From the December 01, 2006 issue of Futures Magazine • Subscribe!

Meltdown insurance

Before the Amaranth story is complete, there likely will be lawsuits aimed at the fund and investment managers of the fund from investors who feel that certain trading activities weren’t fully disclosed.

Mike Klaschka, principal of management risk solutions for Integro Insurance Brokers, offers insurance to hedge funds and managers of funds. He says hedge-fund insurance is relatively uncommon and mostly used to offset costs related to lawsuits. “We typically recommend a minimum of $5 [million] to $10 million, and that is primarily going to be used to defend a serious action against the manager,” Klaschka says.

The cost runs from $20,000 to $35,000 per million dollars of coverage. “A $5 million limit doesn’t do much for a $1 billion fund if they have a complete meltdown. It will provide defense costs,” he says.

At those prices, full coverage would cost 2% to 3% of the value of the fund, but Klaschka expects costs to come down as it becomes more widespread. “It is going to be a few more years before it gets a lot more traction. Your underwriting community doesn’t really know how to price the coverage yet. We would love to see the regulatory community come in and say you need to buy it.’ Sort of like SIPC coverage,” Klaschka says, adding, “It is not uncommon to have an insurance requirement in a lot of other businesses.”

Attorney Charles Crow, partner in the law firm Crow and Associates, who has advised fund managers for many years, says he advises his clients that the coverage is available, but few managers see it as worthwhile.

The high profile of the Amaranth meltdown may give more attention to the insurance option. “I don’t know all the facts around it yet, but they may have made some statements to their limited partners about their controls and procedures. [If] they make these statements and people relied on that, and they say ‘had we really known that your whole portfolio was in energy derivatives we would have pulled out money if we could have,’” Klaschka says they would have benn covered.

“The policy is going to defend them. It covers wrongful acts or alleged wrongful acts in the performance of your professional services. There are some key exclusions that come into play. Fraud [for instance], if there was outright fraud then the policy may exclude the portion of the loss that was due to fraud.”

Fraud would have to be proven in a final adjudication, and Klaschka says it is extremely rare any of these cases gets to that point. They are usually settled.

“I buy property insurance, why shouldn’t I buy insurance to protect the fund from a frivolous lawsuit?” Klaschka says. While on its face a frivolous lawsuit should not be allowed into the system, Klaschka adds, “If they didn’t [have frivolous lawsuits] I would be out of business.”

He adds that regulators, fines and penalties are not covered.

Crow says despite the insurance industry’s political power, he doubts a mandate is likely or necessary.

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