RIA Errors and Omissions Coverage After Retirement

By Jon Talamas

Are you a registered investment advisor (RIA) planning to retire soon? Then it’s time to consider your post-retirement legal risks. Dropping your E&O insurance too soon may be ill-advised.

For decades, the investment-advisory business has been “aging in place.” Today, 21% of the registered investment advisor (RIA) workforce is older than 60. And over the decades ahead, 111,500 advisors, representing more than one-third of all advisors and assets, are expected to retire. According to Charles Schwab’s 2019 RIA Benchmarking Study, the vast majority of RIAs (92 percent) say they’re developing a practice succession plan.

That’s well and good. But the soft underbelly of most RIA succession plans is risk management. Advisors put a lot of effort into figuring out how to sell their firms to a third party or to groom internal talent to take over. But they often fail to consider the risks they’ll face after they pull the ripcord. Specifically, if they cancel their E&O insurance without proper planning, they might leave themselves vulnerable to future client lawsuits. This can threaten the assets they’ll need to fund their retirement.

“How can a retired RIA get sued?” you ask. “They’re no longer working with clients so they don’t make errors that spark lawsuits.” That’s true. However, RIA lawsuits can have “long tails.” For example, if you put a client into an investment to be held for 10 years and the investment implodes seven years later, you might have an unhappy customer looking for financial restitution. The fact you retired in year six won’t get you off the hook. You will likely get sued in any event.

Now here’s the rub. If you canceled your E&O insurance after you retired, you would lose E&O coverage for your past work, and all legal expenses relating to the case would be yours to bear. The bottom line isn’t pretty: a large legal judgment or settlement will make your retirement much less secure and enjoyable. Who wants to be forced to return to work and rebuild an investment portfolio after retiring?

Claims-made implication

Insurers typically write RIA E&O insurance on a claims-made and reported policy form. In other words, as long as the client incident and the notice of claim both happen while your policy is in force, you’ll likely be covered. However, if you cancel your insurance after you retire and then get sued, your last E&O insurance policy won’t protect you. That’s because the claim arrived after the policy went off the books. You will now be held personally accountable for:

• Court-imposed judgments
• Arbitration-derived settlements
• Investigation costs
• Attorney fees
• Expert-witness fees
• Court administration charges

Claims-made insurance is different from occurrence-based policies. With the latter type, as long as a covered loss occurs when the policy is in effect, you’re protected. The timing of reporting the claim is irrelevant. For example, if you cancel your occurrence-based E&O insurance and a claim arises five years later, your past policy will react since the incident occurred during the policy period.

It’s possible to have protection for prior work under a claims-made policy. This requires having an extended reporting period (ERP). Many E&O policy forms provide brief ERPs lasting 30 to 90 days. With this feature, even if you cancel your policy, you’ll still be covered for any claim that arises within the ERP window. But if it comes later, you’ll be on your own.

Getting sued is a sobering prospect, especially when you’re retired. To avoid this scenario, it’s important to make an informed E&O cancellation decision. Your future retirement security could be at stake.

The case of Mary Ria Jones

To put this into perspective, let’s consider the case of Mary Ria Jones, a 67-year old investment advisor. Mary has managed an RIA firm for 35 years. Being a careful and methodical planner, she began envisioning her retirement five years ago. She identified and began grooming a promising young advisor in her business to succeed her. She also decided to sell her company to him when the time came.

Although Mary normally was detail-driven in her client work and in how she ran her RIA, she didn’t fully consider the impact of dropping her E&O insurance. Unfortunately, six months after she retired, a client with whom she worked six years ago filed a notice of intent to sue over alleged unsuitable investments. She was named as the defendant, not her practice successor because she was the investment advisor providing advice at the time. The lawsuit was for $1 million, the amount of money the plaintiff claimed to lose due to Mary’s alleged negligence.

“No worries,” you’re thinking. Mary’s policy most likely had an ERP that allowed her to file an E&O claim. Yes, she did have an ERP, but only for 30 days. Mary never bothered to read her E&O insurance policy, so she never knew her post-retirement E&O coverage was limited to only one month. Due to the timing of the lawsuit, she had no coverage whatsoever for the $1 million judgment that ensued. Mary’s retirement was in shambles.

Avoid post-retirement E&O surprises

What can we learn from Mary’s experience? Here are some basic takeaways:

• Read your E&O insurance policy. This will reveal the policy form on which your insurance company issued your coverage. If it’s a claims-made policy, you’ll know that canceling it when you retire will leave you exposed if a prior client files suit after your ERP expires. If your policy lacks an ERP, you will be liable the minute you cancel your policy.
• Identify your ERP before you retire. If it’s for 30 or 60 days, consider purchasing a longer one, especially if your prior work involved investments with varying risk levels.  This may cost more than your last E&O annual premium but is a valuable investment because it safeguards your retirement assets against a major legal assault.
• If you worked with products with high levels of risk, consider maintaining your E&O coverage in retirement. For example, if you recommended leveraged ETFs or IPOs, among other higher-risk products, then not canceling your E&O insurance when you retire may make sense. This will be a reasonably cost-effective way to transfer your risk to an insurance company while keeping your retirement worry-free. Plus, keeping your policy in force may cost less upfront than paying for an ERP for a lengthy period.

Finally, in the years before retirement, reduce your risks. Develop a risk-management plan (or update your existing one), make sure your firm complies with all RIA regulations and avoid selling products that invite SEC or state-regulator scrutiny. Also, minimize the risks inherent in the following RIA activities:

• Engaging in conflicts of interest
• Using “best execution” trading
• Providing unsuitable investments
• Maintaining professional relationships with third parties
• Breaching contracts
• Failing to prevent cyber breaches
• Not conducting adequate due diligence on recommended investments
• Not keeping detailed records and documentation

If you effectively de-risk your business, you will reduce your need for post-retirement E&O coverage or perhaps eliminate it.

In short, as you approach retirement, don’t just think about how you’re going to fund your golden years. Also, think proactively about how to neutralize E&O threats from your prior work. It’s tempting to assume you’ll never have to settle an E&O claim out of pocket during retirement. But it can happen to even the most careful and competent advisor. Don’t let it happen to you!

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