To buy, renew, reword midterm, or trigger Insurance for Private Equity firms: contact us. DeshCap is ranked online # 1 for Liability Risk and a Top Operational Risk Advisor worldwide, and is independent of any insurance broker, company, or lobbyist. We assess and measure risks, and change insurance that we reword and trigger for best outcomes with brokers and with a direct impact on IRR. We can also contractually guarantee lowest cost in the global marketplace for Private Equity Insurance.
Insurance for Private Equity Firms
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 the benefits of insurance for private equity firms and IRR. Such correlation becomes much stronger if the insurance is reworded and triggered independently of any insurance broker, company, 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.
Private Equity Insurance
Private Equity Insurance consists of:
1. insurance for the benefit of LPs;
2. insurance for the benefit of Fund(s);
3. insurance for the benefit of portfolio companies.
Products within private equity insurance includes operational insurance as well as non-operational insurance, which together form the universe of investment insurance.
Private Equity Risk Management Framework
When a private equity firm centralizes its risk management including the procurement of commercial insurance on its portfolio companies, it derives substantial monetary benefits from protecting cash flow across a group of companies making up its fund, which will in turn yield a noticeable positive impact on fund 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 few years in order to maintain cost effectiveness. Ultimately, the private equity risk management framework will have to 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 us.
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), etc. 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.
Impact of Insurance for Private Equity Firms
The insurance bought by 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. That is 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 Insurance Broker
To hire a private equity insurance broker who is the right fit for your private equity firm, contact us. We make private equity insurance brokers compete for your business to minimize commissions paid. It is important to note that each private equity insurance broker has preferred distribution rights and incentives with specific insurers. It is therefore important to get unbiased technical advice from insurance experts who are independent from any private equity insurance broker or lobbyist.
Private Equity Insurance Companies
Insurance companies that offer private equity insurance include but not limited to AIG, CHUBB, Travelers, and many others. It is important to note that private equity insurance coverage is different from one insurance company to the other. It is therefore important to review and reword the language of the insurance policy that is offered by the private equity insurance broker representing the insurance company. It is equally important to trigger the policy wording at loss effectively for fast and meaningful payouts. Management should therefore be acquainted with the insurance claiming process and specifically as it relates to private equity insurance.
Private Equity Claims
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 independent insurance claim consultants. It is also recommended for Management to learn more about Insurance Risk and insurance coverage denials.
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'What 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.
Disclaimer
This content is independent of any content coming from insurance brokers, insurers, law firms, or insurance lobbyists. 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 Insurance for Private Equity firms, like many other topics in commercial insurance, due to bad habits acquired through over reliance on insurance brokers or insurers or information providers who are lobbied by them. It is also important to note that insurance 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 business and its investors (the point is that going to court to enforce coverage defeats the purpose of buying insurance, so you want to make sure that whatever insurance you buy protects your organization right and pays out fast on large losses).
