Insurance Due Diligence: The Often Forgotten Component in Acquisitions

Too often the insurance agent is not included from the beginning of an acquisition or sale of a business. Yet there are insurance products that can solve problems which arise during the buying/selling process. Understanding insurance issues can reduce the chance of assuming unknown or unfunded liabilities, overpaying for a company or incurring additional expenses after deal closing. The following highlights some of the key areas of concern but is by no means a complete listing of problem areas, since every deal has unique insurance issues. Workers’ Comp Workers’ compensation can be straightforward if the company being sold is on guaranteed cost plan (no dividends). Deciding which party (buyer or seller) gets any future dividends is the biggest issue. If the selling company is self-insured or on a retrospective rating plan, the issue of costs for incurred losses and future reserve adjustments can be very important. An unsuspecting buyer could assume large expenses on claims going back a number of years if this is not identified or reserves are understated. Health Insurance Similar to workers’ compensation, employee health insurance needs to be carefully examined. A buyer on a guaranteed cost plan may struggle to understand future costs when the seller is self-funded. Unlike workers’ compensation, benefit levels and coverage of the buyer and seller can be vastly different from those of the seller. The seller’s past costs may not be a good indication of future costs if the health plan going forward is different. Product Liability Product liability can be confusing. Under an occurrence policy, the policy responds at the time of occurrence regardless of when the product was manufactured. Therefore, a buyer may have to respond to a loss on a product made years before the purchase (depends on terms of transaction). An asset and liability transaction does not automatically relieve the buyer of having to respond to a loss. Depending on what happens to the seller, courts typically allow injured parties to go after the buyer. It is critical to understand which party will respond to future occurrences and to make sure that there are insurance policies in place by both the buyer and seller. Environmental Risks Environmental issues are always key in an acquisition because this issue is sensitive to bankers. This issue needs to be addressed early in the process. Areas of concern are: * Current and past ownership of a site requiring cleanup * Current and past operations that generated pollutants * Current and past transportation and disposal of pollutants Unfortunately, the insurance agent is not involved until the idea of buying an insurance policy is raised. This can slow the sales process and may require more environmental studies because of the insurance underwriter. By addressing the needs of the insurance underwriter early, both banking and insurance requirements can be finished early and save both time and money. D&O Insurance Mergers and acquisitions can cause stockholder lawsuits even if both parties are private entities. Providing protection for the acquired company’s directors and officers over a period of time longer than extended discovery periods will require underwriting review. Depending on the size of the acquisition, the buyer may need to get approval from its underwriter to add the acquisition to its D&O policy. Reps & Warranties/M&A Expense The use of representations and warranties and merger and acquisition expense insurance has increased recently. The use of these products can be the difference between a deal being completed or failing. Making the underwriter as comfortable with the deal as other professionals involved, such as bankers, increases the likelihood of getting a quote and an acceptable premium. The insurance industry relies on past data to price its product. Unfortunately, many times this data is obtained not during the buying process but after the acquisition. This will cause the buyer to incur higher premiums, as the underwriter will always be conservative in pricing without past data. It’s important to request complete data including insurance underwriting data and copies of current and past polices in your due/diligence discovery requirements. Then this data can be saved for future use. Information to request includes: * Updated loss runs for five to 10 years with losses over $25,000 detailed as to cause * Appraisals of buildings and contents – should include construction, age, occupancy, and protection * A listing of past insurers containing policy numbers, effective date, and policy limits for the last 10 years * Payroll history by workers’ compensation class code for the past five years * Sales history by product line for the past five years * A listing, with dates, of any discontinued products for the past 10 years * A listing, with dates, of any change in employee count from plant closings or layoffs for the past 10 years. Lastly, too often buyers assume they can roll the acquisition into their current insurance program at closing. Many times this can be done, but usually insurance policies have language that requires prior notification of a change in exposure. For example, a change in exposure can be a metal fabricator buying a plastics manufacturer. Because plastics is considered a much higher property risk exposure, the company insuring the metal fabricator may not even be able to write the plastics company. Therefore, remarketing the entire risk or finding alternatives for the plastics company may have to be done before closing. The amount of time to approach the insurance marketplace impacts premiums so that identifying areas of concern early results in lowers costs. The above is intended to provide a summary of some of the many insurance issues involved with buying or selling a business. Get your insurance agent involved early and work with someone who has the knowledge and experience in acquisitions. The result will be a deal that will satisfy both buyer and seller with terms, conditions, and pace of transaction. Gary Burton, CPA, CEO, Robertson Ryan & Associates Inc. ACG Wisconsin [email protected] George Patterson VP Robertson Ryan & Associates Inc. ACG Wisconsin [email protected] (c) 2005 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com