M&A Roundtable: Quarterly Market Update

Intro (00:01):
You are listening to the Alliant M&A Roundtable, providing insights and expertise on the unique risk management needs associated with private equity firms. Here is your host, Jonathan Gilbert.

Jonathan Gilbert (00:20):
Thanks, everyone for joining another M&A series podcast. What we wanted to do is share a little bit of what we're seeing in the property casually manage liability and cyber insurance marketplace, as it relates to private equity-owned companies, Alliant M&A has a large presence in the private equity community and has a finger on the pulse of what's going on in the market. We've thought that we share that all with you to start with. We're going to turn to Bobby Horn. Who's the leader of our cyber practice at Alliant and works on a lot of private equity-owned companies? Just to understand a little bit about what's going on in the cyber world. Certainly, you can't open a newspaper or turn on the news without some mention of a cyber, a cyber-attack, a cyber incident, or you even some cases you how that's affected the insurance markets. So, Bobby, just why don't, if you can give us a quick overview on the current state of the market, what private equity-owned companies are experiencing, you know, different from last quarter or last year. That would be great.

Bobby Horn (1:17):
Yeah. Thanks, John. And thanks for having me on yeah. As you mentioned, right? I mean, it's, it's certainly everywhere in the news with its larger manufacturers, retailers, meat, distributors, oil and gas industries been had colonial pipeline was one of the big ones earlier this year. And then just yesterday, right. T-Mobile just came through that. They had a large breach of their network. So certainly, we're seeing it with all industry classes. No one has been immune to the, the kind of issues in the cyber marketplace. And as a result of all of these claims, all these, these breaches, the market has really firmed up a lot over the last 12 months.

I think we started to see that change in the second app of 2020, and then really took off in December of 2020. And then certainly in the beginning of this year, through, through the current market right now, and there's been a real focus on controls, right? While there was always an application process involved, in getting quotes for cyber, it was pretty much just check the box, underwriters, reviewed it and offered quotes and limits and very competitive retentions premiums and very broad coverage. What we're seeing now is hyper-focus on those cyber security controls. So, things like multifactor authentication uses of backups and endpoint detection, response tools those are really key controls that underwriters are looking at these days, that without them, it's very hard to get terms, not even for new business, but also for renewals. We're seeing carriers outright non-renew clients that don't have things like multifactor authentic in place.

Probably the biggest hurdle we've had this this year, making sure that they're aware of what carriers are looking for from a control standpoint. And also just, Hey, look, we're seeing large increases, not only in premium, but retentions and, and the waiting period element, which is, you know, an extension of the, the business interruption side. So, it's been in certainly the, the hardest market that this product is seen. It probably it's 20 years of being around. And I don't see changing through the end of the year, if anything, we're probably going to experience even more difficulties just as carriers pull back on capacity. And in some cases, just not running new business at all, we're seeing some carriers, mostly in the London market to pretty much our pencils down at this point because of the increases they're getting on the renewal book. They have met their capital requirements for new business. So, they don't have to write any new business anymore, which is very difficult at the end of the year, right, when you've got a lot of new business still coming in and you have renewal programs with big limits, it's giving a challenge to get some of our clients, the covers that they have, or they need going forward.

Jonathan Gilbert (03:39):
You know, as you, as we talk to private equity firms and, and sort of help them prepare their portfolio companies for, you know, upcoming renewals or frankly just managing cyber risk, you know, what do we recommend they do from a risk control standpoint, use sort of an insurance term to make sure that they're in the best spot. Is it diagnostic review and corrective action? What would you sort of say to our private clients as you do every day?

Bobby Horn (04:02):
Yeah, so exactly that, right. It's a diagnostic of your controls right now. And we partner with several firms and vendors as you know, John to work with our portfolio clients to make sure that they have these controls in place, at least by renewal. And if not, by renewal sometime close to that, you know, we actually put together a best practice to is worksheet for our clients. It shows kind of the baseline controls that they need to have in place. And then things are a little bit better and then obviously the best practices. So, we've been sharing that with our portfolio clients, so that they're aware of what the underwriters are looking for from a control standpoint. And we've seen that those clients that are able to implement those controls are the beneficiary of better terms and conditions. That's not to say they're not, you know, getting a decreases on their premiums, but at least they're on the lower end of the increase that we're seeing compared to those clients that don't have those controls in place. So, really making sure that they're, we're getting ahead of it and making sure that they understand exactly what they need to have in place.

John Gilbert (04:55):
And that makes a lot of sense, you know, just touching on rate as, as you just did, what do you see as the average sort of increase for companies in the third quarter that we're in right now?

Bobby Horn (05:04):
Yeah, we actually just released or in the process of releasing our midyear review on average, we're seeing 50 to 60% increases in premium for our clients. And that's obviously on the low end, you know, our healthcare clients, we're seeing anywhere between a hundred and 150% increases in premium somewhere in the middle, I think is what we can probably expect for the end of the year. And again, it's going to come down to those controls. If you have good controls in place, you'll be on the lower end of that spectrum. And then the other thing to take into consideration are the increases in retention. Certainly, carriers want to see clients have more skin in the game. So, the days of a $5 million limit with a 25K retention are gone, right? They're seeing minimum 50 to a hundred K retentions for those 5 million limits. And also important to point out too, right? We're not seeing too many carriers willing to keep putting up 10 million limits, unless we're talking about you, large national type accounts, but for our small, you know, middle market sub billion revenue companies, 5 million is pretty much the, the cap from a limited perspective.

Jonathan Gilbert (06:03):
In terms of claims experience. And I know you and I have had a number of portfolio companies that have been affected with cyber incidents, whether it's the various third party attacking the system or something else, you know, what have you seen in terms of losses? To me, it seems as though costs continue to escalate and exceed, in some cases, the limits that are in place are the policies. I think it's catching everyone a little bit by surprise, what's your sort of thought there.

Bobby Horn (06:27):
Yeah. And it varies with each client, right? So, we we've had clients where they had a, you know, a large ransomware demand that the decision between the, the private equity sponsor and a portfolio company was to not pay it, right. It was just not in their interest to pay that demand. And so they decided to, to rebuild from backups. And in that case, you know, they didn't have a sufficient limit. Just, it was a decision that was made at the, you know, when we banned the renewal that they wanted to go with this a lower limit. And unfortunately, even without paying the extortion demand, the business interruption loss exceeded the aggregate limit that they had in the policy. And that's what we're seeing a lot of. Right. I think people tend to forget when they think of ransomware, they think of just the extortion payment, but more often than not the loss on the business eruption side exceeds the actual extortion payment demand. And that's something that we need to take into consideration with our clients and say, you know, when we're going through that process of buying coverage, if you were down for what kind of loss would that be for you from a business income standpoint and making sure they understand that if you do decide to not pay demand, you know, how long can you be out and what, what is that financial impact going to be to your company?

Jonathan Gilbert (07:28):
That's great. Bobby, I think just to kind of sum up, you know, really, I think the key is for private equity firms to take an interest in the cyber insurance renewal at the portfolio company, because there will be changes and there will be a cost increase. So, start early and embrace her impact cause the increase is happening and there's a lot of things that need to be addressed, you know, well in advance of the renewal, particularly any deficiencies and controls, any education matters, things like that. So, thanks Bobby, appreciate your time. You know, next let's turn to Tim Crowley who leads our managing professional liability group focused very heavily on private equity owned companies, which, you know, like cyber insurance has been a very challenging market in 2021, in addition to impacts from COVID, there are other headwinds that are faced in the market. You know, Tim, why don't you give us a quick overview of what we're seeing in the market today and kind of Q2 and Q3 and you know, what companies should we thinking about for the rest of the year?

Tim Crowley (08:22):
Thanks John, the marketplace for management liability insurance in 2021 for PE sponsored portfolio companies remains challenging. However, there is some signs for optimism. In Q2, the marketplace did start to stabilize a bit. We're still seeing increases in premiums, but not to the mag into or levels that we had seen last year. And even in, in Q1 of 2021, I think one of the key reasons for that is that there are a few new entrants specifically on the excess placements. So new capacity coming into the market to provide competition in those spaces, but on a primary basis, we are actually starting to see some differentiation at the insurance carrier level when they're analyzing policy holders applications. And by that, I mean, you know, in 2020, especially in response to the pandemic for certain industry sectors, there was just kind of broad strokes increases or minimums that ensure carriers were, were imposing on their clients in 2021 during the summer.

So far, we've started to see insurance carriers more differentiate between the various risks and applying debits and credits to their underwriting models to, to get a little more competitive on their renewal proposals. For the most part in the retention spaces, those are, are remaining relatively flat, which is more of a function of the position that the insurance carriers mostly raised those over the last two or three years. The one exception I may say is employment practices liability based on the industry class and the location of your employees. We still are seeing increases in some cases for state specific retention levels specifically in state, such as California, where the insurance carriers may be looking to, to increase that retention applicable to those employees. Furthermore underwriters are asking some additional questions on the composition of your employee base, specifically response to the impact of COVID in your return to work plans. As, as we sit here in the summer of 2021, you know, most clients have started some return to work plans, which may or may not be changing in the, in the upcoming environment. But the underwriters are asking questions regarding protocols and procedures for how employers determine which employees go back to work and how often and where they work. So those are, those are some of the key things we're, we're seeing as we sit here in early.

Jonathan Gilbert (10:38):
If you had to put a number on it, what do you see as the average renewal rate up or down for private equity owned portfolio companies?

Tim Crowley (10:45):
Yeah, I mean, on an average, I'd probably say it's somewhere between 15 and 25%, but we're starting to get a little bit lower than that. Like I said, there's a little more differentiation based on your specific business and exposures. So in some cases we're seeing 10 to 15, but you know, in some cases based on the industry sector, it's, it's going a little higher. So, you know, it's somewhere between 10 and 25%, but probably 15 to 20 if I had to get more narrow and from an underwriting perspective, one of the key driving factors that the underwriters use to establish their renewal premiums, you know, is some of the response to COVID both operationally, financially and employee wise and carriers are continuing to scrutinize the financial impact for the last, you know, 18 months or so, but also looking forward, including, you know, revenue, streams, deposits, usages of capital, things of that nature.

Jonathan Gilbert (11:32):
Then just on that topic of COVID given that we're still in this pandemic that doesn't seem to be ending, how is the market continue to, to COVID? How has it changed the underwriting premium results or availability of insurance?

Tim Crowley (11:44):
Yeah, I mean the underwriters are certainly asking questions there three or four questions that every carrier is going to ask for both operationally and employee again, and depending on the sector, depending those responses, they may ask some follow questions. In some cases it may be best to work with your clients either in writing, but probably preferably maybe over the phone to just talk about the strategies they employ to navigate the pandemic and the execution on those strategies. And a lot of times that can generally get the underwriters a little more comfortable with the risk in certain cases where maybe the pandemic has impacted the business a little more substantially you may see underwriters add some specific coverage terms related to, to COVID, whether it be a separate retention or some exclusionary language. And that should be viewed very carefully with your brokerage team.

Jonathan Gilbert (12:28):
And as you look into the second half of Q3 going into the fourth quarter, you know, what can private equity owned companies do to prepare for renewals and have the best possible outcome in addition to hiring Alliant as their broker?

Tim Crowley (12:41):
Yeah, John, I think some of the impact of COVID on kind of the brokerage approach is really somewhat of a getting back to basics or fundamentals, right? In the more soft market years we could get back relatively late in the process and still drive some pretty competitive results in this market, continue to suggest an early and proactive approach to the brokerage process. So, you can get an earlier position on what the incumbent underwriters are thinking, and then kind of develop a more proactive marketing approach if necessary. And as I mentioned earlier, at least in Q3 into there is a bit more competition policies were renewing in Q2, right after the start of the pandemic. Last year, there was a little bit of a beggars can't be chooser market. In this market we should have some different levels of optionality. And the earlier you can establish, you know, which buttons to push and which insurance carriers to focus on. We'll just drive better results for the portfolio companies and, and therefore their PE sponsor.

Jonathan Gilbert (13:37):
Well, thanks Tim much appreciate it. And I think the key takeaway is, you know, similar to cyber insurance start early and maybe brace for some bumps in the road, but no major hurdles from a coverage renewal standpoint, which is good to hear and good to hear things are leveling off and imagine liability insurance marketplace. So with that, it's great to have Dan Schloss the procurement leader for the M&A practice and Paul Cleveland, the west coast procurement leader, who had the finger in the pulse of the property and casualty insurance market on both coasts, certainly as well as you know, internationally, I'm going to start with Dan and ask, just to give a quick overview of the current state of the property insurance market and some of the off opportunities and challenges that we're seeing for various companies that are owned by private equity firms.

Dan Schloss (14:20):
Thanks John. So, for the past 18 months, we've been experiencing a hardening property market, which is largely been driven by catastrophic events, such as wildfire, flood, hurricanes, freezing temperatures across Texas and just general uncertainty with what's going on with the pandemic, BI losses and things of that nature. Heading into the third quarter the market is starting to stabilize slightly as carriers are looking for a way to reduce the volatility on their books. That being said, it's giving way to a two-tiered market. One for the more profitable, straightforward risks, light manufacturing, well protected sprinkler, low hazard operations in low risk catastrophic zones. You know, we are starting to see some more opportunity there where markets are looking for rates from flat to 10 to 15% increases. And the second tier, which is for the more challenging occupancies, which would include things like food processing, chemical manufacturing, sprinkler locations, or CAT exposed properties. And there, we're still seeing a very hard market with rate increases, you know, looking as high as 25 to 30% renewals. And that's because there's a lot of markets right now that are dropping out of these areas and kind of constricting capacity within these areas. So, we're seeing the markets that are staying in this looking for increased rates and tightening up terms and conditions across the board.

Jonathan Gilbert (15:47):
And Paul, just to ask you a question as well, on, on property insurance, you know, what do you see, you know, reliant on risk engineering reports, risk control initiatives, that portfolio companies are only taking and you know, how is that impacting the underwriters view of a risk?

Paul Cleveland (16:03):
Yeah, no thank you for having me, good question. It's more in play than it's ever been. And in the property market, the risk control and engineering is a must for most carriers, regardless of first tier or second tier risk, as Dan was mentioning, they want to see that the RECs are completed or addressed in a timely manner. And frankly, if surges are not adhering to these recs, it's going to make it even more difficult and even a good risk can be pushed into that second tier for some risk engineering issues. If they are, whether it's low hanging fruit or very difficult, expensive engineering reports.

Jonathan Gilbert (16:42):
And Paul just given your geography, how have the wildfires out west, you know, in California and you've seen, have exported to other states as well, like Colorado impacted, you know, underwriters and a certain risk, whether they're exposed to, you know, wildfire risks or not.

Paul Cleveland (16:59):
Yeah, it's, it's made it very challenging. Anything that's in a wildfire area or wildfire zone is going to be without a doubt, a tier-two regardless of the fire protection that they might have. They could have great sprinklers systems and all that stuff, but just mere fact that they're sitting in a wildfire zone makes it very challenging. What we're finding is from an underwriting standpoint is the carriers are reluctant to put up any significant rate. So more than likely, you're not going to find yourself with the opportunity to put together a ground up program. That'll probably be in some sort of a quota and layered program.

You know, I think the most important thing is, and I guess this probably should have been brought up earlier is we want to make sure in the property market, especially for the tough risk that we get out early, so we can address all these issues in a timely manner. So, we're not scrambling at the end.

Jonathan Gilbert (17:53):
Appreciate that Paul that's helpful. I think a key takeaway is starting early in the process, much like other lines of insurance that it just the lines on technical underwriting, you got the insurance carriers has increased dramatically from, you know, a year ago, five years ago. And so just being prepared and starting early is critical at a minimum. Dan, just to turn back to you, what do you see as the average renewal rate in tier one category and the not so desirable tier two category, you know, from insurance carriers in terms of renewal rate year over year?

Dan Schloss (18:23):
On the tier one risks. If you know, they're really good, we're seeing rates from flat to 10 to 15%, if it checks off all those boxes that, you know, Paul kind of mentioned earlier, it risk controls well, they've taken care of subjectivities and it's a fairly low hazard class on the tier two side. You know, it really ranges varying depending on class of business. It's kind of hard because there's not really a one size fits all approach with that. But you know, for those two tier two classes, we're seeing increases 25 to 30%. And even north of that for some of the tougher risks, as you know, you have to share and layer those programs, minimum premiums, reinsurance treaties are all coming into effect, faculty to reinsurance, which is also taking a dramatic increase a over the past year. You know, all these factors are driving those rates up on those tier two risks.

Jonathan Gilbert (19:15):
Appreciate that. Dan let's hope for a, a quiet hurricane season as we're just approaching or just into the beginning of it this year. And we'll be monitoring that very closely, just shifting gears a little bit. Why, why don't we shift to primary casually insurance with, for those listings would include workers, compensation, general liability and auto liability insurance and Paul Cleveland, just to turn to you, what do you see as kind of the current state of the market for those lines of coverage? How does industry impact the view from an underwriting standpoint, they can give us a few words on, on that. That'd be great.

Paul Cleveland (19:51):
Okay. The auto market is still problematic. It's very challenging overall we're seeing anywhere between 10 to 20% rate increases depending upon your loss history. A lot of it is being driven by the higher unknown auto exposure that that clients would have. There's more scrutiny over that risk. They're requiring, supplemental apps to be completed so that they, we can dig into the, the actual exposure. In addition, they want to make sure that the insureds have protocols in place for any employees that are driving their vehicles on personal business to ensure that the employees have their own insurance and making sure that they have proper limit to accompany their insurance.

Jonathan Gilbert (20:37):
Appreciate that, Paul. you know. Dan, recognizing that the pandemic is still ongoing, you know, how has the COVID 19 continue to impact insurers to your risk? Have you seen any meaningful changes over the last 6, 9, 12 months given that we're still well in the pandemic?

Dan Schloss (20:56):
Great question, John, and while there's still some uncertainty with what's going on with the pandemic I think what we found hasn't dramatically changed a lot of the ways that the carriers are at outside of putting some additional exclusions on policies that protect them against claims that arise out of communicable disease or things of that nature. You'd think the worker's compensation market would've taken larger hit, but it's remained fairly stable throughout. Oftentimes insurers now are asking for a COVID 19 questionnaire, which is basically something saying, how are you protecting your employees? What preventative measures are being taken and that's before they even start underwriting the risk. So, I think we'll continue to see that on, on the workers' compensation side, specifically, as I mentioned before, when we were talking about property, business income and business interruption, continue to be a focus on how that could be a affected from that front, whether it's supply chain issues, a shortage of workforce or, or things of that nature.

Jonathan Gilbert (21:54):
Yeah. Dan, that was great commentary relative to COVID 19 as we shift toward the excess liability market. What's the current state of that market. How do you see renewals progressing? How does the vary by industry? Love to give the listeners just the quick on what you're seeing in that space.

Dan Schloss (22:11):
Sure. And last year was a, a really volatile year for excess liability. They were calling it a correction of the marketplace last year, where essentially underwriters were saying that they were deploying too much capacity at too little rate. So, there was a lot of adjustments in that marketplace last year, where a lot you were seeing, you know, the rates increase in the capacity, cut in half. We're seeing less of that this year. It looks like the correction has mostly taken place. So, we're not seeing those huge increases year over year. However, there are still some industries trucking and large fleets being one of them that are still problematic as capacity has been greatly decreased in those areas. A number of markets have pulled out of that space altogether, which is constricting the capacity and bringing rates upwards for large trucking cleats.

Dan Schloss (23:00):
It's still a challenge to fill out towers. Nobody wants to really get on the first 10 million of coverage because they're seeing nuclear verdicts, you know, with these heavy vehicle holes on the roads. And, and that's where they foresee a lot of the risk. That being said, you're having to break up the umbrella into smaller chunks and minimum premiums come into play. And those lines of coverage are getting more expensive, continue to get more expensive for those risks, with heavy vehicles, trucks, things of that nature. Hopefully we are seeing a few new markets that are putting their toe into the water. So, hopefully that will start to stabilize soon. But as of now, we're, we're still seeing 10% increases in some instances, despite the big jump last year.

Jonathan Gilbert (23:43):
Thanks Dan and Paul given that I think a common theme for both primary casually and excess casually seems to be a company's makeup relative to vehicle count fleet size, certainly as well as there's a lot of investment by private equity firms, including our clients into the transportation industry. You know, how important is the use of telematic in vehicles for, one just safety overall and certainly for the eyes of the underwriters and how they view risk of a particular portfolio company.

Paul Cleveland (24:14):
Great question. It's very important. The more controls that you have in place specifically with the auto is going to be beneficial. Having people drive and not check their insurance and making sure their license are valid and running MBRs. And that's very much frowned upon these days. Dan mentioned it there's a lot of nuclear verdicts, 10 20, 30 million losses, especially in and around the auto industry, whether you're a trucking company or a banking firm that has sales person that gets in an accident, having controls in place is going to help us to get you the best deals and coverages out there and open up the marketplace. Like Dan said, there's a limited amount of carriers that are going to write these risks nowadays. So, the more that an insured is per proactive from a risk management standpoint, the more opportunity they're going to have to have better terms, conditions and pricing.

Jonathan Gilbert (25:15):
Appreciate that. Paul, you know, Dan, and then, Paul would love to get your comment here as well. You know, in terms of private equity firms, a lot of times, and a lot of our clients had the buying power equal to that of a fortune 100 to 500 company based on the premium spend. How have you seen and how are we structured differently? And how can firms go further to leverage that buying power into the marketplace to maintain individual coverage for the portfolio companies, but really leverage the spend across the portfolio which made be, you know, 10, 15, 20 companies or more.

Dan Schloss (25:51):
I'll take that one. So, just to start off all of the, you know, private equity M&A business goes through Paul and myself which makes us a bit unique from some of the other insurance brokers out there. It enables us to employ a number of tactics that are helpful in getting the best terms and conditions in the, the marketplace. And one of them certainly is aggregating and leveraging risk wherever possible, whether that's through common, effective dates, common insurance carriers, or master insurance programs for lines like property or product recall we can take advantage of economies of scale and push the insurance markets through things that they wouldn't otherwise do to get better terms and conditions and lower rates.

Jonathan Gilbert (26:34):
Thanks, Dan. Well, thank you all for listening today. We appreciate you taking the time to listen to a line M&A quarterly update on the state of the market. We work with private equity firms, nationwide and hundreds of portfolio companies. We're a team over 1500 people nationwide and continue to be a leader in the private equity community. So, I appreciate you time to listen to what we see going on in the marketplace and for more information please visit www.Alliant.com.