As private equity firms work with their portfolio companies to help them grow and ultimately maximize returns, they will invariably need to manage a large degree of change – integration of bolt-on acquisitions, entering new countries or operational overhauls. This creates not only great opportunities, but also certain circumstances from a risk and insurance perspective that need to be addressed.
The following three themes should be at the core of the risk and insurance strategy for any PE firm and, by extension, each of their portfolio companies.
Design the insurance program to reflect the investment lifecycle
Investors in portfolio companies can play a role in ensuring an insurance program is in place that is fully enhanced to reflect the nature of PE backing. This should include:
- Enhanced protection through wider than standard coverage – Avoid uninsured losses and allow room for the evolution of the business through wordings tailored for PE ownership.
- Flexibility for growth – Avoid additional insurance costs associated with organic growth and bolt-on acquisitions.
- Support in the event of a major loss – Agree terms with insurers that provide cash flow support and reflect the increased likelihood of leverage and existence of bank covenants.
- Financial contribution towards improving risk management – Limit the potential for reputational damage that can impact EBITDA.
- Ease of transition at exit – Ensure insurance is portable and transparent in the event of a transaction to provide comfort and predictability for management, seller and buyer.
Consider how cyber risk could impact the portfolio
For funds with global reach, EU data protection regulations in force since 2018 means companies face onerous requirements, notification rules and significantly higher fines of up to 4% of global turnover or €20 million. Beyond this direct cost, reputational damage caused by a major breach could impact a portfolio company’s value, particularly if it occurs immediately prior to an exit.
Also driving portfolio risk domestically, social engineering and ransomware continue to be commonplace in the marketplace. A thorough understanding of how cyber theft and extortion are addressed in a company’s cyber policy as well as its crime policy is critical to ensuring there are no gaps in coverage.
Helping investee companies gain a clearer picture of their risk landscape will ensure appropriate protection for the business, and subsequently the PE firm’s investment.
Manage ESG risks across the portfolio with purpose
Now more than ever before, managing the ESG performance of assets across the portfolio also represents an opportunity to increase multiples. Many investors now require higher ESG standards; companies that score well in ESG are starting to be seen as the top tier and demand for these assets is intensifying. Insurance companies are becoming more selective in favor of firms who demonstrably go above and beyond applicable regulatory requirements, such as those around responsible investments that the European Union is set to implement in 2021.
Funds can boost asset value by proactively shaping their ESG profile, which will also have a positive impact on perception of their risk management approach and the cost of insurance as a whole for reasons which didn’t apply before.
A good due diligence strategy will look for opportunities in acquisition targets to transform activities, practices and outputs so that they reach a higher bar. Some of those changes can be implemented relatively quickly. Climate scenario modeling, as one example, offers a wealth of levers that can be tracked as part of a cross portfolio monitoring exercise. Ostensibly unattractive assets with a poor ESG footprint ‘today’ could be turned around on the back of the ability to access continuing support from banks and insurers.
Seek clarity on exposures faced by directors of portfolio companies
Even a high quality “off-the-shelf” directors and officers policy may fail to pick up on the nuances of PE ownership structure leaving individuals, including representatives from the PE firm, potentially exposed. We often see a lack of clarity in relation to issues such as:
- Who is offering indemnities to directors? Are they covered by insurance?
- Definitions of key items including “directors” and “transaction”.
- What happens in the event of a change in ownership or insolvency?
By considering the above issues now, investors and management teams will better position themselves to optimize the upside of growth, while minimizing the potential downside associated with an unforeseen event.