E&O Insurance: A Choice You Can’t Afford Not To Make
Advisors that began their career in the broker/dealer model, and/or perhaps still are, are accustomed to receiving errors and omissions coverage (“E&O”) directly from their broker/dealer.
Not only do they receive the coverage, but it is also mandated on them. With a W2 model, it is typically paid for via the advisor’s payout grid. With an independent-BD model, it is usually a separate expense item pushed down to them. Either way, it is a mandated coverage.
I am not expressing this as a negative. The challenge occurs when obtaining coverage is an optional expense, typically the case in the Registered Investment Advisor (“RIA”) model.
Obtaining E&O insurance is as important as obtaining homeowner’s insurance on your house. For those who are able/willing to go without homeowner’s coverage, that strategy works brilliantly….right until it doesn’t!
Most homeowners will never experience a disaster. And likewise, will “waste” money by paying premiums throughout the years. But for the unlucky individual whose house burns down, the difference between having coverage or not is likely catastrophic for that individual.
After your house is on fire, you don’t get the option to go back and get coverage retroactively.
I’ve seen this in the RIA space.
I recall an RIA without E&O coverage. The main principal felt that the firm knew their clients well and that the chance of any of them suing the firm was essentially non-existent.
To a degree, the principal was right. Last I heard, none of the existing clients had. However, one client at one point passed away. The beneficiaries of their assets, the client’s children, objected to how their parent’s account had been managed. They sued the RIA in a manner that E&O would have typically covered for.
The saga to come lasted years, resulting in hundreds of thousands of dollars of legal fees for the RIA. In the end, the RIA was found to be not at fault. The RIA was even granted to be reimbursed legal fees by the opposing party. By that point, though, the children had squandered their assets and essentially could not pay such fees. Thus, the RIA was stuck with out-of-pocket costs of over $400k for something they were ultimately deemed to be not at fault for.
I vividly recall the anxiety and stress the leading principal dealt with for years from the crushing impact the $400k+ had on him personally. I remember him saying… “Once this is over, I am for sure going to get E&O coverage.”
You are too late if you wait till your house is on fire to get homeowner’s insurance.
In my role as founder of Transition To RIA, I help guide advisors on the aspects of transitioning their practice to the RIA model. A mainstay of that conversation is the need to obtain E&O coverage, even if it is not mandated upon them under their new model.
For those skeptical, I often recite the prior story. I encourage you to not have your own tragic story to tell one day.
Written By: Brad Wales – Transition to RIA
Brad Wales is the founder of Transition To RIA, a consulting firm uniquely focused on helping established financial advisors understand everything there is to know about WHY and HOW to transition their practice to the RIA model. Brad utilizes his nearly 20 years of industry experience, including direct RIA related roles in compliance, finance and business development to provide independent advice regarding how advisors can benefit from the advantages of the RIA model.
Today’s BPI Advice: This is a horror story that is not intended to keep you up at night but to help you remember how important it is that you have the right coverage. In my world knowing is 90% of the battle and that is the battle BPI is here to help you win.
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