PI Limits of Indemnity, how much do you need?

Many new AFSL’s and even existing AFSL’s query how much PI they need. The simple answer is to refer to RG126 – Compensation and insurance arrangements for AFS licensees.

If you provide financial services to retail clients, you must have arrangements for
compensating those clients for breaches of Ch 7 of the Corporations Act 2001 (Corporations Act). The key word here is retail.

Under s912B of the Corporations Act, AFS licensees must have arrangements for
compensating retail clients for losses they suffer as a result of a breach by the licensee or its representatives of their obligations in Ch 7 of the Corporations Act. These arrangements must satisfy the requirements in the CorporationsRegulations, which are that licensees must obtain PI insurance cover that is adequate, considering the nature of the licensee’s business and its potential liability for compensation claims (see reg 7.6.02AAA). The key word here is adequate.

So what is adequate compensation arrangements for retail clients?

At its most basic level an AFSL must have a $2m limit of indemnity for any one claim (plus legal defence costs) if its retail revenue is $2m or less. Once the AFSL’s retail revenue exceeds $2m it must carry a PI limit of indemnity equivalent to its retail revenue. Therefore, if retail revenue is $2.5m then a $2.5m limit is required, if retail revenue is $4m then a $4m limit is required and so on, up to $20m.

Even if you match your PI Indemnity limit to your retail revenue some AFS licensees will require a higher limit of indemnity in order for the insurance cover to be adequate. RG 126 stipulates that Licensees must retain records of how they determined what amount was adequate for them.

Where it can get tricky for licensees is in assessing the adequacy of cover as each Financial Planning business is different.

Factors to consider:
1. Is the level of indemnity adequate to cover claims brought both inside and outside of AFCA?

Note: The regulation prescribes AFCA membership as a key factor in assessing the adequacy of PI insurance arrangements. However, an estimate of claims under AFCA might not always provide an accurate guide to an AFS licensee’s potential liability, as claims could be brought outside AFCA, such as through the courts.

2. Does the policy cover claims made by wholesale clients or claims that fall outside the scope of s912B? If so, this might reduce the amount of cover available for claims that fall within s912B and AFS licensees might need to increase the amount of cover accordingly.

3. Does the business carry a higher risk of claims (e.g. does it give advice on higher risk products) or is it exposed to a higher volume of claims and therefore requires a larger amount of PI insurance cover?

4. The AFSL must determine ‘the maximum liability that has, realistically, some potential to arise’: We suggest you do this by making a reasonable estimate of the following factors:
a) the maximum exposure to a single client (‘worst loss scenario’ per client)
b) the number of claims that could arise from a single event (potential for
multiple claims) and
c) the number of claims that might be expected during the policy period.
These are questions that the Licensee needs to consider when assessing the limit of indemnity, they buy.

In summary an AFSL that has say $3m in revenue made up of $2m in retail revenue and $1m in wholesale revenue could just opt for the minimum $2m limit of indemnity provided that they have taken into consideration some of the points above and still consider $2m an adequate limit of indemnity.

Our experience is that AFSL’s will typically insure up to their total revenue (both retail and wholesale) and above regardless of, whether that revenue is retail or wholesale derived. Retail clients will typically initiate a claim or action primarily through AFCA, however wholesale clients will need to go through the courts which increases the time, complexity legal costs and sometimes the quantum of the claim significantly.

If in doubt seek the advice of your compliance or legal counsel, or your Pi Broker who should have a good understanding of RG 126..

Oscar Martinis
Senior Partner – McDougall Kelly & Martinis
0414 620 324