InsureHedge is a division of Brown & Brown of NY Inc., the 7th largest US insurance brokerage. We have been the premier source for insurance for hedge funds, mutual funds and financial institutions. We are a licensed insurance agency, contracted with reputable insurance companies, who will shop for the best coverage at the best price. Choose InsureHedge to outsource your company’s insurance and risk management needs.
The insurance community firmly believes there is a big gray area between these coverages with respect to hedge funds, and that pure D&O does not offer adequate protection. There is also a concept called allocation which makes the case for comprehensive coverage. Insurance companies will not, as a rule, sell D&O coverage only to hedge funds, and since the incremental cost to include E&O is not that great, we feel you should purchase the comprehensive policy. You might be interested to review this table, which explains the differences in coverage as well as this document on “allocation”.
Smaller funds or start-ups with less than $100M AUM will typically purchase a $1,000,000 limit with a $100,000 – $150,000 retention (there are exceptions). Coverage and limit selection should always include your attorneys and other advisers. You would then “grow” into a higher limit, like 2 or 3 million, as the assets under management increase.
No matter how well-run your firm is, you are not insulated from management liabilities, particularly in the current environment. In the midst of volatile market conditions, an increased focus on corporate governance and the potential for greater regulatory scrutiny, hedge funds face a wide array of liability exposures for the fund, its general partners and affiliated service providers.
For example, a hedge fund assumes vicarious liability for the actions of its outside service providers. If an error is made in misstating performance or in the financials, the fund bears responsibility.
Among other reasons, hedge funds can be sued for mismanagement, misrepresentation, employment practices violations, breach of duty, and failure to provide adequate disclosure of the investment risks involved. These suits can be brought by a myriad of sources: customers, members, employees of the fund, and may be directed at the general partner, managing member, directors and officers, investment manager or the fund itself.
The limit of insurance is not directly linked to the assets under management. Many hedge fund managers question the wisdom of carrying a $1,000,000 limit of insurance, when, if things “blow up”, suits would easily exceed this. As stated below, this type of policy is designed to pay defense costs for a mistake, not fund the loss of tens of millions of dollars of trading losses. The policy would be prohibitively expensive if it covered 25% or 50% of fund assets. Plus you have to remember most claims are settled and the largest component is defense.
This type of coverage has always been catastrophic in nature, not first dollar coverage, and the intent of higher retentions is twofold: to make the claim attachment point for insurance companies high enough to keep the premiums from becoming stratospheric; and second to make hedge funds have some “skin in the game”.
Insurance companies are moving to higher standard retentions due to the current market conditions and the regulatory environment surrounding hedge funds. Over the last several years we have seen minimum retentions move from a range of $100,000 to $250,000 to $300,000-$500,000 for larger funds. For funds with less than $250 million under management the retention can still be as low as $100,000.
There are three primary reasons to purchase this coverage:
- Most, if not all, lawsuits against hedge funds are settled and the policy is used primarily to fund defense costs and indemnify the fund for these expenses, should the fund managers be indemnified by the fund. The coverage prevents a fund from needing to liquidate positions or use cash to pay for defense costs.
- To give investors and service providers an extra degree of security and comfort. This broad coverage is an excellent selling point to potential investors.
- To provide employment practices liability coverage to protect the firm against employee suits. You definitely need this coverage,
- Optionally some funds buy the outside directorship liability module to provide additional protection in connection with the outside boards they serve on (non-profit, for profit).
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