Fund management and insurance have always had symbiotic relationship. Fund managers usually need insurance when they are applying for their licensing under whichever regulator the seek to base themselves under and conversely insurers have been able to build a product (and portfolio) out of providing insurance for them. Prior to the rise of the crypto or digital asset industry supply tended to outweigh demand (mainly due to soft competition) but as fund managers have started venturing into investing in digital assets this balance has changed. In this article we look at why this has occurred and provide some guidance for fund managers exploring the asset class.
Riding the Wave of Change
The United States SECs approval of the first Bitcoin ETFs at the beginning of 2024 and the recent announcement that Hong Kong’s three Bitcoin ETFs had surpassed HKD $2 billion in inflows of institutional money into the sector has been a boost to the digital asset sector that had a rollercoaster 2022 with fluctuating digital asset values, the scandal of FTX and a number of digital asset-related corporate failures.
According to the PWC 5th Annual Report on Crypto Hedge Funds, a quarter of hedge funds, including those that are not currently investing in crypto-assets, confirmed that they are were exploring tokenisation in the asset management sector. Around a third of hedge funds currently investing in crypto-assets believe that tokenisation of real assets will be the biggest growth opportunity in this space over the coming years.
With these developments, the insurance market that traditionally provides coverage for fund managers is changing its approach. Insurers are beginning to recognize digital assets as a mainstream investment class.
In this article we take a look at insurance for fund managers with the spotlight on what to look out for if you are thinking of investing in digital or crypto-assets.
The Rise of Digital Asset Insurance
For many decades the specialty insurance market has adapted and changed the way it insures fund managers, reacting to changes in the industry together with changes in regulations. Over time various policies have been launched aimed at capturing the insurable risks that the industry is exposed to culminating in a hybrid of various policies aimed at covering investment managers, investment advisors and investment funds for the potential liability that may arise against their directors while managing investment funds and also their potential liability while performing investment advisory and investment management services. This policy, commonly referred to as Investment Managers Insurance (IMI) has three main components:
| Directors and Officers Insurance | Professional Indemnity Insurance | Crime Insurance |
| Provides protection for the fund manager and the fund for a Wrongful Managerial Act e.g. breach of fiduciary duty, misstatement etc Includes Outside Directorships and Legal Representation Expenses. | Provides protection for the fund manager and the fund for a Wrongful Professional Act e.g. failure to perform investment advisory services Can include Data Protection and Privacy Liability, Loss of Documents etc | Direct Financial Loss resulting directly from any Employee Infidelity and/or Third Party Computer Fraud Can include social engineering fraud, investigation costs and repair of systems Some policies have cyber coverage. |
Whilst the IMI policy has long since been the policy of choice for asset managers the introduction of digital assets to the investment landscape has presented challenges to insurers who are not yet familiar with digital assets. In fact, one of Continuum’s first clients was a Singapore-based asset management company who’s existing (well known) insurer refused to provide coverage for their very small newly created digital asset fund. Luckily, we managed to convince an innovate underwriter to provide coverage on the basis that firstly it was a very small % of AUM so the exposure was low and second this would be a great opportunity to learn about the sector for future opportunities.
What if I am looking to launch a digital asset fund?
With so many headlines about the digital asset market (good and bad, but mainly bad) particularly around fraud, hacking and changes in regulatory stances there will always be some insurers that refuse to get involved but this stance is starting to change, particularly with more stringent rules around Know Your Customer (KYC) and sanctioned individuals. In the last few years new capacity has entered the market allowing digital asset fund managers to have a bit more choice. Still, if you are planning to launch or manage digital assets funds here a few things to be aware of:
- Review your existing IMI policies – be careful to make sure the description of business in your underwriting submissions aligns to what you actually doing. This allows for a better understanding by insurers and also means that there will be no chance for them to deny claim payments should they arise
- Keep an eye on the Exclusions – Some insurers may provide coverage but load the policy up with so many exclusions that the policy is essentially worthless in the event of a claims. Look out for the exclusionary language in relation to smart contracts, ICO’s, cryptocurrencies et and importantly the definition of crypto assets.
- Endorsements are not always Positive – an endorsement is an amendment or addition to an existing insurance contract that changes the terms of the original policy. These are used widely (particular in countries were insurance policies need to filed with the regulator) but they are not always positive and tend to come at the bottom of the policy document.
- Advisory Work may not be Covered – many insurers who cover management of funds do not extend to advisory work (corporate advisory, M&A etc)
- Star the renewal process early – whilst there is new capacity entering the insurance market, availability of coverage is still limited (particularly in Asia) so start the renewal process with your broker early to give company the best chance for the best result.
- Work with an experienced broker who understands your industry and the insurance market. Size doesn’t matter – work with who can demonstrate a track record with helping digital asset companies obtain the best and most competitive coverage.
What about custody?
Typically, an asset manager would engage a third-party custodian to safeguard the asset holder’s securities. This could be an established bank, one of the new custody providers specialising in the safe keeping of digital assets or simply a secure digital wallet provider. What’s important is to fully understand how they intend to keep your clients assets safe and increasingly whether or not they are insured.
This has been further enforced by recent regulation by the Monetary Authority of Singapore (“MAS”) has outlined new measures to ensure that Digital Payment Token (“DPT”) service providers (including custody) protect customers assets by stating that they “ensure that the digital payment token instruments relating to at least 90% of customers’ assets are kept in cold wallets” and DPT services providers “should disclose in writing to customers its processes for handling any losses of customers’ assets arising from fraud or negligence on the part of the digital payment token service provider, these can include having a compensation framework, specifying the type of losses covered, the steps that a customer should take when such losses arise, the investigation or resolution process of the digital payment token service provider, and if insurance is provided, the scope of coverage and the claims process.
At Continuum have been working with digital asset custodians in Asia since 2017 to provide insurance to protect against digital asset theft whether internal or external. Much of the early buying behaviour was driven by a desire to achieve credibility (through marketing) so its welcome that regulation is also mandating transparency regarding insurance procurement.
The future of digital asset fund management?
Well, a much larger topic than we are qualified to comment on but from an insurance perspective we hope that as the crypto space matures, it’s possible that insurance products specifically tailored for digital assets will be integrated into fund management systems. These solutions could provide coverage for various risks associated with cryptocurrencies, such as theft, hacking, and smart contract failures, offering users peace of mind and financial protection. Challenges remain, however, such accurately assessing the value and risk of digital assets can be challenging, leading to potential issues in coverage and claims. The cost of insurance premiums for digital assets still remains relatively high (particularly for startups) and potentially deter users. Additionally, the evolving nature of digital assets and associated risks can complicate the development of comprehensive insurance policies to accurately address the exposures.
How can Continuum assist?
At Continuum we specialize in assisting companies in the digital asset ecosystem with their digital asset insurance needs. We can provide solutions for both onchain and offchain risks. We have the experience of helping companies with digital asset insurance when others couldn’t and have a successful track record of placing new innovative policies across the globe.
Contact us for an informal, no obligation discussion on how we can assist you.
