Why private equity firms need holistic insurance solutions now more than ever

Today’s private equity firms are confronted by challenges that have been years in the making. The low interest rate environment, paired with increasing frequency and severity of claims across commercial and specialty insurance lines of business, has created a hard insurance market, and with that a number of unique challenges for private equity firms. While these challenges are formidable, they also present the opportunity for private equity firms to shape the future by choosing insurance partners that have the expertise to meet their insurance needs, and that can work closely with them to position their portfolios strategically.

The current environment of increasing premiums and decreasing coverage options has been developing for the past several years. This is being driven primarily by the increasing severity and frequency of natural catastrophes, as well as social inflation in the U.S. — that is, societal and legal trends that have undermined profitability for insurers. As these trends have emerged, general liability claims have become more frequent and more severe.

A key factor driving social inflation in U.S. claims, including large award sizes, has been public opinion of big business. As economic inequality has grown, the general public has become more distrustful of corporations, often viewing them as unethical and unfair.¹ This perception has led jurors across the U.S. to empathize with plaintiffs, sometimes despite the facts of a case, and punish corporations with their verdicts by granting ever-larger financial awards to plaintiffs. In 2019, one U.S. jury verdict awarded more than $8 billion in damages², and these types of oversized awards and settlements are becoming the norm.

These trends in claims and awards have caused insurers to increase rates to mitigate losses. However, insurers have struggled to keep pace with payouts as claims activity has persisted, and for a number of insurers, reserve funds have been significantly impacted, and therefore they have been forced to increase rates further, re-evaluate the scope of coverage they provide, and impose stricter underwriting criteria. These changes have reduced the amount of capacity available in the marketplace, forcing underwriting teams to review an increasing number of submissions in shorter timeframes. As a result, Canadian private equity firms with current or prospective portfolio companies in the U.S. may struggle to find adequate insurance solutions with their current insurance partners.

“Despite the challenges that we are seeing in the market, private equity firms can thrive by choosing an insurer partner that understands their business and is committed to their needs,” says Chris Corbeil, Vice President of Commercial Products & Strategy at Liberty Mutual Canada. “Alongside their broker, a private equity firm’s insurer should be communicating regularly in order to stay educated about emerging trends. They will also work with the private equity firm to look for creative solutions not only for the firm itself, but for the portfolio companies which are facing similar headwinds.”

In an environment of heightened claims activity, private equity firms should sharpen their understanding of the insurance market in order to anticipate potential claims and mitigate their impact on the bottom line, which they can do by establishing lines of communication with their insurer. Transparent communication around targeted and expected growth within a firm’s portfolio companies can also lead to binding multiple lines of coverage at a reduced cost, even as the firm continues to expand its operations.

“Private equity firms should think of their insurance carrier as a business partner,” says Sandy Norton, Assistant Vice President of Financial Institutions & Professional Services at Liberty Mutual Canada. “They will see the benefit to their bottom lines when they establish an open line of communication between themselves and an insurer that offers the expertise to bind appropriate coverage with speed and efficiency.”

After declining sharply in the early days of the pandemic, M&A deal volume and value in North America has rebounded since the midpoint of 2020. Megadeals, which are large transactions between two companies often resulting in a merger or acquisition, doubled in the second half of 2020³ and are expected to gain even more momentum in 2021.⁴

“As deal activity surges, it’s essential for private equity firms to partner with insurance companies that can respond quickly,” says Jonah Goldberg, Head of Canada, Liberty Global Transaction Solutions. “And because portfolio companies are complex entities that differ from typical private companies, they rely on carriers to understand their businesses and offer insurance solutions that meet their unique coverage needs. In addition to expertise, this requires open and ongoing communication so that firms can anticipate claims trends and insurers clearly understand what service standards and lines of coverage are required.”

“Private equity firms should also partner with insurers that have the appetite, as well as the underwriting and risk-management expertise, that align with the firms’ target industries,” says David Barry, Vice President, Head of Financial and Professional Services at Liberty Mutual Canada. “For example, a firm that wants to grow within middle market manufacturing should partner with an insurer who plans to provide solutions within that space for the foreseeable future.”

In addition to maximizing financial returns, private equity firms are expected to meet certain standards of environmental, social, and corporate governance (ESG) as well as diversity, equity, and inclusion (DEI). By extension, this requires them to ensure that the business partners they choose — including insurance carriers — also uphold these standards.

Once regarded as a key differentiator that was nice to have, ESG is now imperative. Private equity firms are expected to serve a social purpose and have a positive impact in their communities, and those that fall short risk damage to their reputations, regulatory sanctions, and legal challenges. For example, a public pension plan that takes a stance on a particular social or environmental issue may pull investments from, or even sue, a private equity fund sponsor whose investment practices contradict that stance.

Firms are also under increasing pressure to improve DEI within their own firms and portfolio companies. While some have made progress in this area, there is opportunity to do more in terms of policies, practices, and the prevailing culture. In recent surveys, more than half of executives reported that their companies plan to expand diversity and inclusion training, while nearly 60 percent of consumers said that they are more likely to purchase from a company whose values match their own.⁵ A report published by McKinsey in 2020 also outlined the strengthening relationship between diversity on executive teams and the likelihood of financial outperformance,⁶ further showcasing the benefits of an ongoing commitment to DEI.

“To keep pace with cultural shifts and societal trends, private equity firms need to develop strategies for implementing ESG and DEI policies within their firms and their portfolio companies,” says Chris. “Firms that value and prioritize these initiatives have an opportunity to be seen in a more positive light by insurers, investors, employees, the public, and more.”

With deal activity expected to grow significantly in the coming years, Canadian private equity firms need insurance partners that support their efforts to expand across North America.

“A firm’s growth across borders shouldn’t be limited by its ability to find insurance coverage,” says David. “And a firm that forms a strong partnership with a stable, global insurer will be better positioned for success than a firm that doesn’t. Having a partnership in place will help the firm in the long run as it tries to find coverage for tougher classes of business, or as the market hardens even further.”

Liberty Mutual Canada provides unparalleled expertise and coverage solutions domestically, but offers U.S. property, casualty, auto, and workers compensation as well. Our team of local, dedicated underwriters can also bundle commercial risks into a package that covers even the most complex exposures.

“As disruption in both industry and market conditions continually shifts risks, private equity firms need more than an insurance policy,” says Chris. “They need experts tuned in to the industry, and collaboration they can count on to move their enterprise forward.”

For more information, please contact your underwriter.

¹https://www.edelman.com/trust/2020-trust-barometer
²https://www.reuters.com/article/us-johnson-johnson-risperdal-verdict-idUSKBN1WN2HK
³https://www.pwc.com/gx/en/news-room/press-releases/2021/global-m-and-a-industry-trends-jan-2021.html
⁴https://www2.deloitte.com/us/en/insights/industry/financial-services/private-equity-industry-forecast.html
⁵https://www.pwc.com/us/en/services/deals/industry-insights.html
⁶https://www.mckinsey.com/featured-insights/diversity-and-inclusion/diversity-wins-how-inclusion-matters#