Onerous exclusions impacting investment managers insurance coverage

In our most recent market update, we advised that financial services licensees were the beneficiaries of new market capacity, yielding broader appetite, more competition and consequently lower premiums. We did warn however that those entrants had unfavourable policy terms and conditions. Furthermore with existing insurers looking to compete with these significantly reduced premiums, many have also amended their coverage to limit exposure to liabilities that form the fundamental expectation of coverage under insurance policies.

We have tested insurers intent particularly under investment managers insurance (IMI) policy wordings and found that many insurers are inflexible on amending wording. It follows then, that whilst the benefits of significantly lower premiums are an upside, it must be considered if the licensee, manager and ultimately unitholders, are protected. Additionally, to what extent should the regulator be concerned that the scope of these exclusions impact on the statutory requirements for licensees to hold adequate insurance coverage?

Bellrock’s advice when recommending insurance cover and the scope of that cover is informed by three considerations:

1. Insurance required to be held at law (e.g. Corporations Act 2002 (Cth) Ch7 obligations, ASIC Regulatory Guide126).
2. Insurance cover promised to be held in contract (e.g., obligations imposed in Corporate Authorised Representative Agreements).
3. Benchmarking the level and type of cover an organisation of similar size, type, industry and maturity holds.

ASIC’s Regulatory Guide states that if exclusions in a PI insurance policy undermine the policy objective, cover may not be adequate. We illustrate some of these coverage limitation trends observed in the softening market conditions that exist and the resultant potential exposures and non-compliance of licensees to hold adequate insurance.

One of the most remarkable developments we have observed are exclusions that disclaim all liability arising from “valuation”. Underpinning investment is value and whilst the intent of IMI policies is not to cover the valuation of assets, it is to select outsourced service providers to perform that work. Naturally, managers are vicariously liable for the provision of valuation services. A claim brought by an investor for losses due the negligent valuation of a property development would be excluded notwithstanding that the manager did not do the valuation.

Many new commercial ventures, particularly development funds, are being set up wherein various group entities offer capital raising, feasibility analysis, asset allocation, registry, development management and project delivery. There are ordinarily related parties providing these professional services to the fund, manager or asset owner.

Exposures exist for the entities providing those extrinsic professional services, that are not dealt with under IMI forms. Particularly, exposure to losses such as bodily injury and property damage arising from the provision of professional services. Such exposures are significant in the context of project and construction risk. These exposures are excluded in most IMI policies. Project risk should be separately insured and the entity undertaking those services should be engaged under an agreement on commercial terms. Notwithstanding that the entity may be related to the investment vehicle.

It follows that those entities should effect professional indemnity insurance for the provision of those services, such as the provision of development and project management services in their own right. The professional indemnity policy held by the entity providing these services should make sure where it has “beneficial ownership” of parties in the manager, that there is an appropriate carve out to allow claims to be brought by the manager against it.

In the context of the above, insurers’ products typically contain an exclusion for claims brought by a related or associated entity.

Capacity is limited for these types of exposures wherein the owner / developer comprises a party who has a beneficial interest in a third party service provider. Ordinarily, insurers will preclude coverage for claims brought by a related entity of the policyholder; for instance here where the development manager is sued by the owner or the fund manager.

A common example is where a development fund contracts with a related party to provide ‘development management services’. The fund has obligations to unitholders to ensure that all of its consultants have adequate cover.  The consultant (being a related party) must have adequate insurance – as it being retained, it must be at arm’s length. The consultant (related party) must therefore have a policy which, under its services agreement with the Fund or Developer, covers claims brought by the Fund or the Developer. Bellrock has conceptualised a way and commensurate product to insure for such scenarios.

Furthermore, the way some of the insured vs insured exclusions operate, we would say inadvertently, knock out a claim being brought by a fund against a licensee. Contractually assumed liabilities between licensee and managers may also prejudice loss indemnifiable under the policy. In the context of claims against investment managers such exclusions renders significant foreseeable losses sought to be indemnifiable under an IMI policy un-insured.

As a last observation here, aggregation of claims brought against say licensee, manager and representative by unitholders can be impacted whereby seperate entities provide these services. Where each of the above are covered under one policy, claims brought against or between parties may fall to be uninsured (as they are insured parties suing each other). The policy limit is ‘shared’ amongst all insured entities and their respective directors and officers. This presents a significant exposure in the event of a single claim relating to one CAR eroding the policy limit available for all other insured entities and persons. Recall the policy contains three insuring agreements – D&O, Professional Indemnity and Crime. 

This issue presents the real likelihood of offending the ‘adequate insurance’ requirements stipulated in ASICs Regulatory Guide 126 whereby, due to the erosion of the policy limit due to claims brought against multiple parties insured under a single policy.

Terminology of these exclusions have grown in breadth. The language now excludes any claims brought against an entity arising out of or in connection with insolvency, the failure of a company to meet its debts as and when they fall due. Exclusions can also extend to exclude claims brought by liquidators or administrators.

The concern for fund managers here is two-fold:

1. For retail funds, where a claim is brought by unitholders and the policy fails to respond due to the breadth of language of an insolvency exclusion, we question whether the PI policy is adequate in adherence with ASICs Regulatory Guide.
2. For wholesale funds, unit holders are unable to recoup financial losses as the manager’s insurance policy excludes the claim following an insolvency event.

Summarily, the language of the exclusion must be carefully considered to ensure the policy remains adequate and unit holders are suitably protected.

The Australian Financial Complaints Authority (AFCA) is an external dispute resolution set up for consumers to resolve complaints by customers of member institutions. Under s912B of the Corporations Act 2001 (Cth), AFS licensees must have arrangements for compensating retail clients for losses they suffer as a result of a breach by the licensee or its representatives. Regulatory Guide 126, published by the Australian Security and Investment Commission sets out the compensation and insurance arrangements for AFS licensees. The policy held by the licensees or representative must not have an exclusion for AFCA schemes.

The policy limit must be adequate to cover claims brought both within and outside of AFCAs remit. The policy excess must be at an amount the business can sustain. In considering this the guidance is:

1. A lower excess might be preferable. Whether an AFS licensee has sufficient cash flow to meet the excess for a reasonable estimate of claims is a relevant consideration in determining whether a PI insurance policy is adequate for that licensee.
2. If a PI insurance policy has a significant excess or deductible in proportion to the limit of indemnity, it may not be adequate. However, if the AFS licensee can demonstrate that for other reasons (e.g. other financial resources, systems, and controls in place) that their arrangements are adequate overall, they may wish to apply to have this kind of arrangement considered as an alternative arrangement.

New, and some existing market entrants, require that an excess is payable for each claimant who brings an action against the policyholder (being the fund manager or the licensee). This become problematic particularly where the excess includes legal costs (which means that legal fees are included in the excess and are payable by the policyholder) and where multiple unit holders in a trust or covered fund brings their respective claims against the policyholder. Each “claimant” would therefore constitute the payment of an excess. Ordinarily, aggregation language is used so that where a “claim” constitutes similar complaints, facts, circumstances and or events then only one excess applies.

For further information and advice regarding investment managers insurance, contact Bellrock via the form below.