Portfolio Insurance Programs
This issue of The Partners' Perspective addresses the myths and realities associated with so-called portfolio insurance programs.
A portfolio insurance program is like the mythical unicorn - we know what it is supposed to look like, but has anybody actually ever seen one?
Let's start with the definition of a true portfolio program - the combining of each line of insurance under a single insurance company (per line of coverage) for all companies within a portfolio and across all funds.
The bottom line is this - if you are being told by your broker that they can create such a program, they are lying to you. Their goal is to pick up some new business, and later, they'll give you excuses and ask for forgiveness. They are telling you what you want to hear. This issue of The Partners' Perspective will tell you what you need to hear. To quote Bill O'Reilly, "The spin stops here, because we're looking out for you." However, since so many people are enamored with the concept of portfolio programs, and because our goal is to protect the best interests of our clients, let's outline the necessary ingredients to create such a program:
The name of your fund is Homogenous Equity Partners I, LP
Most private equity firms do not acquire same sized companies in similar industries with similar risk profiles across all of their funds. In fact, the exact opposite is true. Private equity firms are opportunistic. Their portfolio companies vary in size, industry, and risk profile. From a "degree of consolidation difficulty" standpoint, each portfolio company has a unique claims history, risk financing program, and risk appetite (high deductible or low deductible).
Your portfolio companies all have the same ownership and financing structure
Do you own 90% of the portfolio company or 50%? Is the remaining stake in the hands of another private equity firm or management? Did you tell management you would be "hands off" and let them run the company? Does your co-investment partner want to include the portfolio company in their portfolio insurance program? Are the lenders to each portfolio company the same? No? Well, we're sure the different lenders all have the same insurance coverage requirements and additional insured language to be included on their certificates of insurance. And, we won't even get into the issues of consolidating across multiple funds.
Your portfolio companies all have the same expiration dates on their current policies
They don't? You just added 12 months to the process. Some coverages have minimum premiums. Some portfolio companies have insurers that leveraged one line of business to get another (we'll write your "dog" of a workers' comp risk if we get your "sweet" property risk). Often, these policies have different expiration dates. Certainly, the portfolio companies within a fund have different expiration dates.
Your portfolio companies are not dynamic
Insurance is static. Coverage is meant to be bound, and, then, to sit still until a claim is filed. Private equity is dynamic. Portfolio companies are constantly being acquired and divested. Portfolio companies themselves are constantly acquiring and divesting. Old funds are being liquidated. New funds are being raised. A portfolio program has to be dynamic. The nature of insurance does not allow for that.
All Risks Always Insurance, Ltd. gets created
There is not an insurance company on the planet that will write every risk in every line of business in every geographic location. In fact, there are extremely few insurers that would write every portfolio company within a given line of coverage. And, don't you think they know that they have a supply/demand advantage? So, best case, now we are looking at multiple insurers for your portfolio program.
Management has no local relationships
That never happens! In 14 years of serving private equity firms, we've never had a management team try to tilt the playing field to their local relationship. They never take the quotes and savings and funnel them to the "local guy." They never say "My local guy can come within 5% of these premium savings. It's not enough savings to be worth the aggravation of switching to a new program." (Note: please inflect on each "never" to get the proper amount of intended sarcasm)
Oh, and management is always timely in providing all of the information required to try to put the program together in the first place. Sure - and Tiger isn't in Phil's head.
The "Supply" of coverage = The "Demand" for coverage
The demand for portfolio programs and the supply of portfolio programs are inversely related. Portfolio companies are willing to do anything to get some premium savings during a hard market. For precisely the reason why the market is hard, insurance companies are not willing to be flexible. During a soft market, insurance companies are willing to be flexible in order to generate a flow of premium dollars. During a soft market, portfolio companies enjoy significant premium savings without the hassles of consolidation.
You don't mind selling portfolio companies with "strings attached"
In most cases, the future insurance liabilities of a portfolio company go with it when the portfolio company is sold. The new buyer assumes responsibility for retro adjustments, loss development, premium audits, etc. But, your portfolio companies are consolidated into a single program. There is a single retro adjustment or loss development or premium audit for the entire program. You will have to allocate that cost to each portfolio company. Do you allocate costs to divested portfolio companies? (Hint: you'd better or you'll have a revolt among the remaining portfolio companies) So, of course, we'll let potential buyers know that they'll be responsible for future cost allocations of an undetermined amount.
Those are but a few of the "ingredients" necessary to create a portfolio insurance program.
Now, for the good news - it actually can be done and we know how to do it! It isn't easy and it requires a high level of GP involvement. Please feel free to contact your Equity Risk Partners professional for more details. We would write about it, but those same brokers who are lying to you also like to steal our ideas!.
Our objective is to educate and inform. We hope we succeeded. As always, we appreciate your time and consideration, as well as your continued support of Equity Risk Partners.
For further information, please contact your Equity Risk Partners professional.