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Portfolio Insurance Programs

By Josh Warren | Published April 25, 2019

**This is the fifth installment in the ABD M&A Advisory series titled ** “Finding the Upside in the Downturn”

Private equity firms have always looked for ways to take advantage of cost sharing among their portfolio companies. As a result, a role was created at many private equity firms in which individuals became solely responsible for spearheading these aggregation strategies. Whether it’s utilizing the same software, computers, shipping services, raw material suppliers, or insurance brokers.

From the outside looking in, insurance brokers logically draw a straight line from the common ownership of a private equity firm across so many portfolio companies. For the uninformed broker, it seems like someone at the private equity firm should be willing to “drop the hammer” in a draconian manner and force their portfolio companies to buy from one broker. Makes sense, right?

We all know that rarely, if ever, happens. We also know that, with a few exceptions, group insurance purchasing initiatives seldom get prioritized.

In this installment of “Finding the Upside in the Downturn” I’ll explain why my private equity clients were willing to engage in discussions about portfolio programs in 2008 and 2009, and what kind of results were achieved after a lot of time and effort.

A Portfolio Program is in the Eye of the Beholder

Insurance brokers call pooling insurance purchasing for portfolio companies a “portfolio insurance program.” What that really means in practice depends on who you are talking to.

• Does that mean putting every portfolio company on the same policies and allocating premium to each company?

• Does that mean insuring every portfolio company with the same insurer?

• Does it mean combining some policies but not others?

• Does it mean making the insurance broker the common thread in order to streamline process, improve communication, and aggregate services?

Most private equity professionals don’t have time to discuss such ideas, but in the aftermath of the economic downturn, as deal flow slowed to a halt, they grew willing to have the conversation. I think this was for two reasons:

• As I mentioned in the article about how a D&O policy advances defense costs in the event of a bankruptcy, there was a desire to bring consistency wherever possible in the chaos that ensued.

• They were exploring every possible way to reduce expenses and create operational efficiency at their companies.

The conversation and the resulting effort was rewarding, but it didn’t bear fruit for everyone.

I’ve worked with several private equity clients who have tried to implement a portfolio insurance program for policies like General Liability, Workers’ Compensation, Auto, Foreign Liability, and Umbrella. These programs rarely worked out in the end. Here’s what I learned from those experiences:

• Underwhelming Cost Savings: After months of time and effort, when the program comes together, the actual cost savings somehow doesn’t seem worth it. While it’s reasonable to achieve savings of 10% – 25%, in real dollars it is underwhelming to some portfolio companies. _“What do you mean I did all of that to save 0,000?!?!_When it’s all said and done, most of the cost savings will come from the broker reducing their commission. It is justifiable to ask for this since there is operational efficiency associated with having accounts that renew on the same day, with the same insurance company, serviced by the same team, etc. It really could save a lot of time to just hire a broker, tell them to find any savings they can, and cut their commission by X%!

• Passive Resistance: Portfolio company management teams have moved on to bigger and better things than insurance matters – like growing their company! A portfolio program cannot be implemented without their complete cooperation, so it will derail the entire process if a couple of companies move slowly in providing the required information.

• Underwriting Exceptions: While every portfolio company might be in the healthcare field, for example, there is a big underwriting difference between a manufacturer of a component part for a hip replacement, the software that checks patients in at a hospital, and a dermatology practice roll-up. Underwriters will almost always cherry pick and want companies 1-8, but not 9 and 10. Maybe companies 9 and 10 are too big, too small, too international, or too hazardous. Insurers still have reinsurance contracts that limit the scope of what they can insure, and there isn’t an insurance company that will insure every type of business.

• Viability: Keeping a portfolio program viable means that acquired company must be “rolled in” at close. Nowadays, most (not all) private equity firms are loathe to force a broker appointment. Every time you sell a company (and they leave the program) you must add another company to offset it. It becomes impossible to maintain a portfolio program otherwise. Especially if the company that you sold generated a significant portion of the overall premium. This issue has caused portfolio programs that were successful at the onset to ultimately fall apart years later.

• Improper Motivation: The most successful portfolio program implementations that I’ve been part of came to be because a portfolio company was burned for one reason or another. Either there was an incident at a facility that didn’t have the right property insurance, or there was a product recall that was uninsured. In one case, a portfolio company was held for an extra year in order to cover the costs of an uninsured claim. If inappropriate insurance coverage has caused pain or board level attention, there will be proper motivation to push this along. If it’s all about cost savings, you will probably put the brakes on the process when you start getting inevitable pushback from your management teams.

• Looking at the big picture, it’s not enough to just save a portfolio company premium dollars today. The policies should also be fully transferrable to a new owner. If they aren’t, and costs will increase at close when a new policy is placed, you could be forced to restate earnings. If that happens, the savings that was achieved will be lost 6x, 7x, 8x etc.

• Other Initiatives are Easier: Let’s face it, there is a long list of other procurement strategies that can be addressed that are a lot easier, less emotional, and possibly more impactful to the bottom line. When the process starts getting cumbersome, many private equity firms just table it in favor of another initiative.

Not all is lost. There are some policies that lend themselves to a portfolio program approach. These coverages include Executive Liability (D&O, EPL, etc.), Pollution, Cyber, Product Recall, Trade Credit, and Property. While many insurance policies can be purchased “off-the-shelf” these days, the aforementioned policies still require the touch of a skilled broker that can decipher the nuances between one insurer and another.

Underwriters that specialize in these coverages have solutions for difficult exposures, are less concerned about industry sectors, have flexibility to be creative because they can write on “non-admitted” paper, and aren’t bound by regulatory issues germane to coverages like Auto and Workers’ Compensation.

In addition to pooling the risk, these underwriters will be willing to offer creative program designs and enhanced services. The possibilities here are endless, but here are a few that come to mind:

Creative Program Designs

• Shared and Separate Limits: A shared policy can be placed at the fund level with a high limit and deductible. For the sake of discussion, consider a 00MM limit and a MM deductible. Then an individual policy with the same insurance company would be placed at each portfolio company with a MM limit, thus satisfying the deductible of the fund level policy. This gives the companies individually tailored coverage with a dedicated limit, and then access to a higher limit in a catastrophic loss scenario.

• Multi-Year Terms: Underwriters are often asked to provide multi-year rate guarantees. They almost always say no because it is difficult to do that on a one-off placement. However, the size and scope of a portfolio program can persuade underwriters to think longer term.

• Simplified Renewals: Anyone that has gone through an insurance renewal cycle knows the pain of completing countless applications. While they won’t go away completely, the process can be simplified in a portfolio program.

• Best-in-Class Terms: It is common for an underwriter to say, “we don’t normally offer that coverage for companies at that premium level.” That won’t happen if you pool the risks together.

• Full Portability: The underwriters in these segments will normally agree to guarantee the policy terms, conditions, and pricing for at least 12 months post liquidity event.

• You have one premium, and 10 portfolio companies. Most underwriters will allow you to determine how that premium is spread across those 10 companies with reasonable restrictions.

• Different Deductibles: A policy can be structured with different deductibles for each company based on their size and exposure to loss.

Enhanced Services

In insurance, as in everything else, if you pay more you get more. Here are some examples of enhanced services that are available:

• Due Diligence Services: Insurance companies offer many loss control services when a policy is already in place. Although you don’t own a company during due diligence, with a portfolio program you would already be a client. Therefore, the insurer could do things like complete a property loss control visit or perform a cyber network threat assessment. This will answer questions like :_ Is that sprinkler system adequate? If not, what will an adequate sprinkler system cost us? _ Is their computer network an open invitation for bad actors?

• Post-Close Services: Insurance companies have really sophisticated “toys.” They have mobile apps, pre-loss services, online safety training, hardware that can be used to protect your network, etc. With a portfolio program you will have access to the best that they can offer.

• Actual Go-Forward Cost Estimates: As a broker who performs due diligence, invariably I will have to estimate what the go-forward cost will be. It is always a conservative premium range. With a portfolio program in place, you will get the actual

Conclusion

I believe that portfolio programs don’t happen as often as they could because most middle market private equity firms don’t have a single decision maker that can direct initiatives like this. Insurance purchasing decisions are often left to the individual deal teams, and they (rightfully) only focus on it during the initial due diligence process.

If something does happen to give you and your firm motivation to move forward on this kind of initiative, this is what I suggest:

• Choose your Broker First: If you are accustomed to putting an insurance renewal “out to bid” that won’t work here. Meet with as many brokers as you feel is necessary, choose your broker, and then let them run the process.

• Go in Stages: The first step isn’t to replace the brokers that are serving your portfolio companies. Your broker should perform a feasibility study, explain the cost / coverage / service benefits, and lay out a clear timeline.

• Chip Away at it: Don’t try to address every line of coverage at once. Find the one that concerns you the most, or will incur the least resistance, and begin to check them off one at a time. Once you prove that the process results in lower premium and better terms for everyone, replicating the process will be easier for the next line of coverage.

Don’t get me started on employee benefit portfolio programs…

Of course, if you have questions about this, or anything else, please contact us for ways to provide certainty with understandable solutions.