There’s a perception in the market that managed discretionary account (MDA) services are risky. The regulator certainly thinks so, which is why tougher licensing and financial requirements are proposed for advisory firms who are the MDA operator for retail clients.
Many professional indemnity (PI) insurers also share that view. For advisory firms who use MDA services, the essential task of securing PI cover can seem like mission impossible.
PI cover is a complex and difficult purchase for any firm. Add a reference to an MDA service and it’s infinitely harder, assuming they can get it at all. And it is not only those firms that act as the MDA operator that are affected.
In the eyes of many PI insurers, any form of MDA activity is easier to exclude, even if an adviser is simply advising a retail client to invest in an MDA provided by a third party. Being risk averse, PI insurers take the position that it’s easier to assume that all MDA arrangements are likely to be based around complete discretion being given to an adviser.
But not every MDA arrangement is the same. Some advisory firms act as the MDA operator, others as an investment manager (appointed by a third party), others provide personal advice and some firms provide a combination.
Fortunately, there are a number of practical ways for advisory firm principals who use MDAs to maximise their chances of securing appropriate and affordable cover.
Four things in common
Advisory firms that are able to secure the most competitive premiums and terms and conditions typically have four things in common:
- Formal systems and processes in place around how client portfolios will be managed and administered
- An independent investment committee which is responsible for portfolio construction and management decisions
- Compliance with ASIC’s requirements with regard to MDAs
- A third-party MDA and administration provider for the MDA operator function, portfolio administration, trade execution, and portfolio reporting
- A relationship with a specialist financial services insurance broker who intimately understands their business model and the way MDAs work in general; strong relationships with insurers; and a willingness to engage with insurers to address any of their concerns.
Character building
The perception that advisers who use MDA’s are making investment decisions in isolation (often using unsophisticated, manual systems and processes) is rapidly changing.
There’s greater awareness of MDAs as an efficient investment and administration vehicle, and growing recognition that many advisers who provide MDA services make well-thought-out investment management decisions in partnership with a professional third-party asset consultant, research house or fund manager.
In many cases, administration, execution and custody are outsourced to an MDA operator as part of a formal investment framework.
A critical part of securing PI cover is educating underwriters about MDAs, and explaining how a robust, institutional-grade MDA program is able to deliver improved client outcomes.
That’s a key part of an insurance broker’s job.
An insurance broker who has experience securing cover on behalf of MDA operators is also ideally placed to help advisory firms secure PI cover because they have a sound understanding of the benefits of MDAs.
With that foundation, they can then educate insurers about an advisory firm’s business model, in addition to subjective factors like an adviser’s character, qualifications, history and background.
Having said that, most insurers still have reservations about covering advisers who operate MDA services, which is why advisers can expect to pay significantly more for PI cover.
All things being equal, it is not uncommon for a firm to pay double the premium for the same level of cover by merely adding an MDA operator authorisation to their Australian Financial Services licence.
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Premiums can actually fall
However, for those advisory firms looking to advise on an MDA where a third party is the MDA operator, premiums can actually fall when assessed against existing policy arrangements that are based on non-discretionary arrangements.
Fortunately, in the self-licensed advisory firm space, PI premiums have largely remained static for the past few years, reflecting the segment’s diminishing claims experience; however, insurers have moved to protect their interest by narrowing the scope of cover offered in some instances.
Large dealer groups have generally seen their premiums creep up in line with a steady stream of claims and complaints.
Across the board, terms and conditions are beginning to deteriorate, with jittery investment markets seeing underwriters become increasingly wary of being caught out again when the market and business cycle turns and claims rise.
Furthermore, the recent exit of insurers, including Vero Insurance, Dual and Axis, has changed the market dynamic and unbalanced supply and demand.
With the PI insurance market currently in a state of flux, advisory firms should work with a broker who has relationships with multiple underwriters to ensure they can have access to the most competitive policy for their needs.
