Friday, May 22, 2009

Hedge Fund Insurance Costs Rise as Lehman, Madoff Spur Scrutiny

The cost of insuring hedge funds against negligence has risen as much as 20 percent in the past six months after Lehman Brothers Holdings Inc.’s bankruptcy and Bernard Madoff’s Ponzi scheme increased the threat of lawsuits.

A fund manager with $200 million of assets running a “straightforward” strategy is typically paying as much as $60,000 a year for $5 million of coverage, up from $50,000 at the end 2008, said Brian Horwell, director of professional risks at London-based Miller Insurance Services Ltd.

“We’ve had Lehman Brothers, Madoff and the financial downturn, all of which are hitting claims,” said Paul Towler, head of financial and professional insurance at Jardine Lloyd Thompson Group Plc in London. “There’s a lot of worry and concern about what other claims are still to come out.”

The cost of so-called errors and omissions insurance, which is sold by companies including American International Group Inc., Allianz AG and Brit Insurance Holdings Plc, is climbing as investors seek to claw back losses from the worst global recession since World War II. Madoff clients have filed at least 8,848 claims to recoup losses, according to Irving Picard, the trustee liquidating his money-management firm.

“As long as everyone’s making money, nobody cares,” said Evan Rosenberg, senior vice president of specialty insurance at Warren, New Jersey-based Chubb Corp., the second-biggest insurer of corporate boards in the U.S. “Once people start getting hurt financially they start to question, ‘Has my bank, my adviser, my hedge fund misled me?’”

The average hedge fund’s assets fell 18.3 percent last year, and the number of funds closing almost tripled to 1,471, data compiled by Chicago-based Hedge Fund Research Inc. show.

Disputes Increase

Disputes over regulatory and accounting rules increased during the recession. The average cost of settling a complaint filed by the U.S. Securities and Exchange Commission rose to $12.6 million in the first quarter, 50 percent more than last year, according to data compiled by Washington-based NERA Economic Consulting. The number of settlements rose 16 percent from the fourth quarter.

Premiums for errors and omissions insurance are usually quoted on a fund-by-fund basis and depend on measures such as the manager’s past performance, assets under management, location, strategy and the amount of debt held.

Hedge funds with larger amounts of debt and “more complex investments” are the most likely to face higher insurance costs because it’s typically harder for investors to withdraw their money from those funds, Chubb’s Rosenberg said.

‘Nervous’ Underwriters

The coverage, also known as professional indemnity insurance, protects a company against claims for loss or damage by a client or third party due to mistakes or negligence.

“A hedge fund says I’m going to invest in X because it’s safe but instead invests in Y and blows up the fund -- that’s a PI claim,” said Rosenberg, who estimated premiums have increased about 25 percent in the past year.

Robert Kelly, managing director of London-based Baronsmead Insurance Brokers, and Greg Carter, managing director of insurance at Fitch Ratings Ltd., said they have seen premiums climb an average of 10 percent in the past six months.

New York-based AIG and London-based Brit Insurance declined to comment on changes to premiums. Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices, and participate substantially in profits from money invested.

“The premium increases are there because, firstly, the losses that are already with insurers and, secondly, the perception of more litigation to come,” said Horwell of Miller Insurance. “Underwriters are more nervous about saying they fully understand the risk” related to financial services.