Private Equity Insurance is a highly specialized discipline that requires detailed knowledge of both private equity and insurance, along with ongoing monitoring of the latest developments in those areas. It is not a subject for dilettantes or the disengaged.
More than just investors — they are also business strategists, managers, brand-builders and employers — private equity firms face risks that go beyond the infusion of capital into portfolio companies. Those risks include lawsuits, regulatory changes, reputational damage and an ever-evolving investment landscape that can be full of hard-to-foresee obstacles — COVID-19 being one dramatic example.
True professionals in the Private Equity Insurance field differentiate themselves through vigilance — by looking around the corner, seeing what’s ahead and advising their clients on how to manage private equity transactional risk.
For example, one critical yet often underappreciated or even overlooked protection for private equity firms buying middle-market companies is Directors and Officers (D&O) Liability Insurance. In mergers and acquisitions, D&O liability claims lurk around every corner, yet some funds don’t have their own D&O insurance, relying instead on the policies of the portfolio companies in which they’re investing. Many funds that do have their own D&O coverage take a passive approach to policy renewals, neglecting to monitor changes in rates, limits or terms imposed by the insurance company. Both of these approaches are risky, with the potential to become extraordinarily costly, as well.
A qualified, vigilant insurance broker will not only spot lurking D&O claims but also recognize the relevant changes in coverage details and recommend how to reduce and mitigate the risks.
Warnings — and Solutions
In a February opinion piece for the New York Times ominously headlined “The Private Equity Party Might Be Ending. It’s About Time.,” investment banker-turned-author William D. Cohan addressed the ramifications of a December 2020 ruling by Southern District of New York Judge Jed S. Rakoff. In his ruling, Judge Rakoff declared that the former directors and officers of Jones Group, a publicly traded women’s apparel company, could be held liable for approving the sale of the company in a leveraged buyout that led to its bankruptcy. “In other words,” wrote Cohan, “Judge Rakoff said in his ruling, officers and directors had better think twice before agreeing to sell a company to a buyout firm.”
“The ruling has the potential to hold accountable those responsible for allowing otherwise solvent companies to be sold into circumstances that would soon enough cause their bankruptcy,” Cohan continued, before sharing a message the law firm Ropes & Gray sent to its clients: “Ropes & Gray wrote that the [Jones Group] decision ‘should be viewed as a serious warning for corporate decision makers’ and that even though the directors of the selling company were no longer involved, they ‘cannot ignore’ what a company’s balance sheet looks like after it is sold to a new buyer ‘without also risking their protections under business judgment rule.’”
While Cohan’s premise and the Times’ headline may be questionable, it would be foolhardy to disregard a credible note of caution regarding portfolio companies and their balance sheets. Doing a deep dive into a potential acquisition is where an astute insurance broker can help.
Let’s say a private equity firm is considering purchase of a medium-sized manufacturer. Through its own due diligence, the firm may discover that the company’s manufacturing plant has environmental exposures — a significant factor in whether it will attempt to purchase the company and, if so, at what price. A good insurance broker will go deeper, determining whether the company is covered by Environmental Liability Insurance and, if necessary, designing a customized program that would help make private equity investment worthwhile, including Tail Coverage for claims that are reported after the deal closes and the policy expires, and Representations and Warranties Insurance (RWI) to cover elements of a standard purchasing agreement that later prove to be incorrect, resulting in a breach of sale contract.
SPACs and the Need for Speed
In the fast-moving world of private equity mergers and acquisitions, you don’t have time to wait for your insurance broker to catch up on the particulars. You need someone who’s out ahead of potential developments and prepared to respond to whatever challenges you confront. Never has this been more true than during the roughly 18-month period in which special purpose acquisition companies, or SPACs, have become the vehicle of choice for many private equity investors.
As Reuters reported in April of 2021, “SPACs typically operate with a two-year timeline to identify and acquire a target company, leading to an increased risk of lawsuits against the board for breach of fiduciary duty on allegations relating to the merger, such as missed timelines, nature of the target company, or a broad range of other scenarios that have not yet played out.”
The variables involved, the pace required to structure SPACs and the agility necessary to navigate the rapidly changing regulatory landscape typically require eight or nine specialized services for private equity firms. That’s why at Alera Group, a team dedicated to private equity offers three of the core services required by any investment firm — Property and Casualty Insurance, employee benefits and wealth management — while working closely with specialists in related areas such as law, accounting and IPO management to provide comprehensive consultation and support. SPAC investment is expensive, and the risk is high, so working with knowledgeable people who are experienced at working with portfolio companies and thoughtfully placing coverage such as D&O Insurance is imperative.
When a SPAC deal goes badly, it often goes very badly, but at least some of the circumstances that cause acquisitions to founder can be avoided through diligence and sound decision-making. For private equity firms, that includes selecting the right insurance brokerage.
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About the Author
Managing Director, Private Equity Practice
GCG Financial, an Alera Group Company
Teddy Felker is a fourth-generation insurance broker based in the Chicago office of GCG Financial, an Alera Group Company. He spent four years at Marsh (global brokerage firm) in New York and San Francisco before joining GCG in 2012. Teddy works with private equity funds, independent sponsors, family offices, specialty lenders, and investment banks, brokering these lines of coverage:
- Rep and Warranty Insurance
- Directors and Officers Insurance (D&O)
- Property and Casualty Insurance, including Workers’ Compensation, General Liability, Auto, Property, Umbrella
- Professional Liability/Errors and Omissions (E&O)
- Cyber Insurance
- Pollution/Environmental Insurance.