Product Fundamentals: Investment Manager’s Insurance
What is Investment Manager's Insurance?
Investment Managers Insurance (IMI) is a suite of insurance covers designed for financial services licensees and their representatives that raise capital and or manage assets on behalf of investors.
The financial services industry is highly regulated in Australia. Companies and their directors are scrutinised as to compliance and the discharging of their directorial and professional duties. Given the exposures faced by companies and natural persons – and ultimately that compensatory claims or regulatory inquiries against them may be intertwined – the IMI policy was designed to ensure a single policy, issued by one insurer responds to the common exposures faced by the industry. This avoids disputes in the event of a claim.
- Directors’ and Officers’ Liability (D&O)
- Professional Indemnity (PI)
The PI section of the policy covers the licensee or manager for claims alleging misrepresentation, acts, errors and omissions in connection with its “financial or investment services”. Usually, the covered services are commensurate to the licensee’s authorisations (pursuant to its Australian Financial Services License (AFSL)).
Where the insured entity is a Corporate Authorised Representative, then the agreement is between it and its licensee. The indemnity provided by the PI section includes legal costs and expenses (to defend actions) and in the event there is liability, coverage is provided for compensatory damages. Cover is often extended to cover legal representation costs where regulators allege breach of statute in the provision of financial services. Some policies will, where permissible by law, pay fines and penalties for such breaches.
- Investment advisory
- Fund formation and capitalisation
- Fund management
- Responsible entity, trustee and licensee services
- Administration services
- Custodial services
- Registry services
The definition of insured extends to cover any funds or mandates managed by the policyholder prior to or at the inception of the policy. Underwriters ordinarily require that any new funds established during the indemnity period are disclosed, and underwritten. The insurer may charge additional premium to include the cover. They will be more inclined to do so on review of an information memorandum or product disclosure statement relating to the new raise or fund. The policyholder must be cognisant that the policy limit of indemnity is shared for new funds. As funds or assets under management increase, regard should be had to the policy limit of indemnity.
- Breach of fiduciary duties: wrongful disbursement of funds to executor of an estate (loss amount $1.4m, costs $2.3m)
- Complaint to Australian Financial Complaints Authority
- Regulatory investigations (ASIC) failure to properly and correctly label funds
- Allegations of misleading and deceptive conduct as regards representations made in Product Disclosure Statements or Information Memoranda
- Compensatory damages: Insufficient, inadequate or inappropriate advice to investors
- Compensatory damages: Misleading or incorrect information about the risks of an investment product, how the investment operates or the underlying asset(s) or product.
- For example, a fund’s PDS may purport that Loan to Value Ratio (LVR) ratios in a direct property fund would not exceed a certain percentage. A unitholder may be dissatisfied with its investment return and allege the improper management of the underlying asset in the case where mortgages do not comply with the LVR in the IM. In a recent matter it was found that the fund did not have appropriate commercial property experts directing the investments as stated and that the LVR ratios were more often than not in excess of that purported in the PDS. When investments failed resulting in early sales, investors brought claims alleging misleading and deceptive conduct resulting in both defence costs payable and compensation to the complainant.
- A claim was brought by investors in relation to representations made in a PDS about the experience of the manager in assessing prospective investments in certain sectors. Investments were made in sectors which the manager lacked experience and knowledge resulting in financial losses. Claims were brought by investors for financial loss as a result of the misleading and deceptions representations made in the PDS.
For further information on professional indemnity insurance, see our article here.
Directors' and Officers' Liability
D&O covers natural persons for wrongful acts alleged against the directors and officers of the company in the context of their management of the responsible entity (RE)/manager and any of its controlled fund, trust, sub-fund or sub-trust. Typically, an insured person under a D&O policy extends to a director or officer of the policyholder (as defined under the Corporations Act 2001 (Cth)), but the definition also extends to cover natural persons who are trustees, compliance or investment committee members.
Where a licensee or Responsible Entity seeks to raise capital, as distinct to raising capital for a specified fund it manages, then it will also have exposure to risk for that capital raise. Coverage for same may be procured under a Prospectus Liability policy or it may be aggregated under the IMI policy limit. This distinction is an important one if the RE/Manager is raising capital itself. In circumstances the RE/Manager is listed, the entity itself will have exposures commensurate to that of a publicly traded company. Where this is the case, and or RE/Manager has numerous shareholders, we ordinarily recommend a separate “tower” of cover: simply put that the D&O section have its own limit of indemnity that is not shared with the PI or Crime sections of the policy.
- Allegations of misleading and deceptive conduct as to representations made in the Product Disclosure Statement or Information Memoranda.
- Switching and miss-selling of products, (regulatory inquiry involving fines and penalties).
- Breach of continuous disclosure obligations (Against company and its directors and officers).
- Claims brought against the directors of a company following improper allocation of shares. In a recent case, shares were allocated in a subsidiary to key members of a parent as bonus/reward which were not documented in board minutes. The failure to document same led to claims of breach of fiduciary duties and misleading and deceptive conduct following sale of the company for significant profit gain.
- Claims brought against the directors of a responsible entity or licensee for failing to maintain adequate oversight over the conduct of a corporate authorised representative in ensuring its activities and advice remained within the scope of the licence activities.
For further information about D&O insurance, refer to our article on management liability.
The Crime section of the policy covers the RE/manager for internal (employee theft) and external crime that causes it to suffer “direct financial loss” of money, securities, inventory or other property in its care, custody and control.
Cover extends to forgery of negotiable instruments such as cheques and for losses arising from third party forgery; computer crime including funds transfer fraud.
- Misappropriation of trust funds by an employee of an organisation by manipulating financial records and invoices.
- Social engineering (or funds transfer fraud) claims directing employees or accounts staff to pay fraudulently created invoices that imitate invoices or payment directions usually expected from a regular debtor.
- A policyholder reported shortfalls in dividends paid on an overseas investment fund that was managed from Australia. The fund was one of many operated for the benefit of Australian investors in the company. It was found that a staff member in the Treasury department of the policyholder had not been paying investors funds properly. The dishonest employee had been siphoning funds away from investors and providing bogus statements to support the payment. Following a short investigation, Insurers paid the claim in order that the investors were made whole again.
- The CFO at a policyholder had been obtaining bank loans and lines of FX credit in the name of the company and moving the funds for his own personal use. Due to the position held by the individual, the dishonesty was not discovered for over 2 years. The CFO had been gambling the money in casinos all over the world. On discovery of the loss, Insurers agreed to reimburse the bank on behalf of the Investment Manager.
Setting appropriate coverage
There are a number of considerations that inform the appropriateness of cover investment and fund managers should hold. There are legal/statutory obligations, contractual obligations and then there is the question of “what limit is adequate?” in the context of the risk sought to be transferred. Expert opinion from your insurance broker should be sought as regards the last element.
What is required at law?
Regulatory Guide 126 sets out compensatory arrangements in place for financial services licensees. The regulations apply to licensees having regard to what is considered adequate insurance for those with “retail” investors. They do not apply directly to funds with wholesale/sophisticated investors, but it is a reference point when considering adequacy. A link to the guide is here.
The guide requires that the licensee has minimum insurance obligations of $2 million in the annual aggregate for professional indemnity and that the cover is extended to cover fraud and dishonesty of employees and not exclude claims in connection with such conduct brought against principals or directors (crime cover). The limit of indemnity specified in the guide is tied to the level of fee revenue derived by the licensee in connection with the financial services it provides under its license, saliently, to retail investors. That obligation runs up until fee revenue equals $20 million, which is where the limit guidance “caps out”. Sometimes the AFSL itself will specify the insurance that needs to be held.
What limit are you contractually obligated to hold?
Corporate Authorised Representatives (CAR) may be required to hold minimum standards of cover pursuant to any Corporate Authorised Representative Agreement (CARA) between itself and licensee. This level of insurance is ordinarily back-to-back with what the RE/Licensee must hold with the regulator and will ordinarily sound in the maintenance of professional indemnity and crime cover.
Becoming more prevalent are obligations for funds and licensees to maintain Cyber Liability insurance. Some of these obligations are being driven by CARAs, but otherwise the requirement to hold the cover is ordinarily to offset the indemnities imposed on licensees by outsourced third parties – particularly technology providers and other financial institutions. Bellrock recommends that all financial services professionals procure this cover, but before they do, to engage in a network security audit. IMI policies do not cover all the perils of a cyber breach some may be extended to give some cover – the crime coverage may respond to financial loss of money – broadform cyber policy is strongly recommended by Bellrock.
The further obligation to consider for the licensee/manager is the transfer of the risk of the indemnity it gives to its directors and officers (usually under the deed of access and indemnity). The company must maintain adequate insurance commensurate to those obligations and for the period specified (which is ordinarily the tenure of the director’s appointment and for a period of 6 years after termination).
This 6 year requirement is also built into the regulatory guide (insofar as PI requirements) and ordinarily in most CARAs. The timeframe relates to limitation periods (do note limitation dates vary and in deed for instance the period may become 12 years after conduct) and the “claims made” nature of IMI. This is an element that most Licensees/Managers/CARs ought to build in or budget for as an exit cost. Regard should also be had to the claims made nature of the policy when considering the limit of indemnity – especially where managers have been in operation over several years.
What limit of indemnity is “adequate”?
- Categorisation of investors (retail/sophisticated/unsophisticated) in a fund, average investment amount and number of investors
- The type of underlying investments;
- The amount of assets/funds under management
- Average investment amount into funds
- Fund life, accessibility to/timing of redemptions
- Disclaimers and qualifications used in information memoranda
- Internal processes, policies and procedures
- Experience of investment committee and other relevant people in the funds
- Use of third parties
- Shareholders and strategy of “management” entity
In considering policy limit adequacy, many have regard to average investment amounts and in particular the maturity of their funds. As regards the latter, we restate the above point regarding claims made insurance. The IMI policy responds to claims when the policyholder first becomes aware of them, not when the conduct giving rise to a claim occurs. It may mean that multiple claims are received in one policy year regarding conduct over several previous policy periods.
In the instance of a fund manager whose principal concern is a claim from representations made in disclosure documents, there is a time-lag between the identification of the investment opportunity, feasibility in connection with same, preparation and issuance of the disclosure document, the fund’s life/performance and any return (or even no return at all). It is usually at the final stage where a claim manifests.
As such it is less likely that the policy in place at the time a fund(s) or disclosure document(s) incepts/are released will respond to claim. It is more likely that a claim (or allegations giving rise to a claim) will be made when the ‘cycle’ is more mature. It is therefore the policy in place at that stage of the cycle that becomes more critical to consider as regards scope of cover and limit of indemnity. Indeed as more funds / disclosure documents and funds under management are held by the licensee, it is important to revisit policy limit.
The obligation of directors and officers/the licensee is to ensure there is adequate insurance in place in the event of a claim. What is adequate is determined again by what is stated above but otherwise the licensee’s appetite for risk.
Per the above IMI covers PI (errors and omissions in the course of providing financial services), D&O (for allegations of wrongful management of the respective entities and thereunder director/officer obligations) and Crime (direct financial loss of money deemed in their custody and control.
The indemnity available under the respective insuring agreements includes legal costs, (including claimant costs), legal costs & expenses, direct financial loss and compensatory penalties. The beneficiaries under the policy include the company, the funds (including their respective trusts and sub-trusts) and their directors and officers.
The IMI policy is claims made, and as stated covers conduct giving rise to a claim that is first “known” in the policy period. As time passes, the manager or licensee/its funds grow and / or there are additional funds, risk for retrospective conduct giving rise to a claim widens. In the context of this point refer above as regards maturity of funds, new funds and growth of the licensee generally.
Each of the above issues exacerbates the risk of aggregation and erosion of the IMI indemnity limit. As regards aggregation, please refer to our article here.
An IMI policy will ordinarily specify an overall policy aggregate limit. That is the most an insurer will pay for all loss covered by the policy (and each coverage section) for all circumstances and claims notified during the policy period. The risk is that one insured beneficiary, a single coverage section responding to a claim, or conduct relating to one claim in a prior year may erode the policy limit. This would leave no cover for any new claims sought.
- Buy a higher aggregate limit of indemnity based on a shared policy structure
- Have each insuring agreement subject to its own ring-fenced policy limit
- Share cover for the company under 1 aggregate limit and separately ring-fence cover for ‘insured persons’
- Ensure any capital raising for the principal policyholder/RE or manager is insured separately
- Ensure that ancillary covers (such cyber add on and other benefits) are separately insured.
Bellrock is often engaged by clients who present as corporate risks, with complex insurance issues. They require technical and sophisticated risk analysis, bespoke coverage and claims solutions. Their premiums generally range between $100,000 and $2,000,000.
Within financial services we have clients with over $2.5bn in funds under management, small banks with up to $1bn held in deposits and 27,000 + customers, aggregators with over $7bn RMBS loans issued, underwriting agencies who have aggregate $120bn net exposure under policies issued, to small start-up funds with $50-$100m of funds/assets under management.
Our clients comprise licensees (some simply providing governance and compliance only), corporate authorised representatives, trustees, custodians, asset, fund and investment managers who:
- are listed or unlisted
- have wholesale or retail investors
- have various underlying assets or funds under management including:
- agricultural assets
- direct property, including but not limited to:
- mixed use
- childcare – in that regard we advised G8 Education Limited and managed its property portfolio.
- retail/shopping centers
- data centers
- hotels and accommodation
- infrastructure and public works
- transport and logistics
- development funds
- equities (local and overseas)
- impact funds
- mortgage funds
- private equity
In the context of those clients, we have accumulated significant management information which we use to benchmark levels of cover.
What will it cost?
- The limit of indemnity sought to be purchased
- Fee revenue of the investment/fund manager
- The nature of financial services provided
- The use of external consultants
- The classification of investors/average investment amount and number of investors
- The nature of the underlying assets and how those assets are performing in the current investment climate
- The financial viability of the fund
- The experience and expertise of key persons
- Previous claims history
Bellrock’s market updates discuss the availability of cover and insurer appetite for funds/investment managers. See our last update here.
Information required to obtain quotations
- Completed investment managers insurance proposal form which can be downloaded here
- Copy of any information memoranda, mandate, asset management agreement or other disclosure document for any fund, or otherwise any disclosure document for capital raising purposes into the responsible entity or manager
- CVs of key staff (if not in the disclosure documents).
- Correspondence to investors regarding fund performance.
- A copy of an
or business plan (if a start-up fund).
- Financial statements for the past years for the responsible entity/manager and any funds.
- If relevant, any corporate authorised representative agreement downstream (if licensee is the proposer) or upstream (if proposer is a CAR).
- Agreements with external service providers (custodial/registry services).
The number of insurers offering this cover is limited. It is prudent when applying for cover that one broker is appointed to canvass quotations. Having more than one broker in the insurance market will work against the objective to obtain the most appropriate cover at the the most competitive price. See our article on this topic here.
From the above you should now understand that there are complexities in arranging and advising on IMI policies. It is paramount the proposer applying for cover is represented by a broker with extensive experience in the product line and industry.
For further information on Investment Manager’s Insurance or to obtain a quote, please contact us via the form below.