Beware the pitfalls of Claims Made and Notified Professional Indemnity Insurance for Financial Planners:



Given the recent discussion surrounding professional indemnity insurance for financial planners, it is worth providing a practical example of how to ensure your PI works for you.

This is a hypothetical example, however one which may not be uncommon given the increase in claims and litigation in the Financial Planning industry over recent years.

Andrew, a typical financial advisor, was opening his daily mail when one letter caused him to stop. It was from lawyers acting for one of his former clients, Brendan Smith.

Brendan had taken advantage of the non-concessional super contribution rule leading up to 30 June 2007. Brendan had invested $1million into his SMSF and on Andrew’s advice at the time had invested the $1m across a range of equity managed funds, mortgage funds and high yield fixed interest securities. Timing can be everything in this world and Brendan’s timing could not have been worse. Over the next 12 months he lost over 40% of the value of his investment due to the unforseen impact of the GFC. Dissatisfied with his SMSF investment performance, Brendan sacked Andrew as his adviser, sold down his portfolio to cash and blamed Andrew for the losses.

When Andrew and Brendan severed their ties as adviser/client, Brendan demanded that Andrew reimburse his fees and make good on his losses or he will sue. Andrew made a detailed file note of the discussion and thought he would wait to see if Brendan took any further action; however Andrew didn’t hear from Brendan again and thought that Brendan must have decided against any action. After reading the letter from Brendan’s Lawyers, Andrew now sees that Brendan is alleging negligence and is seeking $400,000 in damages.

Andrew immediately pulls out his current Professional Indemnity Insurance policy. 18 months ago, Andrew had changed his PI insurer as the price from his previous insurer had skyrocketed even though Andrew had never made a claim.

As Andrew read through his current policy, his eyes immediately locked onto a section headed “Notice to the Insured”, which included the following:

    This policy provides cover on a claims made and notified basis.
  1. A claim must be made against the insured during the period of insurance.
  2. The insured must notify the insurer in writing of such claim during the period of insurance.

Andrew reads this and thinks to himself; “a claim has been made, I will notify the insurer, I have insurance, I am covered”. While completing the insurers claim form Andrew reads the question “State the date you first became aware of the possibility that a claim might be made.” Contentiously, Andrew writes down the date he made the file note about Brendan’s fee reimbursement and make good demand and attaches the file note to the claim form.

To Andrew’s shock and disbelief, his PI Insurer tells him his claim is declined … because he failed to disclose Brendan’s earlier demand when he applied for the new policy, even though no formal proceedings were initiated. Andrew was not conversant with the nuances claims made and notified policies and had failed to notify his new insurer of a “circumstance which may lead to the claim”.

Andrew’s next step was contact his old insurer, as Brendan’s reimbursement and make good demand was made when that policy was in force.  However, the terms of that policy are similar to the current one, requiring Andrew to give notice to the insurer during the period of insurance of a circumstance which may lead to the claim. As he didn’t notify his insurer during the period of insurance, Andrew is left to defend this claim on his own and could be facing significant legal bills and possible damages that can threaten the survival of his business and his personal assets..

Whilst this situation is hypothetical the complexity of “claims made” insurance policies, (such as Professional Indemnity Insurance) make this scenario a possible reality for many Financial Planning professionals. Unlike traditional policies, such as building or motor vehicle insurance, which are on an “occurrence” basis, Professional Indemnity Insurance covers claims “made” (which typically includes claims notified) during the period of cover.

An insurer offering “claims made” cover will want to be sure all potential claims are identified (and excluded), where possible, before it takes on a risk. Therefore you must identify all potential claims, and give appropriate notice to your insurance company whose policy is in force at that point in time.

If you believe a possible PI claim may be brought against you, no matter how frivolous you may think it to be, or you are in any doubt as to whether a circumstance should be notified to a claims made insurer, seek immediate advice from your specialist broker immediately.

Claims Made Policies in Summary:

Professional Indemnity Insurance is a “claims made” policy of insurance. This means that the policy indemnifies the insured for claims made against them and notified to the insurers during the period of insurance. Importantly a claims made policy does not provide indemnity in relation to:

  • claims made or threatened against the insured prior to the commencement of the period of insurance;
  • claims made against the insured after expiry of the period of insurance even though the facts or circumstances giving rise to the claim may have occurred during the period of insurance;
  • claims arising from facts or circumstances notified under any previous insurance policy;
  • claims arising from facts or circumstances that occurred prior to the retroactive date of the policy;
  • claims arising from facts or circumstances of which the insured first became aware prior to the commencement of the period of insurance, and which the insured knew or ought reasonably to have known had the potential to give rise to a claim under their current policy (unless you have been continuously insured).

It is critical to keep your insurer informed of any potential claims: – Provided you give written notice to your insurers during the period of insurance of any facts or circumstances which you become aware of which have the potential to give rise to a claim against you in the future, the policy will indemnify you notwithstanding that the claim is made against you after the expiry of the period of insurance, subject to the terms of your policy.

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