Report from the Commission to the European Parliament and the Council Final Report of the European Commission on the continued appropriateness of the requirements for professional indemnity insurance imposed on intermediaries under Community law
Date: 2007-04-11
Institutions: European Commission
Subjects: EU law, financial occupation, insurance law, insurance occupation, reinsurance, third-party insurance

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 11.4.2007 
COM(2007) 178 final 

REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND 
THE COUNCIL 

Final report of the European Commission on the continued appropriateness of the 
requirements for professional indemnity insurance imposed on intermediaries under 
Community law 

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TABLE OF CONTENTS 

1. 

1.1. 

1.2. 

1.3. 

2. 

2.1. 

2.2. 

2.3. 

3. 

4. 

PII requirements for intermediaries under community law ......................................... 3 

Article 4 of the IMD..................................................................................................... 4 

Articles 7 and 8 of the re-cast CAD ............................................................................. 5 

Historical background .................................................................................................. 6 

Policy rationale for PII requirements ........................................................................... 7 

Consumer protection .................................................................................................... 7 

Advantages to service providers and markets.............................................................. 7 

Arguments against PII requirements............................................................................ 8 

Targeted Consultation with Member States and Competent Authorities..................... 8 

Public consultation on the Draft Report....................................................................... 9 

4.1. 

Results of the consultation ........................................................................................... 9 

5. 

Conclusions ................................................................................................................ 10 

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INTRODUCTION 

The Commission is required by Article 65(6) of Directive 2004/39/EC on markets in financial 
instruments  ('MiFID')  to  report  to  the  European  Parliament  and  Council  on  the  continued 
appropriateness  of  the  requirements  for  professional  indemnity  insurance  ('PII')  that  are 
currently imposed on intermediaries under Community law.  

1. 

PII REQUIREMENTS FOR INTERMEDIARIES UNDER COMMUNITY LAW  

Professional indemnity insurance is a liability insurance designed to cover, either entirely or 
in  part,  sums  to  be  paid  by  professionals,  either  as  damages  or  resulting  from  approved 
negotiated settlements, to third parties as compensation for losses arising from acts, errors or 
omissions committed by the professional during the conduct of its business activities.  

Community  law  requires  some  investment  and  all  insurance  intermediaries  to  obtain  such 
insurance  as  a  precondition  to  be  able  to  provide  services.  The  relevant  requirements  are 
derived from two Directives: 

•  Directive 2002/92/EC on insurance intermediation ('IMD')  

•  Directive  2006/49/EC  on  the  capital  adequacy  of  investment  firms  and  credit 

institutions (re-cast)1 ('the re-cast CAD') 

The following sections set out in detail the PII requirements under these two directives.  

1 

The  provisions  in  question  are  derived  from  new  paragraph  (4b)  of  Article  3  of  Directive  93/6/EC, 
inserted by Article 67 of MiFID).  

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Summary of PII and capital requirements for different types of intermediaries  

Insurance intermediary

Investment 
intermediary 

Investment intermediary 
which is also an insurance 
intermediary 

PII covering the whole territory 
of the Community with a level 
of indemnity of at least EUR 
1,000,000 for a single claim 
and, in aggregate, EUR 
1,500,000 per year. 

One of the following: 

initial  capital  of  EUR 

(a) 
50,000; 

other 

against 

(b)  PII  covering  the  whole 
territory  of  the  Community,  or 
comparable 
some 
guarantee 
liability 
arising 
professional 
negligence,  with  a  level  of 
least  EUR 
indemnity  of  at 
1,000,000  for  a  single  claim 
and, 
aggregate,  EUR 
1,500,000 per year;  

from 

in 

(c)  a  combination  of 
initial capital and PII in a 
form  resulting  in  a  level 
of  coverage  equivalent  to 
(a) or (b). 

PII covering the whole territory of 
the Community with a level of 
indemnity of at least EUR 
1,000,000 for a single claim and, in 
aggregate, EUR 1,500,000 per year.

+ 

One of the following:  
(a) initial capital of EUR 25,000; 
(b) PII covering the whole territory 
of the Community or some other 
comparable guarantee against 
liability arising from professional 
negligence, with a level of 
indemnity of at least EUR 500,000 
for a single claim and, in aggregate, 
EUR 750,000;  
(c) a combination of initial capital 
and PII in a form resulting in a level 
of coverage equivalent to (a) or (b). 

1.1. 

Article 4 of the IMD 

Article 4.3 of the IMD sets a minimum limit of indemnity for both an  individual claim and 
claims in aggregate.  

All  insurance  intermediaries  are  required  to  hold  PII  covering  the  whole  territory  of  the 
Community,  or  some  other  comparable  guarantee  against  liability  arising  from  professional 
negligence,  with  a  level  of  indemnity  of  at  least  EUR  1,000,000  for  a  single  claim  and,  in 
aggregate, EUR 1,500,000 per year (unless such insurance or comparable guarantee is already 
provided by an insurance undertaking, reinsurance undertaking or other undertaking on whose 
behalf  the  insurance  or  reinsurance  intermediary  is  acting  or  for  which  the  insurance  or 
reinsurance  intermediary  is  empowered  to  act  or  such  undertaking  has  taken  on  full 
responsibility for the intermediary's actions).  

An intermediary, regardless of its size and irrespective of whether it actually operates in more 
than one Member State, must satisfy this requirement in order to be registered and to carry on 
insurance intermediation in the EU. However, the requirements are minimum limits of cover 
so  Member  States  may  add  additional  requirements  under  national  law.  There  are  no 
provisions  in  the  IMD  permitting  Member  States  to  exempt  firms  from  the  requirement  to 
hold  PII  (other  than  where  a  firm  holds  a  'comparable  guarantee'):  in  particular,  capital 
resources are not permitted as an alternative to PII. 

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1.2. 

Articles 7 and 8 of the re-cast CAD 

Among a series of provisions requiring investment firms as defined in Article 4.1(1) MiFID to 
hold varying levels of initial capital, Articles 7 and 8 of the re-cast CAD impose requirements 
relating to PII or initial capital on investment firms which are authorised under MiFID only to 
provide  investment  advice  or  to  receive  or  transmit  orders  from  investors,  without  also 
holding  client  assets  (‘MiFID  intermediaries’).  These  firms  are  excluded  from  the 
requirements relating to initial capital that apply to investment firms generally under Articles 
5 or 9 of the re-cast CAD, and the capital requirements imposed upon them are significantly 
lower  because  they  are  supplemented  by  PII  requirements  that  do  not  apply  to  other 
investment firms.  

Article 7 applies to MiFID intermediaries that do not also carry on the business of insurance 
intermediation. Such firms are required to have one of the following: 

(a) 

initial capital of EUR 50,000; 

(b)  professional 

indemnity 

the 
Community, or some other comparable guarantee against liability arising from 
professional  negligence,  with  a  level  of  indemnity  of  at  least  EUR  1,000,000 
for a single claim and, in aggregate, EUR 1,500,000 per year;  

insurance  covering 

territory  of 

the  whole 

(c) 

a combination of initial capital and professional indemnity insurance in a form 
resulting in a level of coverage equivalent to (a) or (b). 

The  PII  requirements  under  paragraph  (b)  are,  of  course,  identical  to  those  imposed  upon 
insurance  intermediaries  under  the  IMD.  However,  the  re-cast  CAD  confers  greater 
flexibility: a choice between initial capital, PII, or a combination of the two. 

Article  8  applies  to  MiFID  intermediaries  which  are  also  registered  under  the  IMD  as 
insurance intermediaries. In addition to complying with the PII requirements of Article 4.3 of 
the IMD, such firms must have one of the following:  

(a) 

initial capital of EUR 25,000; 

(b)  professional 

indemnity 

the 
Community or some other comparable guarantee against liability arising from 
professional negligence, with a level of indemnity of at least EUR 500,000 for 
a single claim and, in aggregate, EUR 750,000;  

insurance  covering 

territory  of 

the  whole 

(c) 

a combination of initial capital and professional indemnity insurance in a form 
resulting in a level of coverage equivalent to (a) or (b). 

The  deadline  for  the  transposition  of  these  requirements  has  not  yet  expired,  so  investment 
firms  are  not  currently  subject  to  any  PII  requirements  under  Community  Law.  They  may, 
however,  be  subject  to  comparable  requirements  under  national  law,  and  any  observations 
based on the impact of analogous national requirements will therefore be relevant to this draft 

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Report.  Like  the  IMD,  the  re-cast  CAD  permits  Member  States  to  impose  rules  that  are 
stricter than those required in the Directive.2 

1.3. 

Historical background 

As  indicated  above,  the  PII  requirements  that  apply  to  insurance  intermediaries  under  the 
IMD differ from the requirements that apply to MiFID intermediaries under the re-cast CAD. 
The IMD requires all insurance intermediaries to hold PII with a specified minimum cover for 
liability for claims arising from professional negligence whereas the MiFID intermediaries are 
subject to a regime which allows a combination of PII and minimum capital. 

The Commission's  initial proposal for the Directive that became MiFID3 had required firms 
that provide investment advice or services of reception and transmission of orders for clients, 
but  which  do  not  hold  client  money  or  securities,  to  hold  PII  with  a  cover  equal  to  that 
required  under  the  IMD  for  insurance  intermediaries,  without  any  option  to  satisfy  capital 
requirements  as  an  alternative.  However,  during  the  Council  negotiations  some  Member 
States raised concerns. Those concerns were two-fold:  

•  market changes might reduce the availability of PII to investment advisors; and 

•  the proposals might impose excessive burdens on firms carrying out both investor 

advice and insurance mediation.  

Accordingly,  the  Commission  proposal  was  modified  by  the  co-legislators.  First,  greater 
flexibility  was  introduced,  by  permitting  firms  either  to  hold  the  specified  level  of  PII,  or  a 
specified  minimum  capital,  or  a  combination  of  both.  Secondly,  a  particular  regime  was 
designed for investment firms that were also registered as insurance intermediaries under the 
IMD. Those firms must comply with the requirements of Article 4.3 of the IMD in respect of 
those  mediation  activities  and,  additionally,  are  required  in  respect  of  their  investment 
advisory activities to hold either an initial capital of at least €25,000, or PII insurance with a 
coverage of at least half the amount required under the IMD, or a combination of these two 
requirements.  That  is,  the  PII  requirements  imposed  by  the  IMD  must  still  be  satisfied, 
however well capitalised the firm might be. 

Recognising that the PII requirements of the MiFID would therefore differ from those of the 
IMD, some Member States argued during negotiations in Council that MiFID should modify 
the  IMD  so  as  to  allow  (re)insurance  intermediaries  to  benefit  from  the  option  available  to 
investment  advisors  to  substitute,  wholly  or  in  part,  PII  requirements  with  capital.  A 
modification  to  this  effect  was  not  adopted,  but  instead  the  co-legislators  introduced  the 
review clause. 

The purpose of the review is to establish, on the basis of the evidence of their market impact 
in Member States, whether the combined requirements are proportionate to the objectives of 
adequate  consumer  protection  and  whether  firms  in  the  EEA  as  a  whole,  or  in  specific 
national  markets,  experience  particular  difficulties  or  expense  in  obtaining  the  required 
professional  indemnity  insurance  which  should  be  taken  into  account  in  reviewing  the 
effectiveness of the regime. 

2 

3 

Recital  (8):  "Member  States  should  be  able  to  establish  rules  stricter  than  those  provided  for  in  this 
Directive 
COM (200) 625 final, Article 11.2 

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2. 

POLICY RATIONALE FOR PII REQUIREMENTS 

PII  requirements  are  a  consumer  protection  measure,  aimed  at  ensuring  that  client  claims 
against an investment firm or intermediary can be met in cases where the income or capital of 
the firm or intermediary would not be sufficient to cover its liability to a client. But it is also 
valuable regulatory tool, enabling investment firms to carry out certain kinds of business with 
a relatively low base capital. This prevents the barrier to entry from being set too high, and the 
consequential  exclusion  of  smaller  firms  from  the  market.  This  consideration  is  particularly 
relevant in the context of activities such as insurance mediation or investment advice, where 
there is a high incidence of small firms.  

2.1. 

Consumer protection 

PII  clearly  protects  consumers  by  increasing  the  funds  available  to  meet  the  claims  arising 
from  the  receipt  of  negligent  advice  or  some  other  form  of  professional  misconduct.  For 
example, MiFID regulates the service of investment advice for the first time as core service (it 
was  an  auxiliary  service  under  the  ISD).  PII  is  a  useful  tool  in  ensuring  that  the  risks 
associated with providing this service are properly managed. 

2.2. 

Advantages to service providers and markets 

PII also benefits the firms. Indeed, many firms hold PII when under no regulatory obligation 
to  do  so,  or  hold  cover  in  excess  of  their  regulatory  obligations.  It  can  finance  large  and 
unexpected  liability  claims  and  thereby  protect  the  assets  of  its  owners,  and  will  normally 
cover  both  legal  liability  and  the  defence  costs,  the  sum  of  which  may  be  so  substantial  in 
some cases as to jeopardise the solvency of the firm. 

PII  may  be  particularly  valuable  for  smaller  firms  which  might  find  it  difficult,  or 
inappropriate  to  their  business  structure,  to  hold  large  amounts  of  capital.  It  can  operate  in 
conjunction  with  market  forces  by  using  the  commercial  insurance  market  to  help  maintain 
the solvency of firms that provide important retail services such as investment advice.  

In  addition,  mandatory  PII  is  a  useful  regulatory  tool  that  can  complement  capital 
requirements  and  investor  compensation  schemes.  The  requirement  to  purchase  PII  might 
have  a  further  positive  regulatory  effect  in  encouraging  firms  to  improve  their  own  risk 
assessment and risk control activities, as firms with a lower risk profile will tend to reduce the 
size of their premiums and increase the availability of cover.  

Furthermore, it is in the general interests of the regulated community that firms should have 
PII cover, in order to limit the claims made on investor compensation schemes.4 A firm that 
does  not  have  adequate  resources  may  not  be  able  to  meet  justified  claims  that  are  made 
against  it  and  ultimately  could  face  insolvency.  This  could  in  turn  lead  to  claims  on  the 
investor  compensation  scheme,  which  must  be  funded  by  the  rest  of  the  participant  firms 
within  the  relevant  contribution  group.  The  greater  the  number  of  claims  made  on  such 
schemes, the higher the industry levy to fund it. Since such levies are not risk sensitive, the 

4 

When a loss occurs the PII policy provider pays a claim in accordance with the terms of the PII policy, 
and the firm has to pay an amount equal to the excess on its PII policy out of its own capital resources. 
When a firm’s resources are exhausted, the firm is insolvent. Any justified consumer claims then fall on 
the  relevant  investor  compensation  scheme.  Such  a  scheme  will  have  limits,  and  any  residual  loss  is 
incurred by the consumers. 

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costs  of  compensation  may  fall,  disproportionately,  on  the  long-lived,  well-managed  firms 
that  provide  most  of  the  funding  for  the  scheme.  PII  tends  to  reduce  any  such  funding 
imbalance. 

2.3. 

Arguments against PII requirements 

The first and the most traditional argument levelled against PII is that it may create a problem 
of ‘moral hazard’. This means that PII may alter the behaviour of those insured in ways that 
increase  the  probability  or  size  of  claims.  The  theory  is  that,  having  gained  insurance 
protection, firms do not have the same financial incentive to avoid actions or omissions that 
might trigger claims.  

Another  argument  against  extensive  PII  requirements  is  that  the  insurance  market  lacks,  or 
may  lack,  the  capacity  to  provide  PII  cover  to  an  increased  number  of  firms.  It  has  been 
alleged  that  the  limits  specified  in  the  IMD  were  agreed  at  a  time  when  there  was  more 
capacity in the market than there might be now or in the future. The situation may have been 
exacerbated by the requirements under MiFID for firms carrying on both activities, and there 
is some concern that the combination of requirements might stretch PII market to its limits, 
and some firms might be unable to hold the stipulated level of cover. A related concern is the 
cost of PII. By increasing the number of firms that are required to have PII, there is a risk that 
an increase in demand could push up the price of PII, drive some investment advice firms out 
of the market, and create a barrier to market entry for new firms.  

More specifically, it has been argued that the IMD requires a high level of insurance, beyond 
that  which  most  small  firms  would  reasonably  expect  to  hold.  Moreover,  those  PII 
requirements are ‘one size fits all’, and not calibrated to the risk profile of the firm.  

Commentators  also  urge  appropriate  recognition  of  the  role  of  capital  for  insurance 
intermediaries.  Capital  can  help  finance  unexpected  losses  or  fill  the  gaps  in  a  firm’s  PII 
cover, and, in particular, can help to finance any policy excess (that is, the first amount of a 
claim that has to be paid by the firm out of its own resources). Indeed, Articles 7 and 8 of the 
re-cast CAD recognise that capital, or a combination of PII and capital, can deliver the same 
consumer-protection objective as PII. The option to use financial resources to complement PII 
may  give  firms  greater  flexibility,  help  firms  maintain  adequate  resources  overall,  and  to 
obtain compliant PII cover in difficult market conditions. 

3. 

TARGETED  CONSULTATION  WITH  MEMBER  STATES  AND  COMPETENT 
AUTHORITIES 

In  March  2006  DG  MARKT  services  addressed  a  questionnaire  to  the  Member  States  and 
their  respective  competent  authorities  asking  for  information  concerning  the  application  of 
professional  indemnity  insurance  under  the  IMD  and  the  re-cast  CAD.  19  responses  to  the 
questionnaire were received.5 The responses have been compiled and published as part of the 
Draft Report on 14 August 2006. As we understand it, the incomplete number of responses is 
due to the fact that, at the time, the transposition of the IMD had only been completed recently 

5 

Responses were received from Austria, Cyprus, the Czech Republic, Finland, France, Greece, Hungary, 
Ireland,  Malta,  Netherlands,  Norway,  Poland,  Romania,  Slovakia,  Spain,  Sweden,  and  the  United 
Kingdom.  Belgium,  Denmark,  Germany,  Italy,  Estonia,  Latvia,  Lithuania,  Luxembourg  and  Portugal 
did not provide a response 

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in many Member States and that the transposition deadline for most of the provisions of the 
re-cast CAD had not yet expired.  

For the same reasons, it is clear from the available responses that Member States generally 
have little experience and available data on which to base an adequate assessment of the 
impact of the regime introduced by these directives on firms and protection it offers to 
consumers.  Furthermore,  it  is  hard  to  predict  what  the  impact  will  be  on  MiFID 
intermediaries that also carry on insurance intermediation business under the IMD. It seems 
that adequate data which would allow for a proper evaluation will not be available until early 
2008. 

The detailed Member States responses as well as the summary which is part of a draft report 
have been published and are available on the Commission web site6.  

4. 

PUBLIC CONSULTATION ON THE DRAFT REPORT 

The  Commission  invited  interested  parties  to  comment  on  the  Draft  Report  by  31  October 
2006. The recommended format was for respondents to submit general remarks followed by 
answers to specific questions.  

Comments were received from 7 organisations. One was pan- European and represented the 
joint response  from insurance intermediary associations from 14 EU Member States.  Of  the 
others,  4  were  based  in  the  UK,  one  in  Germany  and  one  in  Austria.  The  respondent 
organisations represented various sectors of the insurance industry (brokers, agents, insurers, 
underwriters),  one  represented  independent  financial  advisers  and  one  was  a  regulator.  This 
section summarises the most important outcome of the public consultation.7  

4.1. 

Results of the consultation 

It is important to note that all respondents agreed that PII was an effective form of investor 
protection and most said that it could not be fully replaced by capital requirements. However, 
respondents were divided on the question as to whether the current regulatory PII regime is an 
appropriate 
investor  protection  measure.  Some  respondents  argued  for  stricter  PII 
requirements  while  others  favoured  a  more  flexible  approach  adapted  to  the  size  and  risk 
profile of individual firms  

Two  respondents  said  that  firms  should  be  permitted  to  supplement  or  wholly  replace  PII 
protection with capital requirements to ensure that the lack of affordable PII would not lead to 
the failure of intermediaries.  

One respondent representing insurance agents described the PII requirements as a significant 
and unnecessary burden which had prompted insurers to shift the cost of PII onto their agents. 

Two  respondents  urged  the  Commission  to  undertake  a  further  review  of  the  situation  once 
the  Directives  are  in  full  operation  in  all  Member  States  to  enable  a  more  complete 
assessment. 

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http://ec.europa.eu/internal_market/securities/isd/mifid_reports_en.htm  
A  more  detailed  summary  of 
http://ec.europa.eu/internal_market/securities/isd/mifid_reports_en.htm  

responses 

the 

to 

the  specific  questions 

is  available  at 

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5. 

CONCLUSIONS 

The  analysis  of  the  information  provided  by  Member  States  as  well  as  stakeholders  in 
response  to  the  two  rounds  of  consultation  suggests  that,  on  the  limited  evidence  that  is 
currently  available,  the  policy  reasons  that  motivated  the  PII  requirements  imposed  under 
community  law  remain  valid,  and  there  is  insufficient  evidence  to  indicate  that  those 
requirements are no longer appropriate.  

However, it is also clear that it is too early to make a comprehensive assessment of how those 
requirements impact on the service providers and consumers. The regime under the IMD has 
only been in place in Member States for a short time, and States have no experience at all of 
the  application  of  the  new  PII  requirements  for  investment  firms  under  the  re-cast  CAD.  A 
proper  evaluation  of  the  continued  appropriateness  of  those  requirements  cannot  be  made 
without  more  practical  experience  and  data,  and  that  will  not  be  available  until  the 
requirements  under  the  re-cast  CAD  have  been  implemented  and  applied  in  Member  States 
for at least one year. Then, it may be appropriate to further investigate whether PII and capital 
requirements are adequate substitutes. Accordingly, the Commission will continue to monitor 
the situation if evidence of market failure emerges.  

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