Why should I buy this type of coverage?

Basically, there are three primary reasons for this coverage:

  1. Most lawsuits against hedge funds are settled and the policy is used primarily to fund defense costs and indemnify the fund for these expenses.  Your policy would prevent a fund from needing to liquidate positions or use cash to pay for defense costs.
  2. It provides an extra degree of security and comfort to investors and service providers.   This is an excellent selling point to potential investors.
  3. This policy also provides Employment Practices Liability coverage that protects your firm against employee lawsuits.

Optionally, some funds buy the outside directorship liability module to provide additional protection in connection with outside boards on which they serve.

My operations are very well managed. 
Do I still need to buy coverage?

In the current environment, well-run firms are not insulated from management liabilities. Due to the volatility of market conditions, increased focus on corporate governance, and the potential for greater regulatory scrutiny, hedge funds face multiple liability exposures for the fund, its general partners, and affiliated service providers.

For example, a hedge fund assumes vicarious liability for the actions of its outside service providers.  If an error is made in misstating performance or in the financials, the fund will bear the responsibility.

Even well-managed operations can be sued for mismanagement, misrepre-sentation, employment practices violations, breach of duty, and failure to provide adequate disclosure of the investment risks involved.

Should the insurance limit correlate to the assets under management?

Many hedge fund managers wonder why they would carry a $1,000,000 limit of insurance when lawsuits could easily exceed this.  It is important to remember that this type of policy is designed to pay defense costs for a mistake, not fund the loss of tens of millions of dollars of trading losses.  The policy would be prohibitively expensive if it actually covered the fund’s assets.

Why are the “Retentions” so high?

The intent of a high retention is twofold; to make the claim attachment point for insurance companies high enough to keep premiums from rising to un-affordable levels; and second to share the risk with the hedge fund itself.

Recently, standard retentions have been moving higher due to the current market conditions and the regulatory environment surrounding hedge funds.

What limit do smaller funds usually carry?

(less than $250,000,000 under management)

Typically, smaller funds purchase a $1,000,000 limit with a $100,000 or $150,000 retention.  Then, as the assets under management increase, you increase your limits accordingly.  However, coverage and limits selection should always include your attorneys.

Why don’t I just buy Directors & Officers liability without Errors & Omissions?

Basically, because Directors & Officers liability (D&O) does not offer adequate protection.  Also, there is a big gray area between these two coverages with respect to which type of policy would cover certain claims.  There is also a concept called “allocation”, which makes the case for comprehensive coverage.  As a rule, insurance companies will not sell D&O to hedge funds without including E&O and since the incremental cost to include E&O is not that great, both should be obtained.