Educate | Empower | Protect

Financial Services FAQ

What types of Insurance Protection are available for a firm like ours?

While there are a variety of insurance products specific to Financial Institutions, there are two (2) main types of protection that an Investment Manager and/or Hedge Fund should be thinking about or in many cases have been contractually required to carry as part of an Investors’ due diligence guidelines. The first type of protection is a 1st Party Crime Bond or what is referred to as a Fidelity Bond (aka Financial Institution Bond, Form 14 Bond, etc.).

The basic fidelity bond is a form of 1st party protection which covers loss of money, securities or other property owned by the insured, held by the insured, or for which the insured is legally liable, when such loss is due to the dishonesty of the insured’s employees. Protection is also available for forgery or alteration of checks and other instruments that are drawn by the insured; theft, disappearance and destruction of money and securities; and fraudulent transfer of property via use of a computer.

The 2nd type of Insurance is referred to as Professional Liability/Errors and Omissions (E&O) and Directors & Officers/Management Liability Insurance (D&O). This type of coverage affords protection against 3rd party lawsuits and/or regulatory investigations. Coverage will be provided for the defense and legal fees as well as any potential indemnification due to a claimant.

Sample litigants could include:

  • Investors
  • Limited Partners
  • Shareholders
  • Regulatory Agencies
  • Creditors &
  • Vendors

Allegations would include but is not limited to negligence, breach of fiduciary obligation, failure to supervise, compliance breach or rendering/failing to render investment advice by an Investment Manager/General Partner/Board of Directors/Advisory Board or similar positions thereof. E&O/D&O coverage is very similar to that of malpractice insurance for the medical profession. Other coverage’s such as Employment Practices Liability can also be added to a joint insured E&O/D&O policy to protect against claims by employees alleging wrongful termination, discrimination, sexual harassment, etc. for a nominal cost if any.

Who would be covered under a E&O/D&O Policy?

All past, present & future directors, officers, members, partners & employees of the named insured organizations. As long as all entities that are part of the respective organization are listed as insureds under the policy, then all individuals are automatically covered. That said, it is imperative to make sure all of the relative Investment Advisory/Management entities, General Partners and all funds (both masters and feeders) are specifically named.

Have there been claims?

Yes! The general frequency of claims activity and complaints by investors has increased substantially over the past few years. Moreover, litigation and defense costs/fees have also increased dramatically with the average claim costing north of $5,000,000 to defend. Specific claims related information is available upon request.

How do the Insurance Company’s determine the pricing for the coverage?

The underwriting methodology used in determining E&O/D&O Pricing is quite subjective and ideally based on each insurance company’s appetite for risk. That said, underwriters typically request the following information in order to conduct their due diligence and determine pricing.

  1. Fund Financials
  2. Performance Data
  3. Offering Memorandums
  4. ADV Part I & II
  5. Investment Strategy & Focus
  6. Redemption & Subscription Activity
  7. Due Diligence Questionnaire
Can the fund bear some of the cost of the insurance?

Yes. Based on our experience with other hedge funds and discussions with the various insurance companies, the typical and recommended premium allocation is 80% to the funds and 20% to the management companies. The portion allocated to the various investment funds can be further allocated predicated on the % of AUM of each fund as it relates to the total AUM. The main reason the funds bear a good portion of the total cost is that the insurance fulfills the funds’ indemnity obligation to its directors, officers, general partner(s), managing members or equivalent positions thereof as well as provides entity coverage for the fund itself. In the event of a claim, should the general partner or directors & officers require indemnification, fund assets will NOT be used to fund their necessary defense.

How much Insurance should we carry?

While there isn’t an exact science to selecting the appropriate amount of insurance nor is it a requirement by any regulatory body (like that of Fidelity Bonds for Registered Mutual Funds), a general rule of thumb is .5-1% of total assets under management. In our experience, our clients have either been above or below this range due to their own specific risk appetite. This guide combined with a sampling of peer data that includes companies of similar size and stature and the corresponding amount of E&O/D&O insurance carried should provide a good barometer of the appropriate amount of coverage to carry.