Digital Assets & Investment Management Liability Insurance: Market Snapshot

Digital Assets (DA) such as Cryptocurrency, NFTs, DeFi, & Web3.0, have swiftly moved from a fringe speculative investment into the forefront of the Investment world.  As an RIA, whether you like it or not, these assets are here to stay, and you likely have multiple clients inquiring about them.  Many new options also now exist for managing these assets.  Consequently, these new management options present two important questions: “How do I manage this risk, and does my E&O insurance cover these investment recommendations?”

The most important thing to understand about the Investment Advisor E&O marketplace is ALL CARRIERS HAVE DIFFERENT COVERAGE FORMS AND UNDERWRITING APPETITES.  There are two basic underwriting categories of carriers: conservative vs. liberal (i.e., DA deemed acceptable).  Since DA have only recently become popular with the public, the insurance underwriting marketplace is still trying to determine how they want to cover or exclude these investments.  Footnote, this is ever-changing and evolving and not all DA are viewed the same.

In January 2022, we held roundtable talks with 10 key insurance carriers to talk through the DA exposures, grasp their current viewpoints, appetites, and establish some underwriting guidelines so we can all move forward successfully (insureds and insurers).  Overwhelmingly, many of the key carriers open to higher risk investment strategies confirmed – as our office interpreted in their contract forms – that DA are not excluded.  While the more conservative carriers, who often have already specific exclusions surrounding DA, are open to insuring DA in certain scenarios based on how the RIA is investing assets in the space.

As an aside, overwhelmingly, the greatest concerns amongst underwriters were (1) lack of clarity regarding DA regulation and (2) safekeeping of DA within various custodial platforms. As clarity and security increase, coverage terms are likely to improve.

Now that we have an overview of the marketplace, how do we determine if coverage is provided by a carrier?  This depends largely on how you plan (or have already employed) to incorporate DA into the firm’s operations. The following are some ways you can advise clients around this investment class:

Option 1: Financial planning that incorporates currently held DA into investment recommendations.  In this case, you will find insurance carriers, both conservative and liberal, are comfortable covering this risk. Especially if you are not directly billing on DA, many of the conservative carriers have endorsements to provide affirmative coverage for financial planning recommendations.

Option 2:  Investing into the asset class through a liquid security that tracks DA in some form (Futures ETF, Mining Stocks, Companies that invest in Blockchain assets, Etc.).  If you take this approach, both conservative and liberal underwriters are willing to provide coverage.  It is very important that you understand the specific structure of the investment product(s) you are recommending.  For example, some conservative underwriters will deem the Bitcoin Futures ETF as acceptable yet Greyscale, at this juncture, not.

Option 3:  Direct Investing into Digital Assets.  If you plan to take this approach, underwriting can be more complex.  If you are insured with a carrier who is open to higher risk strategies, they will typically desire total AUM in this category to be 5% or less.  If you plan to invest in direct DA, carriers currently, consider this a higher underwriting risk; expect more underwriting questions, and potentially higher premiums and deductibles.  If you happen to be insured by one of the carriers that specifically excludes DA recommendations, it is imperative your insurance broker understands what risk-management protocols are employed by the firm to help mitigate your exposure to client complaints.  If you are proactively controlling risk, there is a higher likelihood coverage can be acquired.  For the conservative underwriters to consider offering coverage for direct investing in DA, you should have the following proactive measures in place:

1. A good compliance program surrounding these assets, including ADV Disclosures.
2. A 5% maximum allocation in Digital Assets for specific clients and not rolling it out to all clients regardless of risk tolerance.
3. Additional disclosures where clients acknowledge the risk/volatility within the space.

Even with the above, if insured by a conservative carrier, be prepared for an additional premium charge to obtain DA coverage extension.

Since carriers are, currently, still digesting and figuring out how they want to cover DA, it is important that any Investment Advisor looking into recommending DA work with a broker who understands this space.  What was true six months ago, can easily be different now and in the future.

To gain further education, and to serve clients better on the subject of Digital Assets, Cameron Norris completed the Digital Asset Council of Financial Professionals (DACFP) Certification in March 2022. Others on the team are in the process of completing the coursework and we look forward to having quality, in-depth, conversations as the subject arises.

Golsan Scruggs is an insurance brokerage firm operating throughout the United States specializing in investment advisor E&O errors & omissions insurance (aka professional liability insurance) for RIA registered investment advisors. As one of the largest insurers of RIA firms in the U.S., we have a dedicated staff that understands the risks of the financial services industry and delivers superior results.  We make the underwriting process painless.

At Golsan Scruggs, we believe it is incumbent upon us to earn the right to be appointed as your insurance and risk-management agent. Our RIASURE process exists to serve that purpose.

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