PE sponsors make novel play to help portfolio companies weather volatile market

How private equity managers are looking to insurance collateral funding boost IRR and help portfolio companies fund growth.

Private equity sponsors are looking for ways to help their portfolio companies weather a perfect storm of rising inflation, declining stock markets, sharply rising interest rates and a predicted recession in the coming months.

Enter insurance collateral funding. This strategy allows PE sponsors to repatriate capital faster and extract better returns from their portfolio companies, which in turn builds a higher IRR. Using “trapped” insurance collateral, companies gain the liquidity they need to allow it to grow – or even survive – during difficult times.

Stephen Roseman, CEO and founder of the risk financing provider 1970 Group, explained companies will often opt for loss-sensitive insurance policies to lower their premiums on workers’ compensation, commercial vehicle and other company insurance to try to manage costs.

However, loss-sensitive insurance policies require collateral, and the insured companies typically use a bank letter of credit to do that, effectively drawing down liquidity, Roseman said.

“This is a drain on corporate liquidity, hindering the owner’s ability to redeploy capital. Our solution solves that problem. We finance corporation’s collateral for their insurance programs,” Roseman said.

With insurance collateral funding, 1970 Group works with partner banks to issue letters of credit on the insured company’s behalf, which takes the collateral requirement off the company’s balance sheet and restores the full amount of a company’s credit facility.

Roseman explained that portfolio companies can then use the money to fund acquisitions, address cash flow issues during market volatility, or pursue another growth strategy.

The funding option is often used on workers’ compensation, commercial auto and general liability insurance policies which have a collateral component.

Small companies typically don’t rely on this type of funding, Roseman noted, adding that insurance collateral funding typically starts with companies of several hundred million in revenue or more.

These facilities typically have a one-year term and co-terminus with a company’s annual policy renewal. The 1970 Group charges a percentage-based fee for the financing, which Roseman said is “much like paying interest.”

And the funding is a quick financing option for companies, with companies receiving the funding in 30 to 60 days: with 45 days being the average.

Roseman said he has seen more private equity sponsors inquire about insurance collateral funding.

“We have seen as a fund matures, sponsors consider ways to repatriate capital. Our solution is a tool to enable PE sponsors to repatriate capital or give the portfolio company more operating flexibility and liquidity,” Roseman said.

And the prospect of boosting IRR is yet one more reason PE sponsors are looking at insurance collateral funding.

“One of the biggest benefits to sponsors is that it allows them to extract better returns from their portfolio companies,” Roseman concluded.