The Impact of Current Trends on Investment Firm Risk Management

The Growth of the Investment Advisory Industry

Outside of the four major wirehouses (Morgan Stanley, Merrill Lynch, Wells Fargo, and UBS), the investment advisory industry is a fractured market driven by three sectors:

• Smaller, independent registered investment advisors (RIAs)
• Breakaway RIAs that leave the wirehouses to set up their own shops
• Mega organizations with private equity to fund acquisitions

According to Cerulli Associates, 93% of RIAs manage less than $1 billion in assets under management (AUM), while firms above the billion-dollar mark manage 71% of channel assets and employ 47% of advisors. This is an interesting market where both small and mega firms are growing and thriving. Technology platforms such as Envestnet and Schwab allow the growth of independent wealth management and investment professionals to be more efficient from a cost perspective and more competitive from a performance perspective. These advancements are important for the consumer, giving them investment choices due to the growth of advisors with access to investments and broad service providers which also come with new risks to both the platforms, RIA users and consumers not contemplated in the traditional insurance market. 

A bit of history is important regarding the insurance market: 1986 was the first time the Institute for Certified Financial Planners endorsed an investment advisor’s errors and omissions (E&O) insurance policy. Since then, like most management liability programs, the insurance has become common, utilizing a package approach including directors and officers (D&O) liability insurance, E&O, employment practices liability, and sometimes also including a crime bond and perhaps cyber liability insurance.

However, many of these policies don’t cover issues that have emerged in recent years.

Expanding Services, with Greatest Potential in Trusts and Estate Planning

Sophisticated investment advisors are growing their business by broadening the services they provide to clients. This is driven by many dynamics, including fee compression and client retention. According to Marsh Berry, the leading “non-core” services now offered by more than half of advisory firms are insurance planning and risk management services, estate planning, tax planning, corporate retirement, philanthropic planning, and succession services and business planning. The most popular services respondent firms plan to offer are digital advice (21%) followed by succession services and business planning, philanthropic planning, concierge and lifestyle services, and tax planning.

Even though Berry states that 46% of firms already provide some form of trust services, the new services most likely to be outsourced are investment banking, trust, and tax planning. While respondents were somewhat divided on which services offer the greatest potential for growth/demand, those they mentioned most frequently were trusts and estate planning (42%).

The Great Wealth Transfer and the Rise of New Investment Management Clients

This all makes sense due to the rising number of wealth transfer vehicles being created as well as innovative structures. Over the next two decades, nearly $120 trillion in assets will be inherited through the Great Wealth Transfer. Forbes reports that the 2,668 wealthiest people on this planet own a collective $12.7 trillion. The Great Wealth Transfer will total more than five times that amount. 

Most beneficiaries of the Great Wealth Transfer are millennials. Millennials currently own less than 5 percent of the nation’s wealth but in a matter of years, the dynamic will completely flip. Over the next decade, millennials are expected to inherit $5 trillion; by 2045, they’ll begin to inherit more than $2.5 trillion annually. The Great Wealth Transfer will usher in a slew of new clients for investment managers; currently, there are not enough experienced trust officers to provide trust administration to all of them.

Other Emerging Trends that Impact Insurance Coverage

The changes ahead will require knowledgeable insurance advisors to help clients navigate the liability created by these wealth transfer vehicles, whether the services are being provided in-house or are being outsourced.

Additional emerging trends to consider that create exposures include: 

• Private equity behind larger firms fueling acquisitions. The exposure created is not dissimilar to the mergers and acquisition (M&A) insurance due diligence and assimilation processes.
• Wirehouse breakaways that result in a higher number of independent advisors. This will require thoughtful planning for expansion programs. 
• Advisors creating their own platforms. These technological advances are likely to result in full-blown cyber exposures, including vender exposures and significant cybercrime creating the need for technology E&O insurance.
• Ownership and leadership changes. Succession planning for owners and management should be reviewed to ensure appropriate insurance planning. 

How to Navigate Exposures

Along with these trends—more investment advisory services providers who are expanding in the areas of trust management and wealth management/planning--comes growing fiduciary risk and the need for trustee liability services that help fill the gaps in coverage from outdated packaged policies created in the past.

Our current observations are that RIAs tend to purchase low limits which should be investigated. Most policies do not anticipate the expanded services that the firms they cover now offer. Most programs are placed with brokers who access programs that have been in place for years and have not been reviewed through the lens of the latest trends. Peer review is not enough; rather, a deep risk evaluation is necessary to ensure proper risk management. Our advice? Make sure you are working with an insurance professional with a deep understanding of current trends and who knows how to navigate exposures specific to your firm. An experienced broker can help manage and mitigate the nuances in personal, professional and/or corporate risks. 

To learn more on how to better protect your investment firm in an ever-changing risk landscape, contact a Woodruff Sawyer Representative.