VCs Ponder Need for Insurance –

With a recent lawsuit brought against three Silicon Valley VCs, now is a good time for venture firms to revisit their insurance needs.

Typically, venture capital asset protection policies, or insurance policies and related products, cost about $100,000 yearly and come with deductibles that range between $250,000 and $500,000, meaning that they aren’t much help until a major incident arises.

In an effort to address costs, the National Venture Capital Association has partnered with some large insurers to offer its members a competitively priced policy designed specifically for venture firms. (For more about the program, see “Are We Covered?” on page 62).

Another concept that appears to be gaining traction is that of the captive entity, where an insurance firm is formed by a company to protect itself exclusively. Though Fortune 500 companies such as Microsoft Corp. have for decades used captive entities, VCs are beginning to think that they’re a pretty good idea, too.

“The insurance industry is great at creating astronomically expensive products that don’t involve much of a payout,” says the CFO of a San Francisco-based VC firm that’s finalizing how its own captive entity will be structured. “Worse, when you have a claim, your premium goes up the next year by 100%. We’re using [our own insurance] to fill a gap.”

Indeed, Mike McKee, founder of Private Equity Risk Management, a former partner at the fund-of-funds firm Pacific Corporate Group, is hoping to launch a new career around that gap.

PE Risk Management is currently in discussion “with 20 firms, 10 of which are interested” in setting up captive entities, says McKee.

There are many advantages, he says. For one, because the firm is insuring itself, if no claims are made against it, the money that it has poured into the entity goes back into the coffers of the firm’s limited partners.

Also, a captive entity allows a firm to elect a higher deductible when renewing its asset protection policies, saving itself money. Finally, though not a point that McKee promotes to VCs, operating a captive entity allows a VC firm to circumvent a layer of insurance brokers when purchasing its asset protection policies from a carrier, which can cut costs on those policies by anywhere from 10% to 25%, he says.