“DeshCap is referenced by Investopedia for private equity risk management.”
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Lowest cost is contractually guaranteed for similar protection tailored to your goals, otherwise we pay the difference. Applicable worldwide.
You can also schedule DeshCap's PE Insurance Demo showing you how we change and trigger private equity insurance policy language for best cost, compliance, operational protection, financing, and valuations.
- Our insurance engineers are independent of any insurance broker or lobbyist, working for you and not the insurer.
- DeshCap advances cash at loss when managing private equity insurance procurements.
DeshCap is ranked online #1 worldwide for Liability Risk Management, which includes hedging it through coverage such as Private Equity Liability Insurance.
A Comprehensive Overview of Private Equity Insurance
Insurance for private equity firms consists of various commercial insurance and financial insurance products protecting a private equity firm directly or indirectly from physical, cyber, and financial losses.
There is a direct correlation between tailored insurance for private equity firms and IRR.
- Such correlation becomes much stronger if the insurance is reworded and triggered independently of any insurance broker or lobbyist, so that it covers core operational risks of a portfolio company while producing high insurance payout ratios, which translates into measurable cash flow protection.
- Upon measuring the extent to which cash flow is protected, the dollar amount of protected cash flow can be incorporated within the valuation models of a portfolio company impacting both liquidity and valuation of such portfolio company and ultimately IRR.
The 3 Elements of Private Equity Insurance
Private Equity Insurance consists of 3 elements:
1. Insurance for the benefit of LPs;
2. Insurance for the benefit of the GP and the Fund(s);
3. Insurance for the benefit of portfolio companies.
Products within private equity insurance include operational insurance as well as non-operational insurance, which together form the universe of investment insurance.
Whether the goal is to cover long-tail liability risks, protecting Management and the Board through D&O Insurance, maximizing compliance with contractual or regulatory obligations, or hedging investment risks, it is important to tailor private equity insurance independently of any insurance broker or lobbyist.
Private Equity Group Insurance
It is centralized insurance coverage made up of several products to provide comprehensive protection and monetization for the benefit of LPs, the GP and Fund(s), as well as portfolio companies. Contact DeshCap to learn more about our broker-independent services on private equity group insurance.
An independent Risk Management committee or board for the Private Equity firm should oversee such procurement.
If the private equity risk management committee lacks the expertise of business insurance procurement, then they must partner with an independent insurance consultant to participate in the design and maintenance of an unbiased private equity risk strategy.
Operational risk strategies for Private Equity should include the structuring of insurance coverage, hiring and executing with insurance brokers, claims management, and other relevant aspects to private equity risk management.
An Overview of Private Equity Insurance Coverage
Private Equity Insurance is rarely taught in schools, and when it is, it’s mostly done through the lens of brokers or insurers. There are many misconceptions around Private Equity Insurance Coverage due to relying on insurance brokers or lobbyists.
It is important to note that private equity insurance coverage has both an operational aspect and a legal aspect, on which we put weights of 95% and 5% respectively in terms of importance to protecting a private equity firm and investments as well as its LPs.
Going to court to enforce coverage defeats the purpose of buying insurance, so private equity firms must make sure that whatever insurance they buy protects their operations and investments right and pays out fast on large losses.
Private Equity Liability Insurance
- Private equity liability insurance is a critical safeguard for firms navigating the complexities of liability risk emanating from private equity investments.
- This specialized coverage primarily includes Private Equity Management Liability Insurance, which protects executives from legal claims related to management decisions, and Professional Liability Insurance, which is designed to cover investment mistakes made by the GP.
- Transaction Liability Insurance, such as Representations and Warranties (R&W) Insurance, shields private equity firms from risks associated with inaccuracies in financial statements or contractual obligations during mergers and acquisitions.
- These above types of commercial insurance mitigate exposure to costly litigation, regulatory fines, and reputational damage, enabling firms to focus on value creation.
- By integrating tailored liability insurance into their risk management strategies, private equity firms can safeguard their assets, attract investors, and navigate an increasingly regulated financial landscape with confidence.
Choosing the Right Private Equity Insurance Broker
- Tier 1 brokerages such as Marsh, Aon, Willis, as well as Tier 2 and 3 brokerages act as private equity insurance brokers.
- Each private equity insurance broker has strengths and weaknesses driven by their technical savviness and insurer relationships, which can change annually.
- Each private equity insurance broker has preferred distribution rights and incentives with specific insurers.
- It is important to get unbiased advice from insurance experts, such our team of insurance engineers, independently of any private equity insurance broker.
Contact us to hire a private equity insurance broker who is the right fit for your private equity firm while optimizing their commission structure.
We make private equity insurance brokers compete for your business to minimize commissions charged all while distributing our reworded version of private equity insurance coverage to insurers for best results on compliance, operational protection, cost, financing, and valuations.
Choosing the Right Private Equity Insurance Companies
- Insurance companies that offer private equity insurance include but are not limited to AIG, CHUBB, Travelers, and many others.
- Private equity insurance coverage is different from one insurance company to the other.
- It is important to audit the insurance policy wording that is quoted by any broker representing a private equity insurance underwriter.
- It is equally important to trigger the policy wording at loss effectively for fast and meaningful payouts given that brokers are not legally nor technically involved in such a process despite some providing claims advocacy services. It is best to seek the assistance of an insurance claims consultant.
- Management should be acquainted with the insurance claiming process specifically as it relates to private equity insurance.
- Private Equity Insurance Companies can be publicly traded. It is important to monitor their earnings and/or spreads on their Credit Default Swaps.
Private Equity Insurance Claims & Losses
Whether it is a claim against the LP, Fund, or Portfolio Company, private equity claims range in type and magnitude.
There have been numerous instances when private equity firms were not paid out on large losses by their insurers (note the private equity insurance broker is not involved within the claims process).
It is therefore important to ensure the wording of the private equity insurance coverage is drafted correctly before a loss occurs, and triggered correctly by an independent insurance claims consultant.
It is also recommended for Management to learn more about Insurance Basis Risk and insurance coverage denials.
A Comprehensive Overview of Private Equity Risk Management
Defining Private Equity Risk
- It is the risk associated with investing in private equity, also known as private equity investment risk.
- Private equity risk is divided into two main forms of risk: market risk and operational risk.
- Compliance and legal risks can be carved out of operational risk depending on the methodology used to define private equity risk.
Operational Risk in Private Equity
- Operational risk in private equity refers to potential failures or inefficiencies within the portfolio company’s internal processes, systems, or management teams that can lead to financial losses or underperformance.
- Key areas of concern include inadequate governance structures, cybersecurity vulnerabilities, and supply chain disruptions, which can significantly impact profitability.
- Additionally, operational risks arising from integration issues during mergers and acquisitions (M&A), such as cultural misalignment or delays in realizing synergies, can erode expected returns.
- Private equity firms must also address compliance risks, particularly with regulations like GDPR or ESG mandates, as failure to comply can result in fines or reputational damage.
- By conducting rigorous operational due diligence and implementing robust risk management strategies, private equity investors can mitigate these risks and optimize the value of their portfolio companies.
- Commercial insurance products are the primary way for investors to hedge operational risk in private equity. However, to avoid insurance basis risk, such products must be reworded and triggered clinically independently of insurance brokers or lobbyists.
“DeshCap is referenced by Global Finance Magazine for reducing the quantum of operational risk in businesses.”
Contact DeshCap to measure and hedge operational risk in private equity.
Designing a Private Equity Risk Management Framework
- Any private equity firm should centralize its risk management framework including the procurement of commercial insurance on its portfolio companies.
- The primary benefit of having a centralized risk management framework is to protect cash flow across portfolio companies, which positively impacts IRR.
- This is in addition to net savings derived from lower premiums and commissions paid to insurers and brokers.
- Moreover, it is recommended that a private equity firm conduct an insurance broker RFP every 3 years to better control private equity insurance cost.
- Ultimately, the private equity risk management framework has be tailored to the operations of the private equity firm alongside its investment mandate.
- A good way to start is to identify the Operational Risk of a private equity firm and build a framework around that.
Assessing the Risk of Private Equity investments
Both LPs and GPs should utilize advanced risk analytics to maximize their risk-adjusted returns.
We believe that interests should be aligned between investors and fund managers, and would therefore recommend both parties to co-ordinate with each other on how to manage risk best.
Depending on the size and sophistication of an LP and the PE fund in question, an LP may be more suited to recommend certain risk management practices for the GP's implementation.
Otherwise, the GP has a fiduciary duty to accurately assess, and hedge where feasible and economical, the risk of private equity investments.
Whether you represent an LP or a GP, feel free to contact DeshCap for more information.
Private Equity Risk Metrics and Impact on DCF Valuation
Private Equity metrics entail measuring the probability of occurrence along with the severity of specific risks, which will yield an expected value of risk (EVR*) for each risk measured.
The total expected value of risk (TEVR), which is the sum of all EVRs across measured risks, can then be deducted from unlevered free cash flow (FCF), either on an average or weighted basis across periods, which then impacts the present value of unlevered FCF.
In addition, TEVR can impact Terminal Value and corresponding PV of Terminal Value. Together, TEVR will therefore impact Implied Enterprise Value.
Following the same rationale and for publicly traded companies or those going through an IPO, if TEVR is large enough relative to EV it will noticeably impact the implied equity value of the company and therefore impacting the implied share price from DCF.
*EVR is analogous to Expected Shortfall (ES), which is also known as Conditional Value at Risk (CVaR), Average Value at Risk (AVaR), Expected Tail Loss (ETL).
We used a different terminology to highlight the distinction of measuring operational risk to financial risk with various standard deviation outcomes from the mean, not just long tail events. Nevertheless, the mathematical concept is similar in nature.
Tying Private Equity Insurance into Risk Metrics
Insurance for private equity firms will essentially have an impact on TEVR. Specifically, the amount and payout ratio (or inversely the basis risk) of the insurance relative to a specific risk will influence the severity of such risk, which will then impact EVR.
For example, a credit risk that has a maximum severity of $1 million (without insurance) will have a net maximum severity of $500,000 with credit insurance of $600,000 entailing a deductible of $100,000 and a payout ratio of 100%.
In this example, severity was reduced by 50%, which would translate into EVR being reduced by 50% assuming the probability of occurrence of such risk has not changed.
The above illustrates a significant reduction in the magnitude of a single risk. If multiple measured risks can yield similar levels of reduction in EVR, then TEVR will be substantially reduced and will have a noticeable impact on Enterprise Value.
Private Equity Risk Mitigation
Effective private equity risk mitigation is essential for preserving capital and ensuring the success of investments, particularly in a dynamic financial landscape.
One critical technique is implementing well-tailored commercial insurance policies:
- Reps and Warranties Insurance (RWI) to safeguard against misrepresentations during mergers and acquisitions.
- Directors and Officers Insurance (D&O) to protect portfolio companies and funds from legal liabilities due to mismanagement acts. Also known as private equity management liability insurance.
Additionally, private equity firms can mitigate operational risks by conducting thorough due diligence to identify vulnerabilities in portfolio companies, such as cybersecurity weaknesses or compliance gaps.
Establishing robust governance frameworks ensures proper oversight and minimizes internal risks, while business continuity planning addresses potential disruptions like supply chain issues.
Regular financial stress testing and scenario analysis help firms prepare for market volatility, while actively engaging with management teams ensures alignment with strategic goals.
Combining these techniques with comprehensive commercial insurance creates a layered risk management strategy that protects investments and enhances long-term returns.
Popular Online Searches for Private Equity Risk Management and Private Equity Insurance
What is Private Equity
Private Equity is an investment asset class, which entails investing in private companies (those whose shares are not publicly traded).
Risks of Private Equity
Risks of private equity vary and they would fall under 3 main categories: physical, cyber, and financial. Each one of those categories includes various sub-categories. In order for investors or LPs to accurately assess risks of private equity, it is important for them to measure the Operational Risk of the private equity structure they are investing in, including the underlying investments. Our team can assist with performing risk due diligence on private equity investments for institutional investors.
Private Equity Risk Factors
Please see the section right above, which broadly describes the categories of risks of private equity. Individual private equity risk factors require a formal approach to risk assessment and measurement.
Private Equity Risk Assessment
Private Equity Risk Assessment can entail either the LPs assessing the risk of the private equity structure they are investing in, or the assessment of investment risks and insurance for private equity firms by the GP.
Risk Assessment is a part of an overall private equity risk management framework, which we discuss in a section above. It is also important to understand Operational Resilience within Private Equity and how private equity risk assessment plays role in achieving such resilience.
Risk Strategies Private Equity
There are a variety of risk strategies that can be utilized by a private equity firm to boost and/or protect IRR. The first step in the process is to build a private equity risk management framework, which we discuss in a section above.
Private Equity Risk Premium
The risk premium attached to private equity investments depends on private equity risk metrics including insurance for private equity firms. A thorough understanding and analysis of the drivers of risks impacting IRR and how they are hedged is essential to determining the private equity risk premium. Please refer to the above sections.
Private Equity Performance and Liquidity Risk
The measurement and premium attached to private equity performance and liquidity risk follows the same rationale as outlined in the section above.