Risk management and insurance coverage for secondary market investment operations
Insurance programs for secondaries funds address risks arising from investment management activities, fund operations, and transaction execution. While the secondaries strategy involves acquiring existing positions rather than direct company investments, meaningful exposures exist that warrant appropriate coverage. Building an insurance program tailored to secondaries operations protects the firm, its professionals, and investors from potential losses.
Most secondaries managers maintain several foundational insurance policies:
Directors and officers coverage protects fund managers and their personnel from claims arising from management activities. For secondaries funds, relevant exposures include:
Policy limits vary based on fund size, LP base sophistication, and risk tolerance. Coverage may be structured at the management company level, fund level, or both depending on circumstances.
E&O coverage addresses claims arising from professional services provided in connection with fund management. Secondaries-specific considerations include:
Valuation-related claims if LPs allege portfolio positions were materially misstated.
Transaction analysis claims if acquired positions perform materially worse than represented during fundraising or LP communications.
Disclosure claims related to information provided to selling counterparties or underlying fund managers during transactions.
Given the data-intensive nature of secondaries operations, cyber coverage has become increasingly important. Secondaries funds handle sensitive information including:
Cyber policies typically cover breach response costs, notification expenses, regulatory fines, and potential liability from data compromises.
Secondaries transactions may involve insurance products less common in primary fund operations:
While more common in direct M&A, rep and warranty insurance is occasionally used in larger secondary transactions. This coverage can facilitate deals by:
Providing recourse beyond what selling LPs are willing to provide.
Bridging gaps between buyer and seller positions on indemnification.
Supporting transactions where seller creditworthiness is uncertain.
The applicability and cost-effectiveness of R&W insurance varies significantly based on transaction size, structure, and market conditions.
Complex transactions may involve uncertain tax positions where insurance can provide protection. Examples include:
Coverage for positions taken regarding Section 743(b) adjustments or other basis-related items.
Protection for characterization of income items that affect LP tax treatment.
Coverage for positions taken in cross-border transactions with uncertain tax treaty application.
Tax insurance is not routine but may be considered for material uncertain positions.
Crime insurance protects against losses from employee dishonesty, theft, fraud, and similar risks. Given that fund managers control significant capital flows, appropriate crime coverage provides protection for both the management company and fund assets.
Office contents, equipment, and business interruption coverage addresses physical risks to firm operations. While not unique to secondaries, these coverages form part of comprehensive risk management.
Designing appropriate coverage requires balancing protection needs against cost. Key considerations include:
Policy limits should reflect fund size, LP expectations, and potential exposure magnitude. Larger funds typically carry higher limits.
Retention amounts (deductibles) affect premium costs and should align with the firm's ability to absorb smaller losses.
Policy terms and conditions vary among insurers. Understanding coverage triggers, exclusions, and claim procedures matters beyond just comparing premiums.
Coverage coordination ensures different policies work together without gaps or overlaps. Reviewing how policies interact prevents coverage disputes when claims arise.
Specialized insurance brokers serve the investment management industry and understand secondaries-specific exposures. When selecting brokers, consider:
Brokers can also provide benchmarking data showing coverage levels and costs among peer firms.