Loss Prevention & the Greening of the FP Profession
By Bayard Bigelow III MBA CPA
Standardization — the Two Edged Sword. The financial planning profession is at a cross roads — on the one hand, an ever growing number of voices clamor in support of increased levels of government regulation. As is nearly always the case, the cry for increased levels of government regulation has arisen because of highly publicized abuses. Government regulation, however, has a sledge hammer like quality to it.
The response by the profession, appropriately and predictably, has been to launch efforts at self regulation with renewed vigor — who better, after all, to promulgate and enforce appropriate standards of professional behavior than those knowledgeable of the profession itself. Any corrective action, whether imposed from within or from without, will also have the effect of reducing risk to the client base of the financial planning profession, while simultaneously stemming the erosion of confidence felt by the public in general and by would be regulators in particular.
But there’s a fly in the ointment, as those of other professions have come to realize over long periods of time — the standardization of the “rules” of professional conduct and practice has eased the burden of proof that must be sustained by the plaintiff’s bar. To be convinced of the validity of this premise we need only look at changes in the accounting profession over the last decade. Rates for professional liability coverage for CPAs are some 400% higher than they were in 1985. Rates increased because the insurance industry grossly underestimated the number and severity of claims which might reasonably be expected against members of the profession. Claims increased, in turn, not only because of inroads made by the plaintiff’s bar, but also because of the rather sharp increase in the level of self policing activities undertaken by the accounting profession. One need only look at the number of FASB and SAS opinions published in the last decade.
In any professional negligence case, the plaintiff must be able to credibly demonstrate that there existed a generally accepted standard of professional conduct which the defendant failed to meet, resulting in harm to the plaintiff. As with all other professions, the financial planning profession has eased the burden of proof to the plaintiff by taking the necessary step of promulgating standards of professional conduct and practice. But with published standards, the plaintiff will no longer have to demonstrate that a standard exists. A standard will exist, de facto.
Will this result in increased claims activity and therefore increased hazard to the profession? It’s inevitable.
The Implications. With increased levels of litigiousness, and the resultant increase in the level of risk associated with being a financial planner, the obvious question is what can be done to manage and / or control that risk. Before answering this question, however, we need to know something about what risks the practitioner faces.
Claims Experience. Our claims experience, which spans two carriers, is highly informative, but must be viewed with at least two caveats. These are that the experience is not statistically credible, both because of the number of claims and because of their lack of maturity; and, that the experience of carrier may not be the same as the policyholders’ experience because of contractually imposed limitations on coverage.
Nevertheless, the claims experience is a good indicator of where the land mines are.
Message # 1 — Expenses Are The Exposure.
Nearly all professional liability insurance policies will cover the costs of both defending and settling a claim. It is therefore illustrative to examine the split between the cost of defending a claim, and the cost of settling a claim, across all claims. Here’s our data:
Briefly stated, this data demonstrates that a very significant exposure against which the practitioner purchases insurance is to cover the expense of mounting a defense against what in many cases are non-meritorious claims.
This proposition runs somewhat counter to conventional wisdom. The insurance buying public tends to believe that it purchases insurance to protect accumulated assets against the erosion of some unanticipated adverse judgment. The data suggests otherwise – an equally valid reason for buying professional liability insurance is to protect against the expense of providing a defense for a claim that never should have been brought in the first place. While as a professional you may well assume that the quality of your practice is above reproach, you need not have been negligent to be named as a defendant in a lawsuit.