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Insurance Expense Allocation for Investment Managers: A Primer

Management Liability

Walker Newell, Esq.

Aug 12, 2024

6 minutes

Expense allocation is an area of regulatory risk, as finance, legal, and compliance professionals at asset management firms know all too well. The SEC Division of Examinations (EXAMS) scrutinizes expenses allocated to funds with a skeptical eye. If the staff believes investors have not been apprised that the fund is bearing expenses typically borne by the manager in the normal course, watch out below.

Over the years, the SEC has brought a variety of enforcement cases related to expense allocation, including:

Energy Capital Partners: Failing to allocate credit facility expenses pro rata to co-investors, to the alleged detriment of fund investors

Monomoy Capital Management: Allocating costs of adviser’s in-house operations group to portfolio companies, allegedly without adequate disclosure

In the agency’s current posture, it is safe to assume that the staff will continue to scrutinize this area. For example, in the 2023 Private Fund Adviser Rules, the SEC sought to police a variety of expense allocation practices, including:

Non-pro-rata allocation of portfolio investment expenses

Regulatory and compliance expenses

Exam expenses

Investigation expenses

Now that the Private Fund Adviser Rules have been chucked into the dustbin of history, should investment advisers expect the SEC staff to give them the benefit of the doubt on expense allocation?

Not likely. This is a heartland area for the EXAMS and Enforcement programs. And, of course, all the cases the SEC has brought to date in this area have relied on established provisions of the Advisers Act. While the Private Fund Adviser Rules gave the staff more tools to use in this space, legacy hooks like the anti-fraud and compliance provisions remain powerful enough to address a variety of conduct.

For example, in 2024, the SEC brought a case against a registered investment adviser to an open-end investment company for improperly allocating certain legal fees to a fund. This case suggests that the staff will—unsurprisingly—continue to focus on the supposed problem areas targeted by the Private Fund Adviser Rules, using time-tested tools. (For a more detailed description of the facts of this case, check out my article from earlier this year.)

How do insurance premium expenses fit into this landscape? Let’s take a look.

Thinking financier in glasses working with documents and accounts

Does the SEC Care About Insurance?

First, does this even matter? How much does the SEC even think about insurance for private funds?

At a high level, the SEC may have concerns about any expense borne by a fund (1) that only benefits the manager, and not the fund; and/or (2) that is not adequately or accurately disclosed to fund investors. Insurance premiums—like any other expenses—may fit this bill.

Anecdotally, private fund managers have faced questions in the past from the SEC EXAMS staff about insurance premium expense allocations. The SEC’s commentary in the adopting release for the defunct Private Fund Adviser Rules—discussing the requirement for tabular disclosure of fees and expenses charged to funds—demonstrates that insurance premiums are on the SEC’s check list:

"For example, if the fund paid insurance premiums, administrator expenses, and audit fees during the reporting period, a general reference to “fund expenses” on the quarterly statement will not satisfy the rule’s detailed accounting requirement. Instead, an adviser is required to separately list each category of expense (i.e., in the example above, insurance premiums, administrator expenses, and audit fees) and the corresponding total dollar amount."


For example, if the fund paid insurance premiums, administrator expenses, and audit fees during the reporting period, a general reference to “fund expenses” on the quarterly statement will not satisfy the rule’s detailed accounting requirement. Instead, an adviser is required to separately list each category of expense (i.e., in the example above, insurance premiums, administrator expenses, and audit fees) and the corresponding total dollar amount.

Elsewhere in the release, the SEC highlighted a potential nexus between the non-pro-rata allocation rule and insurance:


[T]he adviser’s non-pro rata allocation must be fair and equitable under the circumstances. Whether it is fair and equitable will depend on factors relevant for the specific expense. ... another factor could be that one private fund client may receive a greater benefit from the expense relative to other private fund clients, such as the potential benefit of certain insurance policies.

Finally, the SEC acknowledged the interplay between indemnification and insurance in withdrawing its proposal to prohibit funds from indemnifying managers for negligent behavior.

What do these isolated references to insurance mean? Recent developments strongly suggest that the SEC has no near-term plans to resurrect the Private Fund Adviser Rules. But the commentary in the adopting release remains relevant because it reflects the SEC staff’s observations of adviser practices on the ground—practices that will remain focus areas under the current SEC regime.

While insurance premium expenses are not typically material in comparison to other fund expenses, the SEC staff often shows interest in seemingly minor foot-faults by investment advisers. You want to get this right the first time, not when it is raised as a potential issue by the SEC staff.

Insurance Premium Expense Allocation

Most fund managers purchase a coverage package with several different insuring agreements, each designed to respond to different types of claims. For a good summary of these different types of coverage, check out our insurance guide for investment managers.

To get insurance coverage, of course, managers must pay premiums. Are these premiums expenses of the manager alone or the fund and the managers? If the latter, how should premiums be appropriately allocated between the manager and the fund?

Well, it depends. Certain portions of the premiums should be borne by the manager. Under some circumstances, however, it may be appropriate to allocate other portions of the premium to the fund.

To answer this question, you need to take a holistic view of the regulatory and insurance environment. How does your insurance coverage perform and who does it benefit? Which portions of your premium are attributable to which insuring agreements? How have you disclosed your expense allocation methodology to investors? How would a skeptical SEC examiner react to your premium allocation methodology?

Rather than waiting for an SEC examiner to knock on your door, now is the time to review your premium expense allocations. This analysis should be undertaken in close consultation with your insurance advisors, ideally advisors who have a deep understanding of both the regulatory and insurance environment.