M&A Due Diligence Must Include Insurance Due Diligence

When companies enter the due diligence phase of a merger or acquisition, they typically focus on financials, asset adequacy and issues related to compliance, taxation and the law. A deep dive into insurance due diligence is every bit as important.

Insurance Due Diligence: More Than Numbers Verification

Performing insurance due diligence is much more than simply comparing premium payments with what the policy states, although that’s where it begins. The first step in insurance due diligence involves identifying the target company’s insurance spend (as stated in the financials) and then verifying that those expenses are accurate. At many companies, the total insurance spend includes property and casualty, employee health and welfare benefits, and retirement benefits.

Are Risks Covered?

The next step is to examine the target company’s risk exposure and determine whether existing insurance coverage is appropriate. Look for unprotected risks and inadequate or excessive coverage for identified risks. Continue by determining what addressing those risks will do to your insurance spending and the effect the expenses or savings will have when applying the EBITDA multiple.

Do Gaps Exist?

Significant shortfalls in business insurance coverage are much more common than deal teams realize. It isn’t that business leaders are bad at insurance; they’re just not experts. The path to the executive office doesn’t typically pass through the risk management team. While leaders might know something about insurance, they probably don’t know it well enough to decode policy legalese. Some may make assumptions about their coverage that prove incorrect when there’s a claim.

As the Hylant team has performed insurance due diligence for clients, it has encountered many gaps between the coverage companies thought they had and what they actually had. Whether shortfalls result from the size of the combined company’s footprint or what’s involved in integrating organizations, they expose the company to significant business risks. In these cases, our team has provided step-by-step guidance for addressing issues before and after the deal.

How Are Employee Benefits Impacted?

An example of the importance of insurance due diligence involves private equity firms using platform companies as foundations for expanding through acquisitions. Each acquisition not only brings more real estate and employees but also creates more complexity with employee benefits—complexity that may be beyond the existing agent’s expertise and bandwidth.

What should a buyer do if the target company has a benefits program that is twice as good as the acquirer’s standard? Keep it, and other employees will find out and demand the same. Switch to the buyer’s plan, and employees will disappear. Either way, will the buyer create a compliance issue? Fortunately, there are proven strategies for handling these issues—once they are known to exist.

What Unrecognized Opportunities Exist?

Generous employee benefits plans are among the most effective ways to recruit and retain loyal team members. A key advantage of thorough M&A insurance due diligence is that it presents opportunities to improve the quality—and sometimes lower the cost—of a buyer’s global benefits program.

For example, Hylant’s risk management consultants explore and compare the target company’s benefit structure to the buyer’s program structure. We create benchmarks for a variety of factors. Are employees paying too much for what they’re receiving? Is the company picking up too small a share of the plan’s cost? How does the claims data compare between companies and plans? Are there benefits the buyer’s employees would also find attractive? With those benchmarks, we provide remarkably accurate forecasts for coverage costs so company leaders can budget more effectively.

Insurance due diligence also looks for gaps in other coverages. Maybe the buyer’s company has long been comfortable with a $250,000 deductible for workers’ compensation and general liability insurance. The leadership at the target company may be terrified of that amount. Differences such as these can be worked out, often by phasing in changes over time. An experienced, diplomatic risk management consultant can be invaluable in addressing these types of issues to the benefit of both parties, paving the way for deal closure.

Learning About More Than Insurance

While the obvious purpose of insurance due diligence is to understand where coverage needs to be shored up, it also provides valuable insight into how the current owners have been managing the target company. There may be signs that the company has been using industry-preferred business practices, or there might be some warning signs of less sophistication than expected.

Buyers are sometimes surprised to discover that their acquisition targets have been purchasing only the contractual minimums for insurance, although they had risks and exposures well beyond the limits of those policies. Because they weren’t doing anything to insure those excess exposures, they were essentially self-insuring those risks. What would a single large claim do to the purchasing company’s viability?

Good News: Insurance Isn’t Your Job

You already have plenty to do. Unless you are a risk manager, you don’t need to become an expert on business insurance and risk scenarios. It’s the job of professionals like those at Hylant to understand the M&A landscape and explain how to protect your company and your team.

Insurance due diligence doesn’t replace or outrank legal, tax or accounting advice. It complements it by identifying what could go wrong from a risk management perspective and advising on options for financial protection. By providing action steps at every stage of the transaction and consolidation and putting risks in easily understood, quantifiable terms, Hylant helps M&A deal teams make better-informed decisions.

To learn more about how Hylant’s M&A and Transaction Solutions team can help you, visit www.hylant.com/MATS.

Related Reading: Is Your Business Taking Enough Risk?

The above information does not constitute advice. Always contact your insurance broker or trusted advisor for insurance-related questions.