In private equity, insurance programs play a crucial role in protecting assets, mitigating risk, and ensuring long-term financial stability. However, recent trends indicate an increase in material coverage gaps that can lead to unexpected liabilities. This article explores key steps private equity sponsors can take to assess and strengthen portfolio company insurance programs.
Rising Risk: The Increasing Frequency of Coverage Gaps
During insurance due diligence for private equity firms, we have observed a growing number of material gaps or underinsured risks in portfolio companies’ insurance programs. These deficiencies go beyond typical areas of improvement and pose significant concerns for investors and management teams alike.
Real-World Examples of Insurance Deficiencies
A review of recent portfolio company insurance audits revealed deficiencies that required unplanned capital investment in the form of increased insurance premiums. Many of these gaps were not identified during pre-close due diligence, leading to unexpected costs post-acquisition.
Manufacturing Company
- Issue: Property policy had a high deductible and excluded flood damage and inventory losses. The property is in a hurricane zone.
- Risk: Significant inventory is stored in warehouses, making potential losses a major financial strain.
- Solution: Negotiate coverage options in the insurance market to close gaps and align with the company’s risk tolerance.
Trucking Company
- Issue: Auto liability policy excluded independent contractors unless specific contracts were in place. Many drivers were not properly covered, and liability limits were insufficient.
- Risk: No coverage for legal defense or settlements in the event of an accident involving an independent contractor.
- Solution: Implement proper contracts, refine hiring practices (employees vs. contractors), and procure appropriate insurance to address coverage gaps.
Construction Company
- Issue: General and professional liability policies excluded work performed in specific geographic areas.
- Risk: No coverage for major projects in those excluded locations.
- Solution: Secure a policy that includes the previously excluded geographic areas.
How Private Equity Investors Can Assess Insurance Risks
1. Engage with the Current Broker
- Request management teams to review coverage details with their broker.
- Challenge brokers to clearly explain how coverage will respond to liabilities and confirm policy sublimits and exclusions.
- Ask brokers to provide real-world claim examples and benchmarking data for industry comparisons.
2. Consider an Independent Insurance Review
Common Situations That Lead to Insurance Issues
Private equity sponsors should pay close attention to the following triggers, as they often indicate when insurance coverage may be insufficient:
- Business Expansion: New locations, increased production, or market entry may introduce unaccounted-for risks.
- Revenue Growth: Higher revenue can mean existing liability limits are no longer adequate.
- Mergers & Acquisitions: Post-close operations often introduce new risks that legacy policies were not designed to cover.
- New Products or Services: Expanded offerings may require additional liability protections.
- Regulatory Changes: New laws, especially in highly regulated industries, may necessitate new coverage types (e.g., environmental liability, EPLI).
Why These Issues Are More Common Today
Several market factors have contributed to the rise in insurance gaps:
- Tighter Underwriting & Cost-Cutting: A hardening commercial insurance market has led insurers to be more aggressive in underwriting, claims handling, and renewals.
- Turnover in Insurance Advisory Teams: Broker consolidation and workforce aging mean portfolio companies may be dealing with advisors unfamiliar with their unique risks.
- Stagnant Insurance Programs: Policies that have not evolved with business growth can lead to overlooked exposures.
- Misaligned Incentives: Some brokers prioritize easy renewals over necessary adjustments, leading to underinsured risks.
Best Practices: Third-Party Insurance Diligence for M&A & Portfolio Companies
- Engaging an independent broker with private equity expertise can help ensure insurance programs align with risk management and financial goals. Best practices for third-party diligence include:
- Ensuring confidentiality in all exchanged materials.
- Conducting an initial document review to minimize information requests from management teams.
- Avoiding insurer engagement or marketing of the program without prior agreement.
- Establishing a clear timeline for reporting findings and holding review meetings.
- Aligning scope with financial and risk objectives, including historical claims analysis and program optimization.
Next Steps: Share Your Questions with Us
If you have insurance-related concerns within the private equity space or would like us to explore specific topics, contact the PCIP team at Virtus. We’re here to help you navigate insurance complexities and optimize risk management strategies.