Why purchase a Hedge Fund D&O / E&O Insurance?
As mentioned in other FAQ blog posts on Hedge Funds, Directors and Officers Liability policies and Errors and Omissions policies are very similar in their insuring agreements, structures and exclusions. While the policy forms are similar, they are different. (Yes, the insurance business can seem like one big oxymoron). In this article we explore the hedge fund D&O / E&O insurance policy and why it’s important.
D&O insurance intends to cover decision makers for breaches of fiduciary duty – wrongful acts in operating the firm.
E&O insurance intends to cover claims which arise from errors, omissions, or mistakes made in delivering professional services – namely, operating the fund.
Because potential allegations of wrong doing against a hedge fund can bleed between both wrongful acts in managing the firm as well as executing the firm’s investment strategy, the preferred method of insuring these two exposures in on a combined policy specifically designed for financial institutions such as hedge funds. Since both coverage forms are blended into a single policy with one insurer it reduces the opportunity for disputes over which policy should respond to a claim.
You may ask: “Why should we buy D&O/E&O? We have established guidelines, we follow them, and we’ve never had a problem in the past? And, if a problem does arise, we’ve got plenty of money in the fund.”
Every legitimate business operates under the premise of doing things the right way, yet problems still arise. Insurance, whether it’s to cover your hedge fund D&O/E&O exposure to loss, or fire insurance to cover a property exposure to loss provides two important functions.
- The first is a bucket of contingent capital that can be used to pay for defense costs and ultimately settlements which is separate and apart from your capital under management. Yes, you’ll pay a deductible with your dollars, but after that, it’s the insurance company’s dollars which will be spent, preserving assets under management.
- The second function is to provide you the expertise to respond to a claim and to defend your firm. Whether your policy is a “duty to defend” – which means the insurer assumes your defense once a claim is tendered to them, or a “reimbursement policy” – where you assume defense and tender costs to the insurer, your insurer will be providing guidance and expertise on how to respond to a claim.
The costs of defending against claims can be staggering, even when you’ve done nothing wrong, to be able to delegate those costs and defense functions to an insurer can be invaluable.
The allegations which give rise to claims for Hedge Funds are broad and varied, and can include:
- Claims by investors of misrepresentation or fraud
- Investigations commenced by state and federal regulators and law enforcement agencies.
- Claims arising from activities of directors sitting on outside boards of your investee companies
- Unintentional errors or omissions
- Failure to meet investment expectations
- Failure to follow prescribed investment guidelines
- Conflicts of interest
IMPORTANT – regardless of how a claim occurs or who is bringing the claim it’s important to remember that hedge fund managers face the same unlimited liability as any other corporate director or officer; your personal net worth is on the line! You’ll want to make sure you’re protected sufficiently!
While your partnership agreements may have fairly broad indemnification provisions to indemnify the hedge fund manager, partners, directors and officers from claims, that is not bullet proof. An allegation of conduct which constitutes negligence, willful misconduct, bad faith or fraud may bar indemnification. Indemnification from the firm is also not available in the case of bankruptcy or if the fund is being wound down. These situations strengthen the case for insuring the potential litigation exposure.
What’s the cost of a Hedge Fund D&O/E&O Insurance?
Pricing for D&O/E&O is going to depend on several different factors, but a rough estimate is about $20,000 per million dollar of limit purchased. As you purchase higher limits you will find that the costs start to decline per million of protection. A five million dollar policy is not five times the cost of a one million dollar policy for example.
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Have questions or concerns you’d like to discuss? Give me, Gordon Coyle a call or drop me an email – 845-474-2924 / firstname.lastname@example.org. Thanks!
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