Does Your E&O Cover Alternative Investments?
Alternative investments are getting more attention after the calamitous market downturn decimated many a traditional stock-and-bond portfolio. At the National Association of Personal Financial Advisors' (NAPFA) national conference in June, for example, several advisors said in casual conversation they wanted to explore alternative investments for their client portfolios.

The alternative investment space is a broad category ranging from hedge funds and managed futures to timber land and foreign currencies. In many cases, they're not covered by errors and omissions (E&O) insurance that protects advisors and other professionals against claims of negligence and mistakes.

"We don't cover alternative investments," says Tony Bougere, senior vice president of marketing at Markel Cambridge Alliance, a Burlington, Vt.-based company that provides E&O insurance as part of membership benefits programs at both NAPFA and the Financial Planning Association (FPA). "Our target market is small- to mid-sized advisors, and most of them don't get involved in this area. If we covered alternative investments, our premiums would be more than triple what they are now."

Bougere says his company's concern is that advisors could be sued by clients with assets in illiquid alternative investments, such as hedge funds, that can't be exited quickly during free-falling markets such as in 2008. That, and the fact that many alternative investments aren't registered securities and don't have to disclose as much information.
"That puts advisors in a difficult position if challenged about why they put clients in one of those investments while there are other options with lots of research and available information," Bougere says.

Some insurance companies are re-evaluating their risk appetite. "Recent market changes have exacerbated underwriters' concerns regarding alternative investments," says Sheri Pontolillo, CEO of E&O Pros, an insurance broker in Laguna Hills, Calif. "There's a direct inverse relationship between falling stock markets and rising claims."

But Pontolillo says most underwriters want to be accommodating. "It's about how you tell the story," she says. "If an advisor can demonstrate expertise and caution and good business practices, then we have a story to tell."

Depending on the carrier, it can be easier to get E&O coverage if the alternative investments involved are liquid and are only a small part of an overall investment mix, says Gary Sutherland, CEO of North American Professional Liability Insurance Agency, a broker in Framingham, Mass. "You might pay a little more for it," he says. "They might be willing to write an endorsement picking up certain coverages."

E&O costs can vary depending on the size of the advisory firm. Sutherland says some carriers charge a percent of revenue of around 1%, meaning a firm with $400,000 in revenue would pay a premium of $4,000. Economies of scale can reduce that, though. "An advisor doing $2 million will get a discount and won't pay $20,000," he says.

Sutherland says that the average deductible for the advisory firms he works with is $5,000 to $10,000. He adds that one provider, Chubb, "is a little more aggressive" in its underwriting for alternative investments, but that might come with annual premiums of $15,000 and a $50,000 deductible, depending on the policy. Chubb couldn't be reached for comment.

"Companies such as Chubb, The Hartford, Travelers and CNA will consider underwriting alternative investments if they feel they aren't extremely risky," says Mark Liftman, president of Theodore Liftman Insurance Inc., a Boston-based broker. What makes alternative investments even more difficult to assess from an underwriting standpoint is that certain offices--even within the same company--may view alternative investments differently, Liftman says.