Hey guys, welcome to the most informative piece on Financial Advisor Insurance.
When you go through the full content of this piece, you will know what Financial Advisor Insurance is all about, the relevant insurance scheme you need to consider, and why you need such insurance.
With that said, we’ll talk about:
Let’s dive right in.
Introduction to Financial Advisor Insurance
If you are thinking of starting your financial advisory firm, there are key things you must consider in the path of practicing as a registered investment advisor or a broker-dealer.
Financial advisor insurance is on top of the list.
And so, we’ve dedicated today’s article to help you understand why you need insurance and which ones do you need.
An Overview of What Financial Advisors Do
Financial advisors offer a wide range of services, including retirement planning, estate planning, and financial advice.
They also analyze clients’ needs to develop comprehensive financial plans to help them reach their financial goals.
The needs assessment also helps advisors come up with financial products that would best take care of clients’ long-term goals, be it long-term care after retirement, children’s education, or even owning a home.
When working for brokerage firms, advisors examine their clients’ insurance needs before recommending insurance products that best suit their needs.
They also buy and sell mutual funds, annuities, stocks, and bonds.
Financial Advisor Regulatory Authority (FINRA) only allows licensed financial advisors to sell and buy securities.
Advisors are also at the forefront of making informed financial decisions on behalf of the client for maximum return on investment.
Additionally, financial advisors who are certified financial planners (CFP) offer comprehensive wealth management and financial planning services.
They usually work hand in hand with investors to develop watertight investment strategies.
Another important aspect of financial advisors’ work is the mode of payment.
Registered representatives are often paid in commission depending on the securities they sell.
Registered Investment Advisors (IAR), CFPs, and other specialists in the financial advice industry are fee-only advisors.
As such, they are held to fiduciary standards.
As fiduciaries, they are required by law to put their clients’ interests before their own.
Instead of capitalizing on investment strategies with the most return on investment, the goal is to offer advice and strategies that focus on what’s best for the client.
Holding advisors to fiduciary standards minimizes the cases of conflicts of interest.
With the not so brief overview of a financial advisor’s job, let’s now discuss the various insurance policies that financial advisors should have to practice.
Professional Liability Insurance
Professional liability insurance is also known as errors and omissions (E&O) insurance.
This insurance policy is for lawyers, financial advisors, insurance dealers, accountants, registered investment advisors (RIA), and financial planners, among other professionals who may receive lawsuits due to negligence, misinterpretation, or malpractice.
Since these claims are not covered by general liability insurance, E&O insurance is the best protection.
Professional liability insurance is not mandatory for all financial advisors, but it’s recommended.
Some company investors may require an advisory firm to have it.
Furthermore, Financial Advisor Regulatory Authority (FINRA) requires that financial service firms have professional liability insurance.
An advisor will never know how crucial it is until they face a lawsuit that could potentially throw the business under.
Having professional liability insurance helps a financial planner cover the legal expenses that stem from work performance.
Occasionally, a client may lose money because of the fluctuations in the financial market.
At times, financial advisors may make mistakes in the financial plans or simply forget to inform a client about the 60 days waiting period for 401 (k) rollover.
At other times, clients are just not happy with the services they receive.
There might also be situations where advisors breach their fiduciary duty or fail to comply with regulations.
Whichever the situation, a financial professional is most likely to get a lawsuit when they least expect it.
With professional liability insurance, a financial advisor can rest easy knowing they are covered whether or not they are responsible for the negligence.
E&O insurance license often covers financial professionals up to a particular amount usually specified on the insurance policy.
The insurance license also takes care of the legal cost associated with a claim.
Since the same insurance product from different insurance companies may have different terms, it’s crucial that an advisor consults widely before taking E&O insurance.
A financial advisor should work with insurance agents that understand the financial advisory industry.
This way, they can recommend an insurance product that has comprehensive coverage.
Even then, it’s the responsibility of a financial advisor to read and thoroughly understand the insurance coverage and exceptions in professional liability insurance.
Generally, the E&O insurance doesn’t cover temporary employees, claims of an advisor paying bills on behalf of the client, discretionary advice, and claims that arose before the policy was in force.
Please note that what’s excluded from the insurance license varies depending on the insurance company.
It will be in the advisors’ best interest to do their own research beforehand.
More importantly, the more an advisor understands the insurance’s coverage, claim process, and exceptions, the more they are likely to leverage the E&O insurance to the maximum when claims come up.
More than that, it’s important that advisors align their practice policies with professional liability insurance terms.
Having said that, what is the cost of E&O insurance?
The premium payments depend on several factors, including the location of the business, the kind of advisory services offered, and the number of lawsuits the advisory firm has faced in the past.
It goes without saying that the higher the number of lawsuits, the more expensive the E&O insurance will be.
This is for the simple reason that the firm is a high risk.
General Liability Insurance
General liability insurance protects financial professionals against three things:
- Property damages
Property damages liability claims may be as a result of an RIA firm causing damages to another property.
For example, an employee breaks a client’s laptop or accidentally breaks an artwork at the client’s premises during a meeting.
General liability insurance covers the damages if the client makes a claim.
Property damages don’t include the advisor’s business premise damage.
- Bodily injury
Bodily injury coverage comes to effect when a non-employee gets a physical injury at the financial service company.
The claim may include medical bills, funeral expenses, compensation for the pain the client endured, or a combination of these.
- Advertising injury
A general liability policy also covers claims that are not physical.
The policy covers financial planners from charges on copyright violations, forceful eviction, slander, false arrest, and malicious prosecution, just to mention a few.
General liability insurance is not required by law, but potential clients, landlords, financial lenders, and licensing authorities may require a financial service business to have the policy.
Therefore, many financial professionals consider general liability mandatory for their own good.
How much the policy covers depends on the limit of insurance which is tied to the insurance premium the business pays.
That is to say, personal financial advisors who have a higher limit also pay higher insurance premiums.
For the most part, general liability insurance has a per-year limit, which is the maximum amount the insurance company is willing to pay for damages annually.
The coverage is further split to the per-occurrence limit, which is the maximum amount for a single occurrence claim.
The general liability insurance also covers the legal fees, including attorney’s payment and other court fees.
The beauty of having this policy is that the coverage doesn’t consider who is at fault to cover the claims.
More importantly, there is some exclusion to this policy that an advisory service business must note.
First, the policy doesn’t cover liability from financial advice negligence or financial service malpractice.
Furthermore, liabilities from breaking international law and damages from the same are not covered.
Cyber Liability Insurance
In this age of technological advancement, cyber attack is increasingly becoming a threat to businesses in the financial service industry.
A data breach, a malicious software attack, or a lost digital gadget can cause an advisory firm thousands of dollars when responding to the threat.
Cyber liability insurance cushions investment advisers, registered representatives, and financial planners against the high cost of recovering data.
The insurance covers the cost of credit monitoring, notifying customers, and legal fees incurred by the financial advisory firm.
There are two types of policies when it comes to cyber liability insurance.
- First-party cyber liability insurance
This insurance policy covers liability that stems from a cyber attack in the financial advisory firm.
The policy covers expenses related to extortion demands, customer notifications, and monitoring the affected customers’ credit.
- Third-party cyber liability insurance
If a client’s data is stolen or compromised and they hold a financial advisor responsible, third-party cyber liability insurance comes in handy.
A typical example of this is where a financial analyst might have recommended software that turned out to be malware.
In this case, the client may file a complaint against the financial analysts.
With third-party cyber liability insurance, attorney’s fees, and the settlement cost are all taken care of.
Remember, though, there’s a limit to how much the policy covers, depending on the terms and conditions agreed upon at the beginning of the contract.
Cybersecurity protection is gaining momentum in the financial industry.
Regulators in the industry, FINRA and SEC, have issued cybersecurity guidelines for brokerage firms and RIAs, respectively.
Therefore, whether it’s a small or a big firm, ensuring sensitive information about clients is safe is paramount.
Reinforcing data security is also proving to be critical in financial planning services.
Workers’ Compensation Insurance
Like any other business, employees are prone to get injuries, working at a financial advisory firm.
An insurance agent may slip and break their leg because of the slippery floor.
A tax preparer may experience back pain because of the long hours behind the computer.
Such injuries or illnesses will require the advisory firm to compensate the employee, and that’s why workers’ compensation insurance is important in financial planning services.
The worker’s compensation insurance is divided into:
Employee Injury and illness expenses
Employee injury illness expense applies to both U. S and non-U.S citizens working with RIA or a brokerage firm.
The employees that workers’ comp cover depend on the definition of the term “employee” in that state.
In some states, both part-time and full-time employees are covered, while in others, only full-time employees.
Another important aspect of worker’s comp is that it covers only work-related injuries.
This means apart from the falls, slips, and back injuries at the workplace, the insurance coverage also comes into effect if the employee incurs injury at a client’s site or when traveling because of work.
On the contrary, injuries incurred when going to or coming from work are not covered.
More importantly, every state defines the kind of illness or injury the workers’ compensation covers. Therefore, some work-related injuries may not be covered by the policy, depending on the state.
The compensation an employee receives depends on the injury suffered and may include:
- Injury expenses
Here the workers’ compensation insurance pays for the medical bills, including emergency response expenses, medications, physical therapy, and rehabilitation costs.
It also pays the partial cost of wages lost when the employee is recovering.
Usually, the compensation is two-thirds of the employees’ salary.
This amount varies depending on a state’s regulations.
- Death benefits
When an employee’s death is work-related, the worker’s compensation insurance covers the death expenses and benefits to the remaining family members.
The children may receive compensation until they turn 18 years old.
The surviving spouse may get benefits until they die or remarry.
Again, the death befits vary per state.
Employer liability insurance
Remember, we mentioned that not all work-related injuries are covered by the workers’ comp.
Suppose an employee gets a work-related injury, and it’s not covered in the policy, they may choose to sue the financial advisory firm.
Additionally, an employee may sue the firm due to negligence if they were injured at the workplace and the company has refused to own up.
In these instances, employer liability insurance covers the legal and damages that arise from the lawsuit.
Lastly, let’s talk about exclusions.
The workers’ compensation policy doesn’t cover injuries related to employee-initiated violence, drug-related injuries, and self-inflicted injuries.
Commercial Property Insurance
Damages to a commercial property can cause huge distress for a registered investment advisor firm.
Property damage is usually further aggravated by the damage to office equipment, computers, clients’ records, furniture, and other supplies.
Since these losses can push an investment advice business on the verge of bankruptcy, commercial property insurance helps the firm recuperate by paying for the value of the damaged assets.
Commercial property insurance covers the building and all its contents.
Commercial property insurance covers the property that the wealth management firm owns.
In the case where the firm lease or rents a premise, the landlord may require the RIA to get commercial property insurance.
The policy covers the building and the outdoor signs, the fence, the landscape, and any other physical assets near the building that the investment management firm owns.
An investment management firm may have computers, clients’ personal finance records, and furniture.
Commercial property damage comes in handy when these crucial materials are destroyed.
The policy also covers leased equipment from others.
Although sometimes the owner of the equipment may require that the leased items are insured separately.
The cost of commercial property insurance varies depending on different factors.
However, many insurance companies analyze business risk factors based on the following:
- The type of business
- How risky the neighborhood is in terms of natural disasters, crime rates, and fires
- History of previous property damage incidents.
- Whether the building is old or new construction.
- The value of the equipment in the building
- The types of businesses in the neighborhood.
Through this analysis, investment management firms at high risk are prone to pay higher insurance premiums.
The cost of the commercial property policy is also determined by whether an investment advice firm settles for replacement value (RV) or actual cash value (ACV) for the compensation of the damaged content.
Replacement value refers to the compensation cost of the damaged items with the new items of the same quality as the damaged ones.
On the other hand, actual cash value compensates for the value of the current cost of the damaged items.
Commercial Auto Insurance
Commercial auto insurance is yet another advisor insurance.
This insurance is a great fit for financial advisor companies that have business vehicles with the company’s name.
The financial advisory company can purchase the insurance whether the vehicle is owned or leased.
The advisory firm should insure vehicles that employees drive and the ones used to run errands.
Also, whether the financial advisor company has one or a fleet of cars, vans, or SUVs, commercial auto insurance is required by most states.
The policy coverage comprises commercial auto liability and commercial auto property.
Commercial auto liability
The commercial auto liability component of this policy protects a financial planning company when a personal financial advisor or an employee causes an accident that leads to an injury or damages property, and they are found to be at fault.
In this case, the policy will cover the legal fees if the injured sues the company.
So, how does it work?
In the event that an employee of a financial advisory company causes physical injury to pedestrians, drivers, or passages of the vehicle they crashed into.
The bodily injury liability, which is part of commercial auto liability, covers medical expenses, funeral costs, pain and suffering, income loss, and legal fees.
It also covers the passengers and drivers of the financial advice firm vehicle in case of injury or death.
The coverage has a limit per person and per accident.
Secondly, the property damage liability covers the advisory firm if its driver is at fault while driving and causes damage to another property.
The coverage comes to effect if the vehicle damages another vehicle or runs into a fence or a building.
As long as there is a property involved, property damage liability covers it.
Commercial auto property
The commercial auto property part of the commercial auto insurance covers the RIAs’ vehicle.
It pays for the value of the business vehicle in case there’s a crash or damage.
The collision coverage component of commercial auto property covers the vehicle in case it’s hit by another vehicle or an object like a tree.
The comprehensive physical damage compensates the financial planning company if the business vehicle is stolen, burnt, or vandalized.
Commercial auto insurance doesn’t compensate the company if employees’ personal vehicles get into an accident when running business errands.
Additionally, it doesn’t cover rented cars used for business purposes if they cause an accident.
The premium for commercial auto insurance varies widely depending on the insurance product and the insurance company.
Other factors that determine the cost of this policy include the type and number of vehicles, the type of business, and the type of coverage.
To sum up, there are five types of insurance that financial advisors need.
Each of the financial advisor’s insurance covers different claims.
Together, they protect an advisor against the unexpected, which ultimately helps a financial firm save lots of money that would otherwise go in battling court cases.
Therefore, financial advisor insurance is crucial for an advisory firm to serve its clients efficiently.