The cost of liability insurance is expected to increase up to 20% at some broker-dealers in response to rising arbitration claims by investors after the market crash.

Driving higher premiums on the so-called errors-and-omissions policies are increases in the number of arbitration claims after the 2008-09 market crash. Claims surged 52% to 4,982 in 2008 over the year before and another 43% to 7,137 in 2009, according to the Financial Industry Regulatory Authority Inc.

E&O insurance premiums vary at independent broker-dealers but generally range from $2,400 to $4,200 a year per rep, according to brokerage executives.

While not all broker-dealers are expecting big increases in insurance premiums — some said they have negotiated single-digit increases, and some said their premiums haven’t gone up at all — others are bracing for sharp increases.

“It’s an express elevator going up,” said Ronald Kovack, chairman of Kovack Securities Inc., which has 259 independent representatives and advisers.

Even though few investor arbitration claims have been filed against Kovack, he expects a 10% to 20% increase in premiums. Right now, reps pay about $200 per month for insurance at Kovack, he said.

Likewise, Timothy Murphy, president and chief executive of Investors Capital Holdings Ltd., which has 577 reps and advisers, expects an increase of 10% to 20% for the cost of E&O insurance.

In addition to increasing premium, an increasing number of insurance underwriters are attaching “troubled-investments exclusions” to renewals, said John McKenna, an insurance broker with ARC Excess and Surplus LLC. The exclusions typically pertain to real estate deals or other alternative-investment products, he said.

Broker-dealers have “seen some exclusions already and will probably see more,” said Mr. McKenna. He has about 10 broker-dealer clients with 20 to 900 registered reps, he said.

Securities America Inc. was the biggest seller of the $2.2 billion in private-placement notes issued by Medical Capital Holdings Inc., which was charged by the Securities and Exchange Commission last summer with fraud. When the broker-dealer recently renewed its E&O coverage, its carrier included a rider that excluded clients’ new claims involving Medical Capital losses, said James Sallah, an attorney who has spoken with a number of Securities America reps.

“The brokers feel misled,” Mr. Sallah said. “Securities America just doesn’t care” about the potential impact of claims against the reps, he said.

Typically, if a client makes a claim that is covered before the policy is renewed, the insurance carrier will pay. If an investor makes a claim after the policy is renewed and new exclusions have been added, the broker will be left uncovered, attorneys said. In such situations, broker-dealers and reps can buy tail coverage over such claims, but that can prove prohibitively expensive, industry observers said.

“Securities America advisers have errors-and-omissions-insurance coverage for claims related to Medical Capital made in 2010,” Janine Wertheim, a Securities America spokeswoman wrote in an e-mail. “E&O policies are customarily renewed each year, and renewal policies often exclude coverage for existing matters.”

Now that the stock market has recovered somewhat, the litigation furor seems to have abated. Through June of this year, 2,919 arbitration cases had been filed, a drop of 25% when compared with the comparable period last year, according to Finra.

Meanwhile, some reps and advisers are clueless as to what their E&O policies actually cover. Reps and advisers need to be aware of the limits of their coverage, particularly if they have sold stocks or private deals that have soured, industry observers said.

“Half the reps have no concept of the coverage they have,” said Brian Kovack, president of Kovack Securities and son of chairman Ronald Kovack.

Article Provided by Bruce Kelly for Investment News 8/5/2010