Adequacy of professional indemnity insurance for AIFMs
Published: 12 July 2023
In order to hedge against liability risks arising from professional negligence, managers of alternative investment funds (AIFMs) must either provide additional own funds or take out professional indemnity insurance (PII). PII must satisfy specific conditions to qualify as such under Section 63b of the Decree on Prudential Rules for Financial Undertakings (Besluit prudentiële regels Wft).
Requirements of professional indemnity insurance
The requirements which PII must meet are laid down in Article 9(7)-(9) of the Directive on Alternative Investment Fund Managers (AIFMD) and Articles 12 to 15 of Commission Delegated Regulation (EU) No 231/2013 supplementing Directive 2011/61/EU with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision. Article 13 lists the qualitative requirements which AIFMs must meet to ensure adequate management of their professional liability risks. They must check the criteria listed below before an insurance policy can qualify as PII within the framework of the AIFMD. DNB expects AIFMs that wish to use PII to explain in detail, stating arguments, based on the criteria listed below, and including references to relevant passages in the policy conditions, why it is obvious that the PII taken out satisfies the requirements.
PII within the framework of the AIFMD must meet the following requirements:
- The insurance policy may not provide coverage for additional risks, such as director's liability risks. It must only provide coverage for professional liability risks;
- The insurance policy may not provide coverage for the benefit of any entities other than the AIFM in question. The AIFM must be the only insured entity;
- The insurance policy must at least include the types of professional liability risks defined in Article 12(1) and (2) of the EU Delegated Regulation;
- The insurance policy must meet the conditions listed in Article 15(2) of the EU Delegated Regulation, including those relating to the initial term and the notice period for cancellation;
- insurance policy must meet the minimum coverage requirement specified in Article 15(3) of the EU Delegated Regulation. Coverage for an individual claim must be at least 0.7% of the total value of the portfolios managed by the AIFM;
- The insurance policy must meet the minimum coverage requirement specified in Article 15(4) of the EU Delegated Regulation. Coverage for claims in aggregate per year must be at least 0.9% of the total value of the portfolios managed by the AIFM.
If the insurance policy fails to meet any of the criteria listed above, the AIFM must provide additional own funds amounting to 0.01% of the total value of the portfolios managed by the AIFM, as stipulated in Article 14(2) of the EU Delegated Regulation. The PII must at all times meet all requirements laid down in the EU Delegated Regulation.
Any excess defined under the PII must be covered by own funds, which must be provided in addition to the regular own funds to be held, in accordance with Article 15(2), final paragraph, of the EU Delegated Regulation. A specified excess amount reduces coverage of the PII to a level below the required amount for individual claims as well as claims in aggregate, which is why the excess must at all times be fully covered by own funds in the form of capital.
Minimum and maximum PII coverage
The PII must always provide coverage of at least 0.7% of the total value of the portfolios managed by the AIFM for individual claims and 0.9% for all claims in aggregate. In some cases, the PII policy also specifies a maximum coverage limit. Many insurers apply a formula in which the maximum coverage limit is the lower of
- 0.9% of the total value of the portfolios managed by the AIFM and
- an amount equal to the sum insured.
If the maximum coverage limit is lower than 0.9% of the total value of the portfolios managed by the AIFM, the PII does not comply with the criteria laid down in Article 15(4) of the EU Delegated Regulation. This situation may occur if 0.9% of the total value of the portfolios managed by the AIFM amounts to more than the maximum sum insured.
This means that a PII is valid subject to the condition that the minimum coverage limit of 0.9% of the total value of the portfolios managed by the AIFM must always be lower than or equal to the maximum sum insured. If this condition is no longer met, the PII does not comply with Article 15(4) of the EU Delegated Regulation. The AIFM may then no longer use the PII and must hold, with immediate effect, at least 0.01% of the total value of the portfolios managed by the AIFM as additional capital, pursuant to Article 9(7) of the AIFMD. The AIFM is responsible for monitoring compliance with the minimum coverage requirement of 0.9% and must have an appropriate operational management structure in place to ensure this. The AIFM must notify DNB immediately if he PII is no longer valid. If the AIFM does not have sufficient capital available to hold at least 0.01% of the total value of the portfolios managed by the AIFM as additional capital, it is in breach of the solvency requirement. DNB is authorised to impose enforcement measures in case of such breaches.