Financial R&R: What Private Equity Firms Can Do Now to Differentiate Themselves in the Market

Introduction (00:00):

Welcome to Financial R&R, a show dedicated to financial insurance and risk management solutions and trends shaping the market today. Here are your hosts, Ron Borys and Ryan Farnsworth.

Ron Borys (00:13):

Well, hi everyone, and welcome back. This is Ron Borys with the Financial Institutions team at Alliant. I'm here with Ryan Farnsworth, and we're really excited today to have a special guest Kimberly Patlis, who's the President and Managing Director of Corporate Risk Solutions, a leading consultant to private equity and alternative asset managers. And we're going to be talking to everything, private equity. We obviously like the cover a lot of industry sectors. I think private equity firms are certainly experiencing some interesting challenges in the insurance marketplace today. And we thought it would be good to spend a few minutes this afternoon with him given her background and expertise. So, thanks for joining us, Kim.

Kim Patlis (00:51):

Thank you so much for you and Ryan thinking about having me on, and I'm really happy to be here. There has been quite a bit of changes that we're all watching, shifting trends, lots of emerging issues, other challenges that we're watching alternative asset managers and private equity experience. So, this is I think really, really timely and terrific to be with, with you guys as well.

Ron Borys (01:17):

Well, right. I don't know. What do you think, maybe we start just sort of overarching, right? I mean you know, private equity has been a sector that, you know, if you look back over time had had a period where it performed really well. The market was really soft. There was a tremendous supply of capacity and I'd say in the last few years the market is definitely firmed up a little bit. The deals have changed. I think maybe that's a good place to start what do you think?

Ryan Farnsworth (1:40):

Yeah. And you think about the conversation we were having with private equity clients this time last year and how quickly and how many different considerations are now in play. And Kim, one reason we want you to be here and talk with us is give us a sense for what, for what your private equity clients are seeing and what are the risks that they're thinking about right now as we are halfway home through 2021?

Kim Patlis (02:07):

Yeah, absolutely. I think your lead in was perfect. Ryan. The rising costs is no longer a surprise to a lot of investment firms. I would imagine at this point, because they've been not only armed with what they need to be doing or what to expect from, the good brokers out there like yourself, but the rising deductibles, changing carrier appetites, all kinds of changing terms and conditions that are coming on policies as a result of either sector, specific investors or other challenges that are happening. I think the bigger issue that we're watching a lot of our investment from clients ask and how to address is what should we be doing in order to either buy insurance differently or create, you know, risk management, or combat the rising tide of both costs and also deductibles and how the carriers have shifted.

Especially if you have exposure across Europe, you're in Australia, you're in other places globally, there's quite a bit of challenge that each of these investment firms is facing. And so they're looking for, you know, what should we be doing? And I think if brokers that are appointed, not honestly, we know that Alliant has done that quite a bit because of your sector expertise and also footprint is really arming a lot of these investment firms with what considerations they should be doing differently across their marketplace or their industry sector investments or their thesis across the board.

Ryan Farnsworth (03:47):

Yeah. And I think that's one thing that's been driven home during the past year and a half is how important it is to differentiate a private equity firm’s risk and what it is that management teams are doing to differentiate those risks and to incorporate tools and other processes internally to highlight those risks to the underwriters. It's not just about running out and getting insurance anymore. It's about how to help your underwriters understand how your risks are presented, how they are improved. As you noted Kim, at Alliant, we try to find that more rewarding way to manage their risk and they are finding success in doing so now that the market has opened up a little bit more than it was last year. Underwriters are open to hearing what firms are doing in terms of loss prevention or tools that they're working through, whether it's through a portfolio approach or just specific to the sponsors organization. What are some specific things from your perspective that you see private equity firms in their management teams focusing on right now from a risk perspective?

Kim Patlis (05:02):

Yeah, I think you're absolutely right. Bridging the gap between what the carriers want and what the end-user the private equity fund themselves, or the alternative capital manager or the debt lender or hedge funds marrying the two sides, because one is going to be moving toward trying to get, you know, the best coverage at the least price. And the carriers really want to better understand the investment thesis at any given investment for them. They want to understand how they can make themselves look and be better than maybe their peer group. And so, we're seeing a lot more need for higher level communication and unlike an auto insurer or other things these carriers really want to be in the know of exactly what's shifting. What are the challenges that private equity fund is facing? How do you guide your portfolio? What resources do you do across your investment teams? The portfolio managers? If you're a sector specific risk? Or you're an investor that is in energy and infrastructure? Or industrials or retail or real estate? Some really challenging industry sectors. And when you add into that crypto and the block chain world, more generally you are going to have sector specific headwind that you need to be aware of. You also need to identify how you are mitigating loss and aligning interests with that carrier or carriers that are on your tower. And we think that the best way to do that is to not only create communication and guidance within the portfolio assets, but also create that same level openness with the carrier world as well. And a lot of the times that is identified by the brokers that are involved and we've seen it, you know, we've been on a lot of different risks where differentiating the story is key to driving a different result.

Ron Borys (07:09):

Yeah, I couldn't agree with you more Kim. And you know, we had a call with a client just earlier today and they said, “what's the most important thing we can do to get the best renewal outcome?” And I said, “start early.” I think just having a good game plan getting out early to your point, telling your story, really trying to differentiate your risk because, we genuinely believe, our team here at Alliant, we genuinely believe there's still an opportunity to differentiate yourselves, right? I mean, unfortunately in this market, there are a lot of participants painting, very broad brushes, right? And people are speaking in very general terms, but again, if people are willing to put in the work and the commitment, I think that will absolutely yield a better outcome.

Kim Patlis (07:51):

A hundred percent. We've seen in the highest level of M&A that we've seen in probably five years from now that we're maybe a little bit away from the SPAC mania that was happening a couple months ago, but now all of these back transactions and that is facing investment firms as well. Many of the straight private equity funds or other funds that may have natural hedges within their portfolio going into credit or debit funds or issuance of new funds that may have a different focus or different LPs. As soon as you have a change of risk, you have to be ready and armed with how to present that to the insurance world. And I think a lot of firms that have taken the view of being more covetous of the information, they are absolutely going to be hit with unexpected costs, unexpected higher-level deductibles, or retention and or restrictions to the coverage where they're going to have to go elsewhere, get some level of protection.

Ryan Farnsworth (08:57):

We see that right now. And that wave of focus from regulators from underwriters is not going to go away anytime soon. So, to your point Kim, the sooner that our private equity clients can collectively establish a process going forward to engage early with the underwriters and work, to differentiate those risks, the better off they'll be. And I referred to it briefly there in terms of the current administration and what private equity firms are facing from a regulatory perspective, regulatory risk is one that we haven't hit on yet. It'd be, we'd love to hear your thoughts and your perspective on what private equity firms are facing and seeing and thinking about with respect to the regulatory risks that they face today and going forward.

Kim Patlis (09:49):

Yeah, absolutely. I mean, we were on the phone yesterday about another client and how we both collectively would be addressing, the SEC coming out with requests for, it's voluntary right now, but it was posted publicly and they're urging very strongly to get additional information of any client of solar winds. We expect that to continue. The enforcement division is gaining power and gaining a lot more resources within the sec. But I think that the regulatory landscape in general for investment firms and it could be hedge funds, private equity, or some combination of multi-asset investors, they are going to have to have a game plan on how they are mitigating risks internally, how they are protecting their LP money and also their information as well. I think we're watching GPS need to be much more aware of what that shifting marketplace is and how that regulatory impact is going to impact their risk within their own firm and also within their portfolio.

We've watched a lot of firms, especially those, again, I don't want to go back to sector specific because many of our collective clients are not sector specific, but if you are sector specific and you have healthcare regulation and you're an energy firm with energy regulation or your energy-related to crypto industrials others in terms of emissions or other things, the regulatory floor is only getting more strict and more attentive, and you have to be prepared for that and how it's going to impact your risks. We've seen the best investors out there, the ones that are paying attention to loss prevention and safety and how they are addressing regulatory changes are the ones that are going to be treated best in the insurance as well.

Ron Borys (11:55):

Yeah, no listen, I think this whole solar winds inquiry from the SEC is evidence that just when you think these things are done, they're never done. The fact that the solar winds breach happened back in December of last year and the regulators are still focused in on it kind of shows the level of importance that they're putting on this coupled with the obviously the tremendous uptake this year and in ransomware events. Again, it seems like the folks that are interested in perpetrating these types of crimes or these types of situations are more focused on trying to make people's lives miserable or shutting down their business. Because like I said, I mean, there's still plenty of shifting of assets going on with regards to theft of money, but it seems like the real prize right now is just really trying to hold these firms hostage and shutting them down for an indefinite period of time.

And we've seen that all too much this year. And I think that's going to be something that will evolve over the next six months or more. As carriers are really trying to get their arms around, how do we even underwrite this risk? Right? I mean, I think if you do the homework and do the deep dive, it seems like there are certain firms that are more vulnerable to these things than others. But you know, that's a really big part of what we're doing to advise clients. Particularly on the private equity firms’ side on the hedge fund side is working with subject matter experts and helping them identify what some of these vulnerabilities are. Because I'll tell you in this cyber insurance marketplace, you can't get coverage if you have, if you answer no to some of these questions, even if you're an existing insured whether it's multifactor authentication or other good risk management tools to prevent these types of breaches, underwriters are way more tuned in on this now than they've ever been.

And they're non-renewing deals. They're walking away from business. So being prepared for a tough renewal is more important now than it's ever been.

Ryan Farnsworth (13:44):

Private equity firms and investment management firms have definitely slid under the radar for the past six-seven years, since the SEC was asking in their OC examinations, basically, do you have cyber insurance, and it was kind of a check the box item. And many, many firms just bought insurance without perhaps focusing on the safe guards that can and should be in place in advance. And that kind of speaks to what we were talking about earlier. Focusing on loss prevention and other loss mitigation techniques through audits and through engagement with outside consultants is something that is not just viewed favorably by underwriters, but critically necessary for our private equity clients to focus on to protect their firm, to protect their engagement with their portfolio companies, and then set the example for what they would like to see within their portfolio companies. Cause there's no doubt that those types of events would, would impact a company's EBITDA and, and their performance within the fund. So risk management is primary and should be a focus for private equity firms going forward. Have you seen anything from your clients, Kim with respect to cyber risks and anything that I'm doing specifically on that point?

Kim Patlis (15:03):

Yeah, I think it's really funny that you mentioned the past six or six or seven years or five to seven years, that almost every investment firm that we had worked with, and I know there's many that are common with you all as well, they all believed, oh that's not an issue for us. We don't have, especially if they were not healthcare specific funds or retail specific funds. We don't have credit cards. We don't have PII. We don't have PAI well that's a woefully silly thing to think that you don't have exposure to a cyber-breach or a malware or some type of other challenge that may impact your investment firm or your portfolio. We're watching the same thing that Ron said earlier the ability to get as robust coverage as you want or achieve the renewal that you may want or achieve in the middle of an add-on acquisition or an M&A situation. Cyber now has become the focus, not just because of solar winds, but there's a stat that we read the other day that it says in 2021, there's a cyber-breach or ransom every 11 seconds in the United States.

So, this is not limited to certain sectors. It's not limited to people that are exposed, but all of those low hanging fruit of multifaceted authentication or using Microsoft 365 and turning on certain of the additional security, making sure that you have websites and domain names and passwords that are not so predictable, that people can hack immediately into your bank accounts and into everything else because you use the same password for the past 10 years. We've watched that be the number one thing that not only new funds are facing as challenges to get their own GPL insurance or their general partner D&O insurance, that's also shared with our E&O. Any type of rep or warranty is reliant on whether cyber is up to speed on your security is up to speed all of your underlying portfolio issues and other things. So, it is a compounded issue. Many of the investment firms have utilized solar winds. And so they are now incurring costs in document production and other things colonial pipeline had a massive impact inside the investment community as well. So it's all tied together and they're only focused 5, 6, 7 years ago was more on D&O to have the right level of protection for their funds and their LPs. We've seen hundreds of percent increase of every investment firm that we know trying to get a security action, a cyber program and also making sure that they are armed with how to address a business interruption or other things. And those policies forms are not consistent across the board.

Ron Borys (18:04):

Yeah, no, it's interesting, right? Over the weekend I lost my iPhone and we've become so reliant on technology that I literally was saying to my friends, I could lose my wallet, I could lose a lot of different things, but without my iPhone, I'm lost, you know. When people say, well, I don't have cyber exposure because I don't have personally identifiable information or records. My response back is, well, what if I just shut off your network? Would you be able to run your business because that's essentially what's happening right now is people are just going in and shutting people's networks off and basically saying, unless you pay me X amount of dollars or Bitcoin, we're not turning it back on. Oh, and by the way, when we turn you back on, we're going to wipe everything clean.

So, you know, again, I think this is something that we've been incredibly focused on. You know, we've made tremendous investments in our business with regards to cyber resources available to our financial institution and private equity clients. And I think this is just something that we were going to continue to talk a lot about. As we look to kind of wrap things up here, Kim, and realizing you all are out there meeting new clients all the time. If I was a new client today, and I was looking to hire CRS for the first time to help with my insurance. What's the advice? What advice are you giving these firms as, as they're looking to sort of up their game and really improve how they're managing the insurance process?

Kim Patlis (19:19):

Yeah, I think, I think you're, you're right about that. You know, people come to us and say, there's rising costs. I need to change my broker because of that. No, you're focusing in the wrong places, right? That's not the issue. The issue is, do you have a game plan overall. To your point earlier, you need to start these processes much earlier. The insurance has become paramount to you running your business as an investment firm, and you need to understand where the risks are coming from, how to message those risks that you're doing. You're attentive to them better than others, not having accidental footfalls on cyber or D&O or your own regulatory actions, allowing for certain exclusions, those kinds of things be with the right advisors in general, not just your broker, but also to the extent that you value and independent viewpoint. We think that's helpful obviously, but definitely making sure that you are prepared and executing at a, at a higher level than, than the market. And, and ultimately sharing that information of what distinguishes your firm in their investment thesis and your execution every day differently than their peer groups.

Ron Borys (20:32):

Like I said, I think we're just about out of time here for today, but really appreciate your perspectives here. And you know, I think many folks are going to walk away from this conversation and hopefully realize that as risky as the private equity world can be, there's certainly a more rewarding way to manage risk and that's something that our firms are focused on every day. So, with that, we'll wrap up. Thanks again, Ryan and Kim for joining me today. And for those of you listening and have more questions or interest in learning more about Alliant, you can visit our website www.alliant.com. We'll say goodbye for now, and hopefully talk to you again soon.