when approached by my investment advisor representative about purchasing his/her own policy?” Firms may also be asking: “Is it altogether appropriate for my IAR to purchase their own policy? If so, how should I be thinking about the placement process?” Select considerations in these scenarios may include:

  1. What risk exposures does my IAR have that differ from my RIA?
  2. How do the economics of a separate program make sense considering those risk exposures?
  3. How do the risk exposures of my IAR present a disproportionate cost sharing allocation with the rest of the organization?

When working through the above questions, you might want to consider things such as loss history (for the individual IAR(s)), product and service mix — which may differ from the rest of the firm, prior regulatory actions or disclosures by the IAR, litigation history, potential for lift-out claims, does the individual perform third-party advisory services (perhaps under their own RIA) and the individual’s prior employment history. All can have bearing on the ability to obtain separate terms. Some factors may be negative, but others likely positive. Perhaps the IAR is an exemplary risk and simply wants to engage third-party clients? You may want to consider the impact to your existing E&O program for bringing on a new cross-section of clientele.

Firms will also want to think about their own D&O and E&O policies when implementing an IAR-specific program. Surely the IAR and the RIA are aligned in placing their insurance through the same insurance broker to simplify communication and coordination; however, firms should also consider:

  1. A seamless integration of the IAR and RIA terms and conditions
  2. Coordination of the “other insurance” provisions of each policy to designate which program will sit excess and which program will sit primary (perhaps neither)
  3. Pricing efficiencies for the RIA program generated as a result of the separate IAR program purchase
  4. Secure co-defendant language on the IAR policy to cover the RIA
  5. Ensure the IAR is covered through their own policy (does the IAR meet the definition of an “insured” under their own policy?)

You may also want to consider purchasing the IAR program through the same carrier matching all available sub-limits and coverages. Tailoring two professional liability programs together to ensure a seamless transfer of risk is no easy task. You may also want to consult outside coverage counsel regarding the validation of the IAR program terms and conditions.

In closing, when amending your program or altering your risk-transfer framework, you will want to ensure the process is totally seamless and you are left better off than when the process started. This approach may not be appropriate for all IARs and the outcome of every placement will likely be different depending upon things like loss history, coverages afforded, differences in AUM, among other variables.

Is my administrative assistant covered?

We have received a few questions around coverage for registered and unregistered representative assistants. First, we appreciate your inquiries and value your partnership greatly. As you might expect, the answers regarding coverage for registered and unregistered assistants depends greatly on the policy language and what you have negotiated with your underwriter.

In some policies we have reviewed, limited coverage is extended for registered and unregistered assistants alike; however, in those policies, coverage for unregistered persons is limited to the activities performed by registered persons. Those activities are generally within the “professional services” definition of the policy. But how could an unregistered assistant qualify for coverage if, pursuant to the policy language, they need to be performing activities as registered persons? We too are confused by the wording of these policies. Additionally, some policies require that the “registered representatives” be performing certain “professional services” in the course of committing a “wrongful act” to trigger coverage (defined terms indicated in quotes). It is not clear that unregistered persons would even satisfy the definition of “registered representative,” or that they had ever been performing a “professional service” (which as we discussed before may be limited to registered persons only) in their commission of a wrongful act. Therefore, coverage may be barred or even illusory before a superficial examination of the exclusions is appropriate.

Key considerations in confirming coverage for unregistered assistants may include an examination of:

  • How does my policy define an “insured”?
  • How are my administrative assistants compensated, and does that have bearing on their qualification of coverage?
  • What activities are my administrative assistants performing; is that consistent with the definition of professional services in my policy?
  • Does the definition of wrongful act preclude coverage for administrative duties of reps, IARs and their assistants?
  • Is the definition of “insured entity” is broad enough to cover RIAs and the administrative assistants of IARs under that safe harbor?

Even in the case of Series 11 Assistant Representatives, the issue may not be clear cut. According to FINRA, assistant representatives are prohibited from performing any of the following:

  1. Dually registering as a representative or principal
  2. Rendering investment advice or opinion
  3. Making recommendations
  4. Making transactions in securities markets on behalf of the firm
  5. Accepting or opening new accounts
  6. Prequalifying potential customers

The issue is that all the above activities are typically included in the definition of professional services, back to the issue we discussed above for unregistered assistants. If an assistant representative is performing any of these activities (which would appear to be covered) in violation of the FINRA rules, would that trigger the conduct exclusion and therefore bar coverage? Perhaps it would, which is why it is advisable to confirm coverage in writing with your broker and underwriter for all professional services (client-focused and administrative alike).

It is also advisable to keep a clear and transparent line of communication with your insurance brokers regarding the scope of services performed to ensure that they are not only covered, but not a surprise to the underwriters if a claim issue arises.

Premium rates rise – Strategies and techniques

For insurance buyers, 2020 is shaping up to be a tough year. As discussed above, E&O underwriters are routinely pushing rate increases of 10% to 20%. That’s not to mention the increases in SIR we are seeing with respect to general categories of such coverage as alternatives. Whether you’re a client or prospect, we’re here to support you. If you’re dealing with a difficult coverage issue, let us know. We are available to talk it through and perhaps we may have a solution.

Below, we discuss some techniques and strategies for mitigating premium increases and obtaining a more favorable renewal outcome. Some of these may seem intuitive, but in the current insurance and economic climate they certainly warrant revisiting. We offer these in honor of your continued partnership which we value greatly:

  1. 01

    Begin the renewal process early

    Begin the dialogue with your insurance broker early in the cycle. If you can host an underwriting meeting with your incumbent insurer, this is most certainly the year to do it. It may also make sense to hold underwriting meeting with non-incumbent markets as well.

  2. 02


    It is imperative to be fully transparent with your broking and underwriting partners. From product mix to loss history, it is generally best to err on the side of disclosure. Underwriters will want to hear about the focus on oversight, controls and procedures in a dislocated work environment. How are you keeping tabs on your reps? Have your hiring processes changed? Are you mandating the use of company-approved software for all client and prospect communication? These are things the underwriters will want to work through and discuss.

  3. 03

    Consider alternative options

    As we advised above, our recommendation is to decrease or maintain your current retention levels. When considering alternatives, you may want to think about cutting capacity with your primary insurer and building excess program to reduce your rates online and preserve the same overall limit structure. Another option is to consolidate your carrier relationship to help offset premium increases.

  4. 04

    Silo’ing problem areas of the portfolio

    Are certain products within the portfolio causing loss frequency issues? Perhaps you might consider purchasing a separate insurance policy for those specific products or taking a co-insurance arrangement for those products.

  5. 05

    Retention Adjustments

    We do not recommend upward retention adjustments this year. However, we recognize there may be no other option in some cases. As mentioned in the April Newsletter, you may want to consider the use of a captive to supplement your existing program.

These are just a few of the potential approaches you can take, and, of course every risk is unique requiring its own analysis and tailoring of the policy. We hope these suggestions are helpful to you and your firms and thank you for your time in considering them.


Each applicable policy of insurance must be reviewed to determine the extent, if any, of coverage for COVID-19. Coverage may vary depending on the jurisdiction and circumstances. For global client programs it is critical to consider all local operations and how policies may or may not include COVID-19 coverage. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal and/or other professional advisors. Some of the information in this publication may be compiled by third party sources we consider to be reliable, however we do not guarantee and are not responsible for the accuracy of such information. We assume no duty in contract, tort, or otherwise in connection with this publication and expressly disclaim, to the fullest extent permitted by law, any liability in connection with this publication. Willis Towers Watson offers insurance-related services through its appropriately licensed entities in each jurisdiction in which it operates. COVID-19 is a rapidly evolving situation and changes are occurring frequently. Willis Towers Watson does not undertake to update the information included herein after the date of publication. Accordingly, readers should be aware that certain content may have changed since the date of this publication. Please reach out to the author or your Willis Towers Watson contact for more information.

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