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E&O insurance in focus:

Security for venture capital and private equity funds

We would like to welcome you to our specialist article on E&O insurance and are delighted that you have found your way to us. In this article, we would like to focus specifically on E&O insurance for investment companies. In the future, we also plan to cover the special requirements of E&O insurance for technology companies.

While D&O insurance is usually the first question our clients ask, we find that E&O insurance is often less well known. In our experience, however, it is a crucial instrument in risk management for fund companies. It is therefore important to us (see e.g. Risk Partners in VC Magazin) to increase awareness of this type of insurance. We hope that this article will contribute to this, as nothing is more annoying - for many reasons - than an uninsured "E&O loss" that then leads to a liability claim simply because no appropriate insurance has been taken out.

If you have any questions about E&O insurance based on this article or would like a market tender, please do not hesitate to contact us. In addition to our good access to the relevant insurers, we are also happy to offer our special concepts (e.g. Risk Partners D&O/E&O Moonshot Protect as a fully written set of terms and conditions or our Risk Partners E&O Prime Protect) so that you are insured in a market-leading way.

Are you responsible for a venture capital fund? Then we have created a separate topic page for you, including a free guide with benchmarks on sums insured & insurance premiums (costs), tips and specific claims. 

What is E&O insurance?

E&O insurance, also known as professional indemnity insurance for the fund manager (KVG / AIFM), is also known as "Errors and Omissions (E&O)". It serves to protect the fund, the management companies and the employees and managing directors from claims that could result from sales or asset management services. In connection with the management of the fund, this primarily includes claims by LPs/investors or, in rare cases, third parties (e.g. authorities) who have suffered financial loss due to actual or suspected errors or omissions on the part of the persons involved.

The core scope of E&O insurance is financial loss liability insurance and should therefore not be confused with business/office liability insurance (usually a few hundred euros for investment companies). The latter covers third-party damages in the area of personal injury and property damage as well as non-pecuniary losses (financial losses, e.g. resulting from personal injury such as "wage replacement benefits for a tradesman who has had an accident"). E&O insurance as pure financial loss liability insurance only covers financial losses. The scope of liability insurance includes

  • Examination of the question of liability (damage, causality, fault)
  • Defense against unjustified claims 
  • Assumption of indemnification for justified claims

Risks from the operating activities of private equity and venture capital funds

Venture capitalists (VCs) and private equity companies (PEs) operate in a highly regulated environment with constantly changing legal requirements and jurisdictions. A key aspect of effective E&O insurance is to protect management and employees from potential errors that can occur in this challenging environment. This is often ensured by clear provisions in the policy terms and conditions that cover classic operational errors in the course of business (E&O).

Potential liability risks include, among others:

  • The selection of relevant service providers such as tax consultants, auditors and law firms.
  • Incorrect investor presentations or memoranda, which can lead to prospectus liability risks.
  • Approaching and attracting venture capital from Limited Partners (LPs), avoiding unauthorized marketing activities (conference in Switzerland).
  • Careful screening of potential investors with regard to anti-money laundering (AML) and know your customer (KYC) requirements.
  • Compliance with investment limits in terms of amount and focus.
  • Incorrect investment decisions or inadequate due diligence procedures.
  • Problems in handling/monitoring the portfolio companies.
  • Proper management and reporting to investors and supervisory authorities such as BaFin or CSSF.
  • ...

It is crucial to regularly check whether the scope of cover of the insurance corresponds to the scope of activities of the fund company, as these criteria are used in the event of a claim. It should also be noted that claims usually require a financial loss. They are therefore more common in less successful funds, although even well-performing funds are not immune to legal risks, particularly in relation to regulatory matters. In this way, insurers indirectly take on some of the performance risk on their own balance sheets - despite a standard performance exclusion in the market. Understandably, the insurer does not want to assume any liability for the GPs' performance commitments. 

Risk Partners - known from, among other things:

What sum insured is required for E&O insurance?

Unfortunately, the question of the ideal sum insured cannot be answered simply or solved mathematically. Rather, it is advisable to entrust yourself to a specialist broker with extensive claims experience and carry out an individual analysis that takes into account factors such as the investment and investor structure (keyword: "friendly LPs/GPs"). This analysis can then be translated into a suitable sum insured.

In addition, experience has shown that the cost factor of E&O insurance is significant (minimum premium: four figures). Ideally, a large number of insurance sums should be requested as part of a market tender and various structuring options for higher insurance requirements (keyword: excess / co-insurance solutions) should be discussed.

Although this article is intended to deal exclusively with pure E&O insurance, the question of stand-alone E&O insurance versus "blended cover" together with D&O insurance also plays an important role. In the case of "blended cover", a uniform structure aims to avoid demarcation problems between the two financial loss liability policies. The D&O risk should therefore also be taken into account in the sum insured. It is important to note that claims experience shows that with a functioning E&O insurance policy, the unpleasant D&O claim often does not occur at all or is reduced to initial legal advice costs (so-called precautionary legal advice costs). Particularly in the case of fund companies with more than 1 billion assets under management, we see a desire to assess the D&O risk and the E&O risk separately, so that "blended cover" is only purchased up to a certain amount or two separate insurance programs are purchased. Fund companies with lower assets under management generally opt - for good reasons - for a combination of E&O and D&O insurance. One good reason is a higher aggregate sum insured than would probably be achieved with the expensive solution of separate programs. 

Finally, in the context of the sum insured, the question of whether the sum insured should be maximized once or twice must be clarified. This is not about a multiplier for a sum insured in the event of a claim - here the sum insured remains the upper limit - but about the provision for several insured events in one insurance year. As this is usually accompanied by an additional premium of 15%, it is advisable to consider a higher sum insured.  

Tips for taking out E&O insurance

Basically, the most important tip is to entrust your advice to specialists who are experienced in transferring more complex fund profiles on the insurance market and can advise you accordingly. In this context, you should pay attention to E&O concepts developed by the broker (e.g. Risk Partners E&O Prime Protect), but there are also (not many) other specialist brokers with good concepts. Here you have the advantage that these are conceived from the customer's point of view and include appropriate improvements (e.g. exclusions, obligations, cover modules, grace periods). Not only with us, you will notice the considerable improvements in a comparison, so that this is certainly the most important tip for inexperienced insurance buyers.

We also recommend a broad definition of the insured activity, which ideally does not allow any discussions in the event of a claim. In addition to asking about the activities, your specialist broker should also have access to a corresponding set of special conditions in which, for example, activities from the LP agreement are automatically included.

With EU Directive 2011/61 and its translation into national law(Section 25 (6) KAGB), E&O insurance can meet BaFin's expensive capital requirements in the case of full regulation and create additional value here. As the insurance benefits - especially in the case of high-performance terms and conditions - go beyond those required by law, it is advisable for BaFin to add a side letter focusing on the statutory requirements.

While the sales/advisory function of the fund is covered under the "normal" fund E&O insurance, special forms of sales can be discussed in the context of sales, e.g. in the context of joint ventures. Here it may make sense - depending on the insurance portfolio - to delineate this in a separate cover (e.g. under Section 34f GewO), which is also more easily accepted as compulsory insurance by the responsible Chamber of Industry and Commerce. The same applies to highly operational fund companies that are heavily involved in advising/developing companies/restructuring cases. 

Are you responsible for a private equity fund? Then we have created a special topic page for you, including a free guide with benchmarks on sums insured & insurance premiums (costs), tips and specific claims. 

"We are one of the market leaders and drivers of innovation in the insurance of private equity and venture capital funds. As an owner-managed specialist insurance broker, we can promise you leading expertise and continuity in the quality of our support, which is now a unique selling point in times of the "war of talent".

Conclusion on E&O insurance

E&O insurance plays a crucial role in the risk management of fund companies and serves to protect the fund, the management companies and the employees and directors against claims that could result from sales or asset management services. It is important to understand that it is a financial loss liability insurance that covers only financial losses and therefore should not be confused with public/office liability insurance.

In the highly regulated environment in which venture capitalists (VCs) and private equity firms (PEs) operate, protection against potential errors and omissions is of paramount importance. E&O insurance provides an important protection mechanism here by covering classic operational errors in the course of business activities, thus protecting management and employees from potential liability risks.

When determining the ideal sum insured, it is advisable to consult a specialist broker with extensive claims experience and to carry out an individual analysis that takes into account the specific needs and risks of the fund company. The question of stand-alone E&O insurance versus "blended cover" together with D&O insurance also plays an important role and should be carefully considered, especially for fund companies with an AuM of more than EUR 1 billion.

Another important aspect is the broad definition of the insured activity in order to avoid discussions in the event of a claim. This can be achieved through a corresponding set of special conditions that also automatically includes activities from the LP agreement. In addition, the focus of activities (e.g. new SPV / co-investment vehicles, convertible loans instead of equity investments, etc.) should be discussed and regulated in the terms and conditions.

Finally, E&O insurance can also add value by meeting BaFin's expensive capital requirements when fully regulated. 

 

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