Private equity partners who make control investments in middle- and lower-middle-market companies typically rely on their lawyers, accountants and bankers to be trusted advisors. However, they often overlook the important role an experienced insurance broker can play in their portfolio’s success. As a former investment banker who now works exclusively with private equity funds, I have audited numerous portfolios and have found that most are overpriced, improperly structured (with overlapping coverage or gaps and conflicting or ambiguous language between carriers) and poorly managed.
When I’ve asked partners why they haven’t taken a more strategic, hands-on approach, I have heard numerous reasons for this attitude: “Insurance is a commodity, so it doesn’t matter who I use.” “I have limited bandwidth on time and relationships.” “I don’t want to spend my political capital, so I leave the insurance to be handled by the portfolio company.” “I hate dealing with insurance.”
With insurance typically being one of the largest expenses across a portfolio, partners who fail to develop a relationship with an experienced private equity insurance broker are missing an opportunity to improve EBITDA and strengthen a portfolio’s coverage profile. With insurance markets in turmoil due to catastrophic losses, increased claims activity and the uncertainty caused by COVID-19, private equity professionals need trusted insurance advisors who can act as outsourced risk managers. To meet that standard, brokers need to keep several things in mind.
Relationships. Insurance brokerage firms are under increasing strain from both a human capital and revenue perspective, depending on their finance structure. With each renewal requiring more work and time, the best brokers are unable to handle the same volume as before. This often results in less important (i.e. less revenue) clients being pushed to the B/C/D teams, who may not have the experience to competently mitigate a fund’s or portfolio’s risk.
Aggressive marketing. When M&A activity was strong and the insurance markets were soft, many private equity partners lost focus on insurance, allowing brokers to become complacent. With deal-making slowing and the foreseeable economic outlook uncertain, private equity professionals will be demanding more from their brokers.
Brokers will be expected to obtain quotes from every carrier in the market, not just three or four preferred trading partners. They should also engage specialty private equity wholesalers when appropriate, even though it is against their economic interest. Finally, brokers should begin the marketing process at least 120 days prior to expiration to ensure portfolio companies do not face last-minute, take-it-or-leave-it policy terms or outright denial surprises.
Innovative strategies. The bigger the company, the more market leverage it has – and private equity partners can use this truism to create economies of scale by aggregating their portfolios. Accordingly, a good broker should align all portfolio insurance to one renewal date and go to market as a fund-branded conglomerate. Brokers should also build fund relationships with three or four main carriers across the portfolio to improve carrier claims handling and service. Finally, for D&O, brokers should secure lower limits (cheaper pricing) for each portfolio company and then cover with a higher-limit umbrella to reduce tail pricing at exit.
Attentive, proactive service. Just as private equity partners love to do deals, brokers love to place a well-priced policy with broad coverage. But too often, service becomes an afterthought. To provide attentive service, brokers should engage in frequent communication with partners and management teams to advise of market developments that could have a significant impact on upcoming renewals. Regular communication will also help brokers understand the changing dynamics of a company (employee headcount, revenue, work-from-home arrangements, etc.) so that policy adjustment/credits can be negotiated with the carrier.
Non-insurance solutions. The best option to mitigate a risk might not always be a high-cost, robust insurance policy. There are innovative solutions in some areas, like employment practices liability, that can transfer risk more effectively than a standard EPLI policy. Brokers who value client relationships should always be looking for the best solutions to mitigate portfolio risk, wherever they may be.
Rammy Streit is a vice president on the private equity services team at the Plexus Groupe/Plexus Financial Services. She is a former investment banker with Lehman Brothers and Bank of America Merrill Lynch.