Financial advisers saw sharp increases in both the number and financial severity of liability claims paid by their insurers last year, according to proprietary data compiled by Golsan Scruggs, an insurance brokerage firm that caters to financial services companies.
Golsan Scruggs, who compiled data from a pooled group of 2,042 US-based independent RIA firms with an average AUM of $400 million, found a 213% increase in paid errors and omission claims against RIAs in 2023. Severity of claims increased by 85%.
Rising contribution: Paid investment eligibility or breach of fiduciary duty claims were six times higher in 2023 than a year earlier, and paid wire fraud claims grew four times more, according to Golsan data Scruggs.
Suitability claims often increase after a market downturn, such as the one investors experienced in 2022, according to the firm's co-founder and managing director Kenneth Golsan. But eligibility claims also tend to have higher payouts and account for most of last year's increase in the total value of all claims.
For years, the industry standard has been that adviser shops with $250 million to $300 million in assets under management would buy insurance with about a $1 million limit per claim, Golsan said. But that $1 million includes defense costs, and when the markets fall and one client files a successful breach of fiduciary duty claim, other clients follow suit, quickly piling up costs for the RIA.
“You have a case that's going on, it's taking two years to arbitrate, and now you've spent $200,000 in defense costs, you're only left with $800,000,” Golsan said. “You can easily, especially in these market curves, pierce the $1 million liability limit.”
However, the growing number of underwriters and the volume of insurance capital flowing into RIAs has kept a cap on the premiums RIAs pay for insurance, despite the increase in claims in 2023.
“The price has been very stable,” said Brian Francetich, shareholder and director of GSRIA with Golsan Scruggs. “One component is the capital that has come in.”
Another is how adviser E&O insurance is generally integrated into the wider market for directors and executive officers insurance. “The public D&O market has really stabilized in 2023, so there hasn't been internal pressure on insurance companies because they're pooling all these risks,” Francetich said.
Claims paid arising from trading errors, regulatory actions or cyber security breaches remained relatively flat in 2023. This was against expectations. The brokerage firm's 2023 RIA Risk Survey named them as the top three risks of concern to advisors.
Increasingly, RIAs are aware of cybersecurity risks, and between 80% and 90% of Golsan Scruggs' clients currently carry insurance to cover it, Golsan said.
However, when a cyber security incident involves a financial loss, it is classified as a wire fraud claim under insurance policies, meaning that covered digital breaches likely contributed to the dramatic increase in wire fraud claims. seen last year.
“Wire fraud saw a huge jump,” Francetich said. “If it starts with a cyber breach but leads to a direct loss of dollars that makes it covered from an insurance standpoint under a crime policy and not a cyber policy. it's usually some kind of hacking of a customer account or even an internal email hack. There is no doubt that the threat of cyber is real. But it's not so much the privacy they're looking for. They're going straight after the customer's funds.”