The Great Recession of 2007 to 2009 has finally caught up with the US private equity (PE) industry. While the financial crisis had a more immediate impact on other sectors within financial services, PE firms were less scathed in the short-term due to the long-tail nature of their financial exposures. Even if some of their individual portfolio companies suffered as a result of the financial crisis, the impacts of those events did not catch up with limited partner investors or other fund constituents until some years later.
Shortly after the Great Recession, the regulatory authorities – including the US Securities and Exchange Commission (SEC) and the US Department of Justice (DOJ) – started bearing down on PE firms, holding them to a higher standard of reporting and disclosure than ever before, which caught some companies off-guard. This confluence of events – the Great Recession, followed by increased regulatory scrutiny – triggered an uptick in the frequency and severity of insurance claims from the General Partnership Liability lines (D&O, E&O, Employment Practices Liability for the Fund Sponsors) filed by PE firms once the impacts of those events were realized. The losses started to pick up in 2013/14, causing the PE insurance market to react by tightening up capacity across multiple lines.
“We’re currently in a hard market,” said Mark Reilly, SVP and head of Ironshore’s financial institutions group. “It’s no surprise to anybody. It’s something we’ve been building towards for the past four or five years, and it’s driven by claims activity. Much like the PE funds themselves, these are very long-tailed exposures [...] whether it’s trouble at a portfolio company, or claims, or investigations from regulatory agencies, it all tends to play out much longer in the PE space. We will often go a cycle or two of renewing before we start to see the losses pile up. They’ve been building since about 2013, and from the second quarter of 2019, the market has become pretty firm.”
It’s not just the PE firms that are dealing with tight insurance market conditions; PE firms’ portfolio companies have also experienced the shift. RT Thomas, vice president and underwriting manager for Ironshore’s newly formed PE Portfolio Company team, said this is the first real hard market for commercial management liability lines that he’s experienced in his 18-year career. He said that after 15 years of soft conditions and, more recently, a few consecutive years of loss deterioration in commercial lines, the market became unsustainable in terms of the rates, retentions and the breadth of coverage that insurers were providing. When the market started to harden, that’s when Ironshore decided to create the PE Portfolio Company group in order to help guide PE-funded firms through the changes.
“PE firms tend to run their companies a little bit different than your average private company business,” Thomas told Insurance Business. “They will have more debt, they will focus more on EBITDA [Earnings Before Interest, Taxes, Depreciation, and Amortization - a key metric evaluating a company’s operating performance] than net income, and you need underwriters who are experienced in that to be able to read the signs and understand the way they run their companies. If you were to look at some of the balance sheets and income statements of portfolio companies, they could seem strained to an average underwriter. But the point of these PE firms is to run them differently, create value, and then unlock that value when they choose to execute their exit strategy.
“For us to be able to devote a dedicated, experienced team specifically to these private equity portfolio companies in a market that is starting to change, will allow us to write the business at sustainable rates, while partnering with PE firms on a long term basis. Creation of this team allows us to use our expertise to craft company specific solutions that will help portfolio companies navigate the currently tough management liability market.”
Tying this all together and overseeing the aggregate risks and insurance needs of PE firms and their portfolio companies is Liberty Mutual’s Global Private Equity Practice. This group, led by Amy Gross (pictured), looks to create holistic solutions for the private equity space by utilizing both the Liberty Mutual and Ironshore product solutions. As the market hardens, Gross stressed just how important it is for PE firms, their portfolio companies, and their risk management partners (insurers, brokers and third-party consultants) to “look at the big picture” and manage risks at an aggregate level. “Liberty Mutual offers products across the organization that can support private equity firms and their portfolio companies. From our transactional liability products to our traditional property and casualty products – we can be a total insurance solution around the world.”
“We’re seeing a tightening of capacity in a lot of lines in the market, whether it’s general or excess liability in the casualty space, primary commercial auto liability or in the property markets. These firms, both the PE funds and their portfolio companies, are certainly feeling the hardening of the insurance market,” said Gross. “My role, and the role of the private equity practice, is to pull together the big picture for these firms, look at the aggregate of the business we do together, and help them stay on top of things because the market is certainly tough right now.”
For brokers navigating the hard PE insurance market, one thing that’s key to their success, according to Reilly, is strong communication. Culturally, PE firms typically like to keep things close to the vest, but in order to get the best policy rate, limits, terms and conditions they should open up to some extent. The insurance community is often asking to be treated as limited partner investors throughout the underwriting process. They can also become more favorable risks if they take advantage of third-party consultants and advisors who will lay an “independent set of eyes” on their risk-taking decisions.
Reilly commented: “Larger PE firms have the resources to utilize outside counsel, consultants and industry experts. Historically, the smaller sponsors rely more heavily on their insurance brokers to be their risk management consultants, but it can also be helpful to work with a third-party consultant. In this period of economic uncertainty, it’s great to make sure PE firms are out there crossing every t and dotting every i, just being as careful as possible with regard to disclosure and communications.”
Even with strong communication, upcoming renewals are going to be tough, stressed Thomas. He said: “The more time everybody has to give those tough messages, the better; because there are going to be shifts in every insurance program this year and if appropriate time is allotted we can all work together to find a joint resolution. Communication is key, and getting ahead of things this year will help everybody on all sides.”
