Typically, risk management and insurance due diligence doesn’t kill a deal. But it can help buyers negotiate a lower price, a larger escrow fund or earn-out, or require a letter of credit for assuming certain risks.
During a potential acquisition or merger, the buyer should give his or her risk adviser access to the data room. That adviser can review the current insurance, loss runs, loss and claims experience, safety and employee policies, contracts and financials.
“Then, we come back with a report telling them what we think — particularly making sure they don’t inherit something that will haunt them later,” says Tony DeRiggi, area vice president at Arthur J. Gallagher & Co.
Smart Business spoke with DeRiggi about a few of the many insurance factors that need to be discussed before you close the deal.
What do buyers need to know about claims-made and occurrence polices?
Most general liability, products liability and umbrella policies are occurrence policies. The coverage trigger for these policies is the date the incident occurred, so buyers don’t have to worry about future claims. Some liability policies — typically directors’ and officers’, errors and omissions, professional liability, environmental/pollution liability and possibly product and completed operations liability — are claims-made policies, which trigger when the lawsuit or demand is received.
To counter this, buyers can require sellers to purchase an extended reporting period ‘tail’ endorsement or add the potential ‘tail’ cost to the negotiations.
Where else can liability policies present challenges?
Your risk adviser should provide an in-depth review of all exclusions. Some will be common and normal; others will be different than your risk appetite or uncommon to your experience. For example, if a pollution claim is reported next year, you don’t want to find out then about an exclusion in the liability policy.
Also, it’s important to know whether the target company has ever purchased a loss-sensitive rating plan as part of its insurance program. This usually applies to workers’ compensation, general liability or automobile liability. For any loss-sensitive policies (i.e. retrospective rating plans, large deductibles, self-insured retentions, fully self-insured programs), the reserves need to be accurate, accounting for all open claims. The acquisition should include a mechanism to cover the claim payments as those claims mature and pay out. If the potential sale is an asset purchase where the buyer doesn’t pick up the seller’s liabilities, this is less of a concern but should still be addressed.
The review should examine the contractual insurance obligations and indemnification clauses found in rental/lease agreements, loan/financial agreements and contracts in general. These agreements typically have minimum insurance requirements and obligations that may differ from the buyer’s current insurance program.
A risk adviser may also do an onsite inspection of the operations. Concerns to be considered include: Do the current safety procedures meet best practices? Do the employees receive harassment training? What are the hiring practices? What are the policies for pre-employment physicals or drug screening? The risk adviser can let you know what you’re in for.
What about property insurance? Does this review work the same as liability?
On the property side, it’s still about exclusions, deductibles, etc., but it’s more straightforward. The review should also consider whether the seller’s locations are in a flood zone, windstorm zone, etc. If the acquisition involves expansion into different or foreign geographic areas, you will need to consider any specific or special risks related to those areas (i.e. earthquake, kidnap, etc.).
What else is important to understand?
After the review is complete, your risk adviser will recommend that you integrate the insurance immediately, at the expiration of the seller’s policy or to let it run separately for a year or two. This last option may be a good idea if pricing and terms are competitive, so that you can wait until you get policies in place to feel more confident about the safety or risk management practices. A number of options exist, the key is to have a good strategy addressing the newly acquired risks — keeping surprises to a minimum.
Insights Insurance/Risk Management is brought to you by Arthur J. Gallagher & Co.