Hedge Fund | Hedge Fund Insurance -- Just How Much Should You Buy?

The first mistake that many hedge fund managers make when it comes to choosing a level of coverage is to buy every possible kind of coverage from several different companies, paying the highest premiums just on the off-chance that they get hit with a really big case later. Bearing this mistake in mind, other hedge fund managers only buy minimal insurance, thinking that since they're not likely to be sued and if they are sued whatever insurance they have probably won't be enough to cover the multi-millions worth of dollars they could be sued for, they might as well not bother.

However, both the overkill and overly stringent methods are bad approaches that stem from a common misunderstanding of how hedge fund insurance works. Hedge fund insurance is not designed to correlate with the assets you have under management or on hand at any given time. The majority of hedge fund cases are settled, and your hedge fund insurance policy is not intended to be enough to cover a major loss of funds or to replace any funds for which your client or customer might be suing you. Rather, it is intended primarily to fund the defense costs of a court case so that the hedge fund itself remains untouched while the case works its way through the court system.

Indeed, this is the main threat to hedge funds in lawsuits -- that the fund itself will have to be used to pay for defense costs, become drained and therefore exacerbate the financial strain brought on by any kind of lawsuit. This eventually causes the hedge fund itself to perform worse and lead to more clients abandoning ship, filing more lawsuits, etc. in a snowball effect. So, although hedge fund liability insurance performs a very important function in keeping the hedge fund afloat it is not intended to pay off a large claim, which you will most likely never have to do anyway.

Realizing just exactly how hedge fund insurance functions is crucial to choosing the right amount you need for your fund -- so instead of trying to calculate how much you would need for a claim, think in terms of settlement amounts and you'll get a much better estimate of just how much hedge fund insurance coverage you need.