The market for selling liability insurance to hedge fund managers has been described as a feeding frenzy but some commentators think they do not deserve their reputation for volatile, high-risk exposures. Ralph Savage reports
'Absolute return' managers, who promise to make money in both bull and bear markets, have generally been the preserve of high net worth investors and a smattering of banks. However, with the advent of 'A Day' in April this year, when the government opened up the market for self-invested personal pensions, several insurers, brokers and law firms began to push the issue of hedge fund liability to the top of the agenda. Some suggested that this market - should it begin accepting retail investment - would be exposing itself to untold levels of claims and litigation with the vast majority of managers having no insurance to protect them.
The London market is key for insuring these risks - with firms such as Novae, Brit, AIG, Dual Corporate Risks and Hardy writing the most. This year, two insurers publicly promoting their wares have been Ace and Chubb, the former announcing that its broad-based Elite Investment Management product had been well received in the hedge fund community, and Chubb launching professional indemnity specifically aimed at hedge funds.
Richard Coello, financial institutions underwriter at Ace Europe, explains that EIM is a catch-all investment management product incorporating errors and omissions, directors' and officers' and PI coverage, but Ace is wary of retail exposures for hedge funds: "We don't want to be seen as making a big push for it," says Mr Coello. "Our product is designed to be broader than simply hedge funds - it covers everything from private equity and hedge funds to mutual funds invested in equities alone."
Chubb Speciality Insurance's European product manager, Michael Tyssen, adds: "As a general rule we prefer to insure hedge funds with an institutional investor base rather than those with a retail investor base because institutional investors - contrary to most retail investors - are experienced professionals who better understand the specific risks involved with hedge funds."
However, Lloyd's broker Baronsmead, which specialises in the sector, reports that Ace and Chubb's decision to avoid retail exposures is not representative of any wider trend. "Quite the opposite," says Robert Kelly, managing director at Baronsmead. "In the investment world there are only a few hedge funds but if you look at how many independent financial advisers, investment managers and building societies there are, the exposures from them are far greater. There's a growing acknowledgement from the regulator that these funds are lower risk than people perceive."
Richard Ellis, associate director in Aon's Professional Risks Unit, adds: "The jury is still out as to whether we will see a 'retailisation' of the hedge fund space but if it does happen, as many observers expect, those investment managers and funds who already have PI and D&O liability programmes in place will be at an advantage."
Rupert Boswall, partner at law firm Reynolds Porter Chamberlain, explains the areas where hedge funds can come unstuck and why PI insurance is a sensible tool. "The core exposures are the investment manager giving negligent advice to the fund, or trading errors - the sort of 'fat finger' problems. There are also grounds for a claim when it is alleged the fund's entire strategy was negligently conceived and executed."
Generally speaking, Mr Boswall says the directors of a fund are normally covered under D&O but PI for the managers themselves has a low take-up, with around 75% to 80% of fund managers having no cover against negligence claims. "I don't think there ever will be rules to indemnify all hedge fund managers but there is certainly a case for a higher percentage to at least be seen to have it. It also makes economic sense to them as a hedge in itself."
Broker Willis has also made a significant play for the hedge fund sector in recent months, with its financial institutions team of 25 working with around 70 hedge fund clients. Last December, Willis hooked up with specialist intermediary ASF Financial in a joint venture to target this sector. Duncan Holmes, executive director of Willis' financial institutions practice, explains: "We thought that product development was lacking in the sector so we have come up with our own proprietory product, with wordings specifically tailored to the hedge fund sector.
"The hedge fund community is quite insular and, in order to access the market, you often have to speak with prime brokers, outsourced administrators, compliance companies and law firms. This is why we connected with ASF."
Of course, wherever Willis and Aon compete, Marsh is generally there too. Calum McPherson, senior vice-president at the latter's Finpro practice, returns to the concerns about retail exposures: "Even without any developments into the retail sector there is a growing interest in insurance from both managers and funds," he says. "There are a number of factors - not least the investors requesting managers have suitable insurance in place." Referring to the recent furore over split capital investment trusts where the mis-selling of these vehicles led to regulatory intervention and huge multi-million-pound fines, he adds: "The insurance market's concerns over retail exposure are clearly based on past systemic problems in the wider investment management arena."
Mr Kelly highlights this as evidence of the misplaced perceptions regarding hedge funds. "The drivers for price are the assets of the fund and the fees for the manager. Since the hedge fund market has a higher fee structure than the conventional market, this often prompts underwriters to charge higher rates, but is their exposure greater?"
He explains hedge funds tend to charge a 2% management fee (based on funds under management) and a 20% performance fee. "More traditional fund managers have a much lower fee structure but have more funds under management. Their exposure is far greater and if you look at the split capital investment trust losses, these are driven by the regulator, which fines the managers heavily."
With the consensus being that hedge fund managers should look at PI cover more seriously, it appears there is no shortage of willing brokers and insurers hoping to sell it to them. However, the crystal ball view on these fabled exposures to angry retail investors is somewhat cloudy. Mr Boswall concludes: "There is a feeding frenzy at the moment to get more of this business but the main frustration lies in persuading the fund managers to buy this cover. The essence of the exposures are clear already. In practice, when more retail money heads towards hedge funds, the real exposures will be on the IFAs if they recommend them."
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