Insider-Trading Fears Raise Insurance Rates for Hedge Funds

Insider-Trading Fears Raise Insurance Rates for Hedge Funds
June 10, 2012

Insurance companies are asking for higher rates for hedge funds’ directors and officers (D&O) and errors and omissions (E&O) insurance after more than two years of price cuts.

The higher insurance rates are being requested in anticipation of more government insider-trading investigations, investor lawsuits, and claim payouts.

According to an analysis by SKCG Group, a risk management and insurance advisor to some of the world’s largest hedge funds, carriers are quoting average rate hikes of between 5 percent to 10 percent for this insurance that fund managers buy to protect themselves from the costs of investigations and lawsuits.

Even the best-run hedge funds are beginning to see requests for increases, while insurers want premiums that are 15 percent higher, or more, from fund managers with poor performance and large redemptions.

Years of Investigations

Insurance companies are responding to expectations of a more aggressive approach by regulators toward Wall Street as fraud and debacles such as MF Global continue to dominate the headlines and force carriers to pay out more claims. The SEC is focusing on compliance issues, including insider dealing and the role of expert networks, and the FBI says it has enough information to keep its investigations of suspected illegal insider trading at hedge funds going for at least five more years.

“Insurance carriers know that hedge funds are in regulators’ crosshairs,” said Richard Canter, president and chief operating officer of SKCG. “More than just insider trading, the SEC is cracking down on a variety of areas, and when regulators come knocking, the cost to defend these funds is seldom cheap and the insurers may be on the hook for it.”

Millions a Case

Investigations and any resulting lawsuits can cost tens of millions of dollars, Canter says. At the deposition stage, a defense can burn through as much as $1 million a month.

The cost of E&O and D&O insurance had declined in recent years, to the benefit of hedge funds, as insurance companies had initially increased rates following the Madoff scandal, expecting a flood of lawsuits and investigations. Those lawsuits did not materialize as predicted, making this niche of the property and casualty insurance market particularly attractive to the new insurance company entrants who flooded in.

Combined with the fact that fewer hedge funds were launched in the wake of the 2008 credit crisis, this created more supply than demand for coverage, which drove premiums down dramatically, sometimes by as much as 50 percent for smaller, newly launched hedge funds.

—Staff report