Broker dealers and investment banks operate in an extremely litigious environment resulting in costly E&O insurance premiums and large retentions. Even when firms operate at the highest standards, misstatements and errors of its registered reps create vicarious liability and generate claims involving failure to supervise. Statistically 70-80% of all claims are brought against the firm – either solely, or alongside the registered rep involved. Accordingly, it’s not uncommon for broker dealers and investment banks to research options allowing the firm to defer some of those insurance costs. With a number of different policy structures available, deciding on an optimal program will largely depend on the type of the firm, its goals, and risk tolerance.

The most common policy structure, implemented by the majority of traditional brokerages (with employed reps), is a shared policy approach, providing a shared “per claim” and “per policy” limit amongst both the firm and its registered reps. This structure is the simplest and cleanest, requiring no creative layering by the insurer. For brokerages with more unique models looking to shift some of the policy premiums to its reps however, there are some cost shifting challenges. While some firms may implement an annual fee or take deductions to offset those costs, such fees would have to be estimated and calculated arbitrarily. Additionally, there is a real possibility that a large claim (or series of claims) against the broker dealer fully erodes any limit remaining for subsequent claims brought against the registered reps themselves - who could find themselves without coverage after possibly having paid in.

One solution financial institutions could deploy, in the interest of preserving policy limits, is a large aggregate limit, or separate policy limits for the firm’s registered reps. Ideally the policy limit pertaining to any registered reps should also have its own separate aggregate limit to help preserve coverage for other reps in the event that there are multiple claims against the rep group in a single given policy year. This approach does however have its own advantages and disadvantages. While it’s a more cost-effective option and should cover all current and future reps (without needing to wait for any opt in period), it doesn’t allow for accurate premium allocation.

Firms such as those running independent BD models, looking for accurate premiums on a “per rep” level do have another option. In addition to the split/dedicated limit structure discussed above, some policies can also apply a registered rep roster to the policy. In addition to allowing the firm to “gate-keep” coverage and limit it only to those that have opted in (and paid), the carriers will also develop a rate basis per rep (often based on volume), allowing for accurate cost shifting. Such a policy structure however can also leave some reps without coverage, which can result in some claims (or portions of claims) being denied, can result in uncovered damages, or potentially create contentious claim scenarios. Maintaining a registered rep roster does provide some other advantages though; having each rep named within the policy, with their own retro date, would likely allow them to pursue their own insurance (carrying over retroactive coverage) in situations where the broker dealer’s insurance is terminated, the firm decides to cancel their own coverage, or coverage needs to be tailed.

Lastly, while rarer, some financial institutions such as highly specialized brokerages, virtual firms, and those operating on more of a subscription model, may seek to secure their own insurance, requiring each of their registered reps to secure their own E&O insurance (potentially naming the BD as an additional insured for vicarious liability). Such arrangements also have their pros and cons. One advantage for the registered reps, is maintaining control of their own program, with the ability to secure a more fitting policy that may also extend to include coverage for any additional (shared) entities that may transact unregulated transactions, and/or any outside business activities they may be involved with. It could also help isolate against claims – as a claim brought solely against one rep would not impact premiums for other reps. On the downside, such a program is often costly and can be difficult to put together. For starters, the market for stand-alone registered reps is somewhat limited. When terms are secured, pricing and retentions can often be very high (similar to that of a broker dealer) and may be deemed cost prohibitive. Even when registered reps are able to secure strong coverage terms at reasonable premiums, carriers may be unwilling to add the broker dealer as an additional insured, should there be such a request. Such an approach also creates considerable administrative oversight for the broker dealer, requiring careful review of each of the underlying policy’s terms to ensure coverage adequacy, and constant monitoring to ensure that continuous coverage is maintained.

When structuring any program, there are also some additional coverage details that should be considered – in order to maximize coverage, the broker dealer should:
 

• Secure Split Retentions for Registered Reps: While broker dealer retentions often range between 100-500k depending on the size of the firm, most insurers apply a considerably lower retention for registered reps, which can be as low as 5k, however not all policies automatically provide such retentions. When absent, policyholders and brokers alike should request a split retention option. 
   
• Understand Requirements for Covering New Reps: The policy structure will dictate when new registered are covered by the policy. Policies providing shared limits, or dedicated limits (shared by all registered reps) should automatically cover any new reps, whereas policy forms that schedule the covered reps may have opt-in periods where they can be manually endorsed onto the policy as insureds. Its equally important that any such opt in periods are clearly communicated when onboarding new reps.
   
• Understand Defense Cost Allocation: Coverage allocation is another important consideration. In claim scenarios where litigation names both a registered rep and broker dealer and there are separate limits, how will the insurer allocate defense costs and settlement? Are defense costs allocated between the 2 parties (helping to preserve some of the broker dealer’s limit) or are all the defense costs levied against the broker dealer’s limit?
   
• Align Policy Terms for Excess Coverage: Registered reps looking to secure their own excess limits over the limit(s) being provided by the broker dealer’s policy, will likely encounter resistance from carriers if coverage terms are not tailored appropriately. Most E&O insurance policies contain clauses that state that the policy’s coverages and limits are excess any other insurance in force. As a result, any policy secured to provide excess coverage will create a conflict resulting in each carrier finger pointing, in the event of claim. In order to avoid such conflicts, the primary insurer would need to amend their policy language stating that their coverage is primary in the event of a loss.  
   
• Consider how Ancillary Services are Insured: Where registered reps provide ancillary services or have separate entities for unregulated transactions that may be excluded by the broker dealer’s E&O policy, has coverage been secured separately for those entities/services? Broker dealers themselves also need to give careful consideration to their program's structure. It's not uncommon for some broker dealers to establish a separate entity providing investment advisory services. In such cases, it's natural for firms to consider adding the RIA entity to the firm's E&O policy, however this will often result in a shared limit, resulting in quicker potential limit erosion. Increasing the liability limits on a broker dealer form (to account for such limit sharing) can also be costly. Accordingly, securing a separate E&O policy for the investment advisory practice may be a more optimal solution for ring-fencing policy limits and minimizing increased costs.
   
• Inquire About Proof Of Insurance: Will registered reps be able to secure proof of insurance in their names (if scheduled on the policy), as evidence of insurance, as required by their clients?
   
• Ensure Independent Contractors are covered: In programs where registered reps are independent contractors and not scheduled on the policy, is coverage adequately extended, or does the policy need to be endorsed?
   
• Perform Careful Policy Cover Audits: Coverage audits are a critical part of securing insurance. As discussed in our broker dealer E&O guide, there are number of coverage and policy terms that should be carefully reviewed. At a most basic level, policyholders should ensure that all products and services are adequately covered, the policy’s many conduct exclusions contain appropriate “final adjudication” language, contractual exclusions contain appropriate carve-backs, and regulatory coverage is being extended.