07 Jul Securing Proper Investment Management Liability Insurance: The Who & The What
Article originally published June 21, 2022 on IIA website.
Life teaches that success is based not only on what you know but also on who you know. Additionally, life teaches that success includes the avoidance of or protection from unnecessary risk.
When investors select an investment adviser, both the “who” and the “what” are important. All advisers – the “who” – are not the same. To the investing client, one adviser may seem appropriate, yet a different adviser may be a better fit depending on the client’s investment objectives and other needs – the aforementioned being the “what.”
This “Who & What” principle equally applies to the subject of Investment Management Liability Insurance, e.g., Errors & Omissions (E&O) and Directors & Officers (D&O) Liability. The “who” being the insurance broker selected. The “what” being the particular insurance company, its policy contract forms, endorsements, and provisions (negotiated by the “who” broker) insuring the advisory operation.
Investment managers may feel they have adequate E&O/D&O coverage placed through a broker with an insurance company and contract, yet that may not be the case. How crucial is this concern?
E&O/D&O claims can be boiled down into five legal “camps” as follows:
(1) Transactional losses (ex: trade errors)
(2) Suitability claims (ex: breach of fiduciary duty)
(3) Regulatory matters (ex: formal orders of investigation, Wells Notices, and SEC subpoenas)
(4) Violation of trade practices, libel, and/or defamation (ex: competitor disputes)
(5) Minority shareholder disputes
These claims and/or legal actions, while infrequent, are normally quite severe in nature. Therefore, the “who vs. what” maxim is critical — and there are three key points investment management firms should know:
- No Standard Insurance Contract: Most common forms of commercial insurance (property, auto, product liability, etc.) are written with commoditized language under the oversight of the Insurance Services Office (ISO) — an organization that provides data and services to insurance companies. Yet in the case of investment management liability insurance, no such oversight exists. ISO asserts that the exposures presented by the investment marketplace are constantly changing and too unique for them to address. Therefore, underwriters choosing to insure asset managers are free to issue their own independent and unique policy contracts with differing terms, conditions, definitions, limitations, exclusions, etc. Additionally, many carriers issue their contracts on what is called a “non-admitted” basis; meaning, they are free to modify terms and conditions with very little state-by-state regulatory supervision. Contract language in the investment management underwriting arena is ever-changing and subject to constant modifications.
- Underwriter Limitations: Underwriters speak insurance. Naturally, they may have limited knowledge of the investment world and its many aspects and vocabulary. As coverage forms are non-standard, the insurance contract issued may contain provisions that do not synchronize with a firm’s exposures and characteristics. Different asset categories and investment terminology can be foreign language to underwriter generalists insuring a multitude of different commercial risks.
- Agent/Broker Limitations: Because most insurance brokers are generalists insuring a variety of different industries, they, too, may have limitations such as knowledge of: the investment world; how coverage must be structured to meet the respective fiduciary profile of the asset manager; how to effectively explain the individual risk profile and asset exposure to the underwriter; and insurance marketplace relationship depth and carrier placement authority. Retaining an inexperienced broker who then submits your account to an equally inexperienced underwriter can only compound the problem and result in the issuance of an unsuitable insurance contract.
With that knowledge, how should an adviser approach the process of securing the most effective investment management liability (E&O/D&O) insurance?
Foremost, know your “who” (broker) by determining:
- How long have the respective agent and agency been insuring investment managers? How many investment management firms do they insure?
- Do they have a process for analyzing the firm’s individual fiduciary exposures and presenting how the insurance contract is structured to meet those exposures?
- To what degree have they asked questions that demonstrate their knowledge of the investment management space and its exposures?
- What is the depth of their underwriting market appointment authority and relationships?
Through that important “who” (broker) selection, a firm should be able to then move confidently toward the selection of the proper “what” (insurance product solution). Get the “who” right first, and the right “what” should naturally follow: avoidance and protection from unnecessary risk.
Ken Golsan is co-founder/managing director and Brian Francetich is director of GSRIA at Golsan Scruggs, a nationally recognized insurance brokerage team specializing in insuring investment managers.
This article is for general information purposes and is not intended to be and should not be taken as legal or other advice. The views and opinions expressed in this article are those of the author and do not necessarily reflect those of the IAA.
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