PE firms are adroitly aware of the need to transfer as much operational risk from their funds as possible. This isn’t a process for the faint hearted. Fund managers need to play a not insignificant role in partnering with their Broker/Risk Advisers to ensure that the scope of risk is properly communicated to the underwriters. Generally this is a subject for the true specialists that offer tailored policies and access to high limits of indemnity.
PE firms owe a heightened duty of care to an especially vigilant customer base – investors. The risks are all too apparent. Errors or negligence in the management of investments, or even criminal conduct, will result in claims for damages.
The targets of the litigation might be the funds, the managers, the firm or the directors individually.
Very special attention needs to be paid to US exposure where individuals VC directors on portfolio company boards are often described as “having a target on their back”.
PI insurance will respond to professional service failure, and D&O will deal with a director or officer’s breach of fiduciary duty (management conduct rather than professional services). And the latter, as with all such D&O risks, seeks to cover the personal liability for losses (non-indemnified), rather than the loss incurred by the firm.
A number of insurers offer a policy covering both the Professional and Director’s risks in one form, often referred to as a VCAP policy.
PE firms then need to cast an eye, possibly both eyes in a prolonged fashion, at the risk management/insurance processes adopted by their portfolio companies. This again is complex and calls for a close relationship with the Broker and Insurer. Cover is needed for board roles, contingent protection for Fund Management involvement, carve-outs in the D&O, and importantly the investee company’s insurance must be independently audited on a regular basis.
At the back end of the PE investment cycle, transaction risk is now commonly insured under “reps and warranties” policies, offering back-to-back cover for breach of warranties, and tax indemnities, under a multi-year single premium policy which ideally protects the buyer and seller from unintended breach of warranty claims.