Private Fund Risk Profiling – Limited Partner Positioning

Underwriting considerations for Private Fund Managers can be intricate, and in this article, we aim to emphasize the significance of Limited Partner (LP) risk profiling in positioning of your fund(s) with insurers. We often find this aspect overlooked, as Errors & Omissions/Directors & Officers (E&O/D&O) applications in the Private Fund sector tend not to delve into this area extensively. This oversight results in missed opportunities to present your fund more favorably to underwriters and negotiate better terms and conditions.

One might ask, why is LP risk profiling important to underwriters? The straightforward answer is that LPs are the most likely party to litigate against a fund manager/GP, and different demographics of LPs are perceived as less litigious than others. As we delve deeper into this topic, key considerations include Institutional LPs vs. Retail LPs, LP sourcing, minimum fund investment thresholds, and follow-on LP fund participation.

When presenting your fund to underwriters, distinguishing between Institutional LPs and Retail LPs is crucial. For this discussion, institutional LPs encompass endowments, pension plans, foundations, corporations, and family offices, while retail LPs comprise individual investors or families. Underwriters generally favor institutional LPs over retail LPs. Institutional investors are typically more sophisticated, possess longer investment horizons, maintain diversified portfolios, and are more inclined to terminate a GP rather than resort to litigation. Litigation by institutional investors against GPs is viewed unfavorably within the fund community, particularly by top managers. Moreover, litigating against a fund presents a significant business risk for institutional LPs, often leading them to terminate underperforming managers instead.

If your fund is primarily retail LPs, the outlook is not entirely negative. Key areas to address include qualified purchaser requirements, minimum fund investment thresholds, and retail LP sourcing. Funds with mostly qualified purchaser LPs are preferred. QPs are considered more sophisticated and better equipped to handle risks compared to high-net-worth (HNW) LPs. Underwriters in the private fund space generally prefer larger fund minimums, as they attract LPs with greater capital and perceived higher risk tolerance. Additionally, insight into the fund’s capital-raising process can be advantageous during underwriting. For instance, if other broker-dealers or RIAs are introducing LPs to your fund, it suggests that another fiduciary has already vetted the fund for LPs, potentially mitigating liability in the event of a claim.

The final point to highlight is the significance of follow-on LP fund participation. If your fund is in the process of raising capital for the next fund and boasts significant follow-on LP investments, this should be emphasized. Such commitments serve as a strong indicator to underwriters of LP satisfaction and confidence in the GP/management.

As a fund manager approaching the next renewal, remember that LP risk profiling can be a pivotal tool in strengthening your standing with insurance carriers, but it must be approached thoughtfully. Ultimately, your broker serves as your representative to carriers, and effective communication between you (the fund manager) and the broker is paramount.

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.

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