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

At the same time, insurance companies are cutting coverage for broker-dealers who have exposure to future claims, especially those involving private placements that have gone bust.

Driving higher premiums on the 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 2007 and another 43% to 7,137 last year, according to Washington-based Financial Industry Regulatory Authority Inc.

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

Although not all broker-dealers expect big increases in insurance premiums—some said that they have negotiated single-digit increases, and some said that 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 Fort Lauderdale, Fla.-based Kovack Securities Inc., which has 259 independent rep and financial advisers.

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

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

Exclusions deployed

In addition to increasing premiums, more insurance underwriters are attaching “troubled-investments exclusions” to renewals, said John McKenna, an insurance broker with Garden City, N.Y.-based ARC Excess & Surplus L.L.C. The exclusions typically pertain to real estate deals or other alternative-investment products, he said.

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

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

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

Typically, if a client makes a claim that is covered before the policy is renewed, the insurer 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 the case of Securities America, however, claims made against reps and the firm over Medical Capital Losses will be covered by the firm's 2009 policy, a company source said.

“We care deeply about our advisers and, as we've stated before, plan to vigorously defend them as the Medical Capital issues progress,” said a Securities America spokeswoman.

“Securities America advisers have errors and omissions insurance coverage for claims related to Medical Capital made in 2010,” the 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.

Bruce Kelly is a reporter at Investment News, a sister publication to Business Insurance.