Hedge Fund D&O and E&O Insurance. Do you really need it?
I’m often asked by hedge fund managers about the need for D&O and E&O Insurance?
I’m just a startup, what’s the risk?
I’m a very low-risk fund, who’s going to sue me?
I get it. Fund managers are risk-takers. It’s what makes you successful. It’s what you do for a living.
So I’m not surprised when a hedge fund manager says – Look the only reason I’m buying hedge fund D&O and E&O insurance is because a big client (usually a pension fund) requires it. Otherwise, I’d just go bare.
For me in the insurance business, this always feels a bit shocking. I think to myself, why risk the tremendous cost of a potential lawsuit for a relatively small premium that insurance often costs?
Rather than argue about who’s right or who’s wrong, because I don’t think anyone is really right or wrong on this issue, it’s really about perspective, I thought I’d give you my perspective on it.
Hedge fund managers face potential liability risks from two main sources:
- Your clients can allege some form of malfeasance or wrongdoing when it comes to their money and their expectations of returns based on what’s been “sold” to them. You’ll notice that I said “can allege” because we often think of these types of claims in just their settlement costs and not what an allegation may cost just to defend to the point of being dismissed. The average defense cost associated with a claim that is eventually dismissed is around $400,000 – which is pretty staggering. You’ll pay a good portion of that in your retention (today that’s averaging $250,000), but if the claim really blows up you’ll have the protection.
- The second source is other “interested parties” who may include client/investors, partners, creditors, vendors, competitors, and most importantly government regulators who may allege wrongdoing in the operation of the business.
For fund managers, the dread associated with a regulatory inquiry is only surpassed by the potential costs which often are covered by insurance.
The point is that while the retention or deductible you’ll pay out of pocket is typically high – in the neighborhood of $250,000, the potential out-of-pocket costs beyond the retention is still very high and can easily reach into the millions for defense and settlement costs.
So what’s the offsetting premium cost for a hedge fund?
Today for startup funds and those younger funds with less than $100M under management we’re seeing premiums for hedge fund D&O and E&O insurance start at around $15,000 for the first million of coverage and following layers of coverage slightly lower per million.
So if you purchased a $3M limit of liability the premiums would generally not total $45,000 but probably be closer to the $40,000 ballpark.
How much coverage should you buy? We’re seeing most new funds start at the $1m limit mark for the most part. Some funds have clients with larger investments mandate higher limits, which we can accommodate, but generally, $1M seems to be the starting point.
Once a fund exceeds the $100 AUM we have a conversation about higher limits on renewal and in many cases, the fund managers, now past the start-up cost phase of life are agreeable to the additional protection.
Want to learn more? Give me a call, or drop me an email so we can schedule time to chat. My goal is to help design the right protection program to fit your needs today and to keep it up to date down the road while making the process as painless as possible.
For hedge funds, we’re a boutique insurance brokerage focused on the needs of the financial services community with robust expertise in this space, and great market access to assure that we can get you the coverage you need, tailored to your situation, at an affordable price.