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What are the primary reasons hedge funds buy professional liability insurance?
Not long ago it was rare for clients to bring legal action against their investment managers. Unfortunately for the industry that is no longer the case. Today’s financial press is replete with allegations of fraud and wrong doing against investment managers. In addition to investors who believe that they have been wronged, regulators at both the State and Federal levels are more likely to initiate investigations that culminate in formal regulatory or legal proceedings. The purchase of Professional Liability Insurance is one-way investment and fund managers can protect themselves and their business. Properly tailored coverage will provide you, the investment manager, with a mechanism to defend yourself against allegations of wrongdoing and to protect your personal assets should an action result in a judgment against you. Pending SEC registration requirements will bring managers’ actions under closer scrutiny, making administrative or legal actions more likely. These registration requirements may well test the scope and breadth of your indemnification. If your indemnification does not apply, your personal liability would put your assets at risk. Accordingly, if you are a responsible firm manager in today’s environment, it is imperative that you seriously investigate the protection available to you and your key staff from a Professional Liability and Directors and Officers Liability program.
I maintain very strict operational procedures within the management of my fund. Why should I buy this coverage?
The short answer is that the coverage will provide you with valuable defense cost protection should you or your team be charged with mismanagement or wrongdoing. In addition, the indemnity component protects you should a settlement be required or a judgment entered against you. It is extremely costly to defend claims alleging financial mismanagement and the purchase of insurance with its important defense element is vital for protecting your assets.
Why are retentions on these policies so high?
Retentions for various types of financial Professional Liability Insurance may appear on the high side due to the extensive regulatory scrutiny that Hedge Funds receive and the fact that the defense of legal actions is so costly.
How do I determine the adequate amount of coverage to carry? Should it be determined by the assets under management?
While the purchase of a specific limit is somewhat subjective and varies from manager to manager, a key benchmark is the level of assets under management coupled with the sophistication of the investment strategy. In short, the bigger the fund and the more complicated the investment strategy, the more limits one should consider purchasing.
Are there typical limits carried by small, medium and large funds? Is there benchmarking data available?
The average limit carried by most Hedge Funds tends to be in the $5,000,000 range. It is possible to purchase lower limits if the fund is managing a small asset pool. Conversely, funds with assets beyond a billion will normally carry much higher limits. Coverages are generally available in $5,000,000 to $10,000,000 layers and a proper limit can be structured for any fund.
Why can't I buy D&O coverage without E&O coverage?
The reason for this is quite simple. In the vast majority of claims against investment managers, it is difficult or impossible to separate the D&O exposure from the E&O exposure. For example, if a fund were to experience style drift or a cost correction problem, which would be categorized as an Error or Omission, it is likely that the D&O’s, GP’s or managing members would be sued along with the professional staff. It is also important to note that in any alternative investment arena, where investment assets flow to funds based on the pedigree of the manager, it is likely that an E&O claim will be filed in addition to a D&O claim alleging improper management policy.
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