Predictions and Advice on Private Equity, Due Diligence, and Transactional Risk Insurance
A wide variety of issues are fundamentally reshaping how GPs, CFOs, COOs, GCs, and deal teams view and consider risk pertaining to the funds and deals. In this Private Equity M&A Looking Ahead Guide you’ll get an in-depth analysis and predictions for 2022 on topics such as the General Partnership Liability (GPL) marketplace, representations and warranties Insurance (RWI), private equity and de-SPAC insurance due diligence, and more.
Woodruff Sawyer has been working with private equity and venture capital firms at the fund level for over 25 years and advises on over 150+ transactions per year, ranging from growth equity deals, strategic acquisitions, traditional private equity buyouts, and SPAC/de-SPAC transactions.
Fund-level insurance and transactional due diligence work is intrinsic to our DNA and we’ve infused that into our Guide to the M&A landscape in 2022—so that you can be prepared for your M&A deals from an insurance and risk management standpoint. Following are some highlights—read the full Guide for more details.
Top Trends in the Guide
A Calming Storm in General Partnership Liability
Moving into 2022, underwriters feel the rate shifts in 2021 have improved profitability and lessened the need for exorbitant rate increases, obviously pending year-over-year claims. While pricing is not static or decreasing, the insurers with whom we spoke feel they’re inching closer to general rate adequacy on the primary level.
The story is not the same for excess layers, where the majority of significant rate increases occurred in 2021, and we expect this trend to continue in 2022. In the guide, we discuss the reason for this continuing trend, as well as what is driving the GPL rate environment.
Hardening Insurance Market for Transactional Risk
We are experiencing the first real hardening market in the representations and warranties insurance (RWI) space in recent memory.
Three main factors are impacting the general rate landscape:
- Sustained high levels of claims activity
- Increased deal flow at all ends of the middle market
- Increased underwriting scrutiny around certain key topics due to claims activity
Insurance Due Diligence Protects EBITDA
In 2021, we have seen an increased demand for speed and certainty across the insurance advisory landscape as our private equity clients look to close transactions. This renewed attention is due to the opportunity, both at close and post-close, to positively impact or otherwise protect the go-forward entity’s year-over-year EBITDA margin.
Private Equity General Partnership Liability Market Update
Broadly speaking, a GPL program includes fund-level directors and officers liability, employment practices liability, professional liability, and outside directorship liability. Following are market trends we’re seeing:
Top Trends Discussed in the Guide:
- Trend #1: Rate increases, while still happening, are slowing. As one underwriter put it, “We are in a much better place than we were a year ago, but there are still concerns in terms of general rate adequacy.”
- Trend #2: There is a capacity and retention rebalancing act happening. In fact, 36% of our survey respondents indicated they would seek to decrease capacity, while 100% said they would seek to increase retentions.
- Trend #3: Underwriter loss ratio is improving, but largely due to insurers increasing their rates, not because there are fewer claims.
- Trend #4: GPL Claims are still largely driven by portfolio company issues, from E&O to bankruptcy and/or creditor claims to outside directorship liability.
- Trend #5: Portfolio programs, whereby a single insurer writes both the primary GPL program and the management liability policies for all portfolio companies owned by the firm, will continue to be available—but not to everyone.
Private Equity Fund CFOs, GCs, and COOs: Review Your Coverage in 2022
As we move into 2022, we anticipate that the GPL insurance marketplace for middle market private equity firms will continue on the current course—but at a lesser degree than in 2021. The geographic discrepancies between New York and California rating methodologies have largely normalized, and we think that will hold true in 2022. Since claims are largely being driven by portfolio company losses, we believe the more focused approach to portfolio company underwriting will also continue.
Read more about the trends in general partnership liability and the insurance marketplace, as well as our advice about insurance due diligence and coverage in the Guide.
General Partnership Underwriter Survey
As part of a comprehensive approach to client advocacy, a good insurance broker partner will listen to their insurer and underwriter partners to better understand their view of the world—including their current appetite for risk. We approached our top insurance partners with whom we place fund-level GPL insurance for private equity firms around the United States.
We asked questions regarding the current risk environment, fund size specialization, future retention and pricing expectations, and differences in approach to primary versus excess layers of coverage. When asked for their perspective on 2022 primary renewal rates for private equity firms, 91% of respondents see 10%–20% increases, on average.
Representations and Warranties Insurance: Additional Capacity in a Hard Market
Increasing deal flow, de-SPAC transactions, limited capacity, exiting markets, and general underwriter bandwidth has helped create the first “hard market” for reps and warranties insurance (RWI) solutions since the wide adoption of RWI insurance in the United States.
Here are two of the trends we’re seeing and how they’ll impact the insurance environment in 2022.
The hard market for reps and warranties insurance will continue into 2022.
Deal flow and bound RWI policies in 2021 (through July) have outpaced 2020 month to month. This trend will continue into 2022 as deal flow continues to increase.
Underwriting scrutiny is increasing for key areas like insurance and cyber.
In addition to the standard heightened risk areas, or areas where underwriters tend to focus their efforts (legal, financials, tax, environmental, etc.), we’ve seen an increase in focus in two key areas: insurance and cyber risk. In this hardened RWI marketplace, underwriters want to know exactly how a target company approaches risk management and cyber security.
Insurance Due Diligence for SPAC and de-SPAC Transactions
The Woodruff Sawyer Private Equity Practice Group has advised on thousands of middle-market transactions from a due diligence perspective.
Among our core, middle-market private equity and de-SPAC transactions, we typically find one or more of the following situations is true. Read the Guide for a deeper dive into these situations.
- The target has not implemented an adequate insurance foundation.
- The target has implemented an acceptable foundation, and the core exposures are acceptably covered.
- There does not appear to be a comprehensive, strategic approach to insurance and risk management.
- The target has little to no management liability coverage in place.
- The target has an inadequate limit or retention structure for various coverages.
Insurance Due Diligence for Middle Market Private Equity Deals
We believe the following three areas are going to be focus areas for private equity deal teams in 2022.
- Insurance can be used as a mechanism to improve your EBITDA margin
- Cyber liability will be an increasing exposure.
- Portfolio programs may not be the best fit for all portfolios.
For deeper insight, advice, and our predictions for the mergers and acquisitions and private equity landscapes in 2022, read our full Guide.
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This Guide should help you identify, quantify, mitigate, diminish, or otherwise transfer the potential risks that could negatively affect EBITDA for the portfolio company.