In today's landscape of economic uncertainty, private equity funds and their portfolio companies are under continual pressure to reduce costs to maintain earnings before interest, taxes, depreciation, and amortization (EBITDA) levels. Challenges can seem relentless —high inflation, geopolitical headwinds, more than $530 billion in portfolio company debt and nearly $1.5 trillion in commercial real estate debt coming to maturity in 2025, falling price multiples, and higher financing costs.
At the same time, insurance costs continue to rise in many areas, with notable increases in real estate, energy, and transportation. To successfully navigate these hurdles and maintain profitability, risk management professionals in private equity must identify and execute a suitable insurance cost optimization strategy (ICOS).
ICOS can be a game changer. When leveraged effectively, the strategy allows firms to streamline and restructure to reduce costs, empowering professionals to strike the right balance between risks and insurance costs.
Here's how to take advantage of insurance cost optimization to grow private equity firms and portfolio companies simultaneously.
ICOS considerations for private equity leaders
There are three questions private equity firms and their portfolio companies need to ask to deliver ICOS successfully:
- Is there a true understanding of the business' risk and insurance cost drivers?
- What could or should the risk and insurance cost be to finance the firm and its portfolio companies effectively, and is this sustainable?
- Does the business demonstrate the right competencies and mindset to deliver genuine cost savings rapidly?
Depending on their answers, executives can proceed with ICOS development using an approach tailored to their precise needs.
Tactical approaches for implementing ICOS
After determining their business's ideal ICOS's scope, intensity, and timing, risk managers and business leaders take one of the following approaches:
- Incremental approach: This is designed to offset pressures in a low inflation environment while delivering a few percentage points of cost optimization, at best. The usual starting point here ranges from streamlining the number of insurance vendors, such as brokers, to reducing risk mitigation education spending.
- Benchmarking approach: A more tactical, top-down approach compares one's insurance and risk spending to its peers to identify cost-takeout opportunities. While this may achieve 5-10% of incremental savings, the risk is that a firm focuses solely on premium as the sole benchmark without identifying the other key benchmarks to identify risk mitigation activities and other risk management activities that lead to the favorable premium benchmark. Implementing these risk mitigation activities may require a broader buy-in that can be a challenge for some organizations.
- Consultant approach: In contrast, this approach is business-driven. Such a strategy focuses on the critical value drivers, scrutinizing all operations from the bottom up and revealing the insurance and risk costs that significantly impact profitability. The approach often leads to better internal acceptance, given the collaboration required throughout the process. A consultant approach can improve margins by more than 15%; however, the cost savings produced may be substantially reduced by the consultant's implementation cost and often result in short-term gains, where costs may creep back in 12 to 18 months.
Reduce risk and create value through targeted improvements
Once the ICOS approach — and its scope — have been determined, the next question is which insurance cost and risk areas should be targeted for improvement. Here are four key areas that risk management teams should address:
1. Get a grip on spending Consider and examine all forms of risk and insurance spending, not only the premium, input, and vendor costs but elements of indirect expenditure as well.
2. Simplify where you can Business simplification enables sustainable cost optimization. Complexity grows in businesses over time, reducing productivity and increasing costs. This complexity makes it more challenging to fully grasp the businesses' true cost drivers.
3. Focus on talent Labor costs are critical to any ICOS. To offset inflationary wage increases, focus on productivity and remove activities with low-value add or duplication. Recruitment teams today face an ongoing battle for talent, where skilled employees are increasingly expensive to attract and retain, with rising hiring costs forcing the broader use of contractors. The retention and development of talent, combined with recruiting exemplary high-quality leadership, are core factors in creating a value-driven culture.
4. Think long-term and holistically While traditional focus areas and methods are valuable, they often can't be performed due to inadequate systems and resources and usually only provide short-term gains, where costs may creep back in 12 to 18 months.
Leaders must look holistically at their risks and insurance costs, bringing together a mix of competencies across commercial, finance, legal, operations, technology, and data analytics to focus on the immediate priorities that deliver sustainable value.
The key to resilience and future growth
Today's business leaders face unprecedented burdens, inflationary pressures, and talent shortages. To survive and thrive in this environment, businesses need to rethink their approaches to insurance cost reduction.
Private equity firms and their portfolio companies evaluating their insurance and risk costs increasingly want to know the total cost for those assets. What benefit level could be achieved if all realizable cost-saving opportunities were realized?
Firms and companies that effectively and sustainably implement insurance cost optimization strategies will maintain resilience and experience growth well into the future.
