Along with the risk of higher interest rates and uncertainty about the economic outlook, you can add higher insurance costs to your wall of worry, warns Kevin Maloy, senior managing director in M&A and special practices at strategic risk an insurance adviser Crystal & Co.
“We’ve been in a very extended soft market. The last really hard market we had was in the 1980s,” said Maloy, who said he counts 75 private equity sponsors, mostly in the United States, among his clients. The market hardened briefly after the terror attacks of 9/11, then softened again
But a series of catastrophes, dating from Hurricane Katrina in 2005 to Superstorm Sandy last fall, have put pressure on insurers and reinsurers from the underwriting side of the business, while low interest rates have pressured the companies’ investment income. Sandy alone has been estimated to have caused $50 billion of insured losses, Maloy noted.
“At some point rates will plateau and go up. We’re nearing the end of the plateau in most risk areas, property most notably,” Maloy said. “We’re starting to see it already in most areas of risk.”
Another factor making life more complicated for sponsors is the Patient Protection and Affordable Care Act, whose major provisions are to be phased in this year and next. “It impacts every business,” Maloy said. “It has added an extra layer of financial diligence and risk diligence.”
But the health reform law known as Obamacare will have widely varying impacts on sponsors, depending on the sectors where they invest. In particular, target companies that are high headcount businesses, especially employers with lots of part time workers, like quick service restaurants, may face confusing and expensive increases in health care costs, while manufacturing companies, especially those with established health plans, represent less of a wild card, he said.
To be sure, risks abound, from the classic directors and officers risk that sponsors take when they join a portfolio company board to the geopolitical risks that appear to be at large in Europe, Latin America and Asia, Maloy said. “What happens if China invades Taiwan? There are a lot of risks, and some of them are insurable.”
With all that, however, buyout firms seem less concerned about potential risks and more on the prospect of returns in today’s environment. “Our clients kept their foot on the gas right through 12-31,” Maloy said. There was a flurry of activity in the second half of 2012, as investors sought to complete transactions before taxes went up this year, but the pace of activity continues unabated, he said. “Our clients had a very active fourth quarter, and they just kept rolling right along in the first quarter.”