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Insurance: Vehicles Want More

The credit crunch and wave of credit hedge fund collapses has spurred hedge fund and fund of hedge funds managers to take out insurance or reassess their existing policies. Robert Kelly at London-based insurance brokers Baronsmead estimates that fewer than 10% of hedge fund managers in London have no directors and officers (D&O) cover. Under this cover, if investors are unhappy with a fund and seek to make claims against it, the directors’ assets will be protected. “Now, however, and in particular with the push to have independent directors, we are seeing managers take a closer look at the quality of their cover,” says Kelly.

In the US, such insurance cover has been less widely used. Joe Ehrlich of US broker Owens Group says penetration is not what it could be because hedge fund managers, by nature, are comfortable with risk. “That said, certainly those who are having a harder time with their returns have started to think about insurance,” he says.

Ben Hancock of Howden, a Lloyd’s broker specializing in hedge fund management liability insurance, says coverage for many hedge funds has been substandard. “Last summer made people think long and hard about their policies. However, some policies still contain inappropriate exclusions, making them not worth the paper they are written on. Management performance exclusions, major shareholder exclusions and regulatory investigation sub-limits are all examples of unnecessary restrictions of cover that directors and managers should not accept.”

Kelly says there is increasing interest from managers in taking out combined policies of D&O and E&O (errors and omissions), or P&I (professional indemnity) as it is known in the UK. E&O covers losses associated with operational errors. “Some managers trade frequently and are more likely, therefore, to have trade errors, such as processing the wrong volume in stock or the wrong currency. It’s a common event, but in a volatile environment such as now, the market can move before the mistake is corrected and they end up sitting on a big loss.” Managers are also increasingly enquiring about add-on coverage such as crime insurance and fidelity insurance, say brokers.

In the US, hedge fund policy premiums zoomed up last year in response to the markets. The London market has remained largely unchanged, but capacity is limited. Hancock says only a limited number of underwriters will write cover for managers that are investing in CDOs or other structured products. Premiums for those funds have doubled from a year ago.

US managers across the board are seeing some increase in premiums. “Being a more litigious society, we’re expecting a few more claims in the US and prices to go up there,” says Kelly. Hancock says he has heard that insurers are closing down their hedge fund books in the US and not renewing policies.

On the investor side, insurance cover against fraudulent managers was introduced this year by Protean Investment Risks. The biggest interest has come from funds of hedge funds, says Protean founder Nathan Sewell. The policies aim to insure against fraud across an entire portfolio. Policies are based primarily on investors’ due diligence and monitoring expertise rather than underlying manager strategy. Manager experience, location and size does play a part, however. Six insurance firms are at present underwriting the policies, and Sewell expects more to follow.

Article by Helen Avery, courtesy of euromoney.com