Having the right insurance policies in place might not necessarily be top of the to-do list when setting up a hedge fund. This article is part of a 4-part series detailing some of the key risk areas and insurance solutions when setting up a hedge fund.
This article details the importance of financial insurance, a category of insurance designed to protect a hedge fund from professional and director level liability.
There are two main forms of financial insurances to be aware of:
- Professional Indemnity (PI) insurance
- Directors and Officers (D&O) insurance
Professional Indemnity Insurance
Professional Indemnity insurance covers professionals for their legal liability to compensate other parties (generally their clients) for any losses they suffer as a result of the professionals’ breach of their professional duty (known as professional liability).
The insurance also covers the professionals’ legal liability for the legal expenses that other parties incur in making the above claims for compensation, as well as the legal expenses incurred by the professionals in defending the claims (defence costs).
Directors & Officers Insurance
Directors & Officers insurance cover directors and officers for their legal liability to compensate other parties for the loss which they suffer as a result of any wrongful act, error or omission committed by the directors and officers. ‘Other parties’ in this context could be shareholders, the company, competitors, employees and liquidators.
“For example, if the director decides to move the office to Dorset, which results in a loss of talent within the firm, the said director could be sued by one of the fund’s shareholders for any loss of earnings,” says Swadling. “The D&O insurance also covers costs of any formal or official hearing, investigation or inquiry by any official body into the affairs of the Company, or a director or officer.”
Limit of Liability
Hedge fund managers can choose the limit of liability they wish to have in the policy. Typically, this will be predicated on the amount of assets under management which Willis will take into account when giving a range of options across PI, D&O and Fund D&O insurance.
Choosing that limit of liability will depend on each individual hedge fund manager. However, based on existing Willis hedge fund clients, Swadling is able to provide some general ballpark figures as a rough guide:
Clients with Assets under Management (AuM) of less than USD1bn, on average, purchase around USD28k of financial insurance per USD1mn of AuM. A manager launching with USD300mn would therefore require a liability limit of USD8.4mn, which we would typically round up to USD10mn.
That liability limit can either be in the form of one consolidated pot, meaning the USD10mn limit would apply across PI, D&O and fund D&O. Alternatively, the manager could choose to establish separate lines of liability covering them for up to USD10mn on claims against PI, up to USD10mn on claims against D&O and up to USD10mn on claims against Fund D&O.
“We see a range from USD10,000 of financial insurance per million of AuM up to USD100,000 of insurance per USD1mn of AuM. It’s really up to the manager to decide based on the range of options Willis (or any other broker) is able to provide,” says Swadling.
Cost to the Manager
In terms of cost to the manager, in relation to their financial insurances, it will again fluctuate on a case-by-case basis. As a general rule of thumb, Willis’ clients pay 0.6 per cent of the limit of liability for their financial insurance policies. A manager with USD5mn liability limit would therefore be looking at a premium of circa USD30K per annum.
How that percentage is calculated will depend on various risk factors taken into account by the insurer. For example, a hedge fund with a high US investor base might be expected to pay a higher premium purely because of the litigious nature of US investors. Ultimately, the insurer will want to know as much about the hedge fund as any institutional investor would when doing their due diligence.
“They will look at the fund’s AuM, the organizational structure chart, the investment management agreement, remuneration, details of financials and business plans, as well as biographies on key individuals,” says Swadling.
Sam Swadling is Business Development Executive in Willis FINEX Global‘s hedge fund practice group, where he focuses predominately on professional indemnity and directors & officers liability insurance for the hedge fund and asset management community. He has been with Willis since 2012.