Posted In: Business Transactions & Corporate Counseling, Insurance Recovery & Mergers, Acquisitions and Divestitures
By Molly Z. Brown & Thomas Hite, AINS (SeibertKeck Insurance Partners) on May 10, 2023
A key part of any M&A transaction is insurance due diligence, and Thomas Hite of SeibertKeck Insurance Partners joins us to discuss this crucial aspect of such transactions. The overarching goal in the due diligence process is to come out with an accurate projection of the insurance costs associated with the acquisition of a new company. This principle should guide the risk assessments for strategic buyers.
While there are many steps in insurance and risk evaluation as part of due diligence, the first four steps in the due diligence process for buyers will likely include the following:
(1) evaluating property insurance which is often the most expensive component of insurance programs;
(2) evaluating the overall insurance program relative to industry norms, as well as the coverage and risk expectations of the buyer;
(3) assessing areas that might lead to strategic advantages and modeling changes; and,
(4) reviewing cybersecurity systems and assessing needs for system modification to facilitate ongoing cybersecurity coverage and risk mitigation.
Each of these steps is discussed in more detail below.
Step One: Property Insurance. In conducting insurance and risk evaluations for buyers and private equity firms, the best means to accomplish this first step is to gather relevant information, including all real property information. Real property information is crucial because property insurance is often one of the most expensive and most-manipulated figures.
The purchaser’s insurance broker must work with due diligence teams to advocate for their clients to ensure that necessary and relevant information about physical plants is obtained, such as when the roof was last replaced, the age of wiring and heating systems, and whether the sprinkler system matches the occupancy. The more information that the broker is able to gather about the properties at issue, the more accurately the broker can project the cost of insurance and the cost of property improvements to mitigate long-term costs of the buyer’s insurance portfolio.
Step Two: Industry Norms. The next step is to make sure the policies that have been provided are appropriate for the risk that the target entity faces. SeibertKeck often sees target companies underinsuring their buildings, not buying flood or earthquake coverage, or removing their executive packages to ratchet down expenses and make EBITDA look better than it should. These mistakes can obviously cause problems for the purchaser post-closing. In addition to finding gaps in existing coverage, it is important to conduct a comparison of the current policy and the company’s financials to ensure that the appropriate amount of coverage is bought post-transaction.
Step Three: Earnings Estimates Feedback. A crucial follow-up step is providing feedback on insurance and loss expenses to the deal negotiation team, as well as expected expenses to facilitate cost savings. This aids in the preparation of estimates of post-transaction earnings by accounting for strategic advantages and/or differences expected due to underinsurance or delayed maintenance. In our experience at Brouse McDowell, this is the type of information that allows legal and due diligence teams to work together to be able to better predict strategic advantages and ensure successful deals post-closing.
Step Four: Cyber. As many of our clients know, cyber continues to be the most volatile marketplace in the industry. And, in the context of an acquisition, there are a variety of restrictions carriers place on newly acquired entities. Typically, the carriers will not provide the same limits of liability if the company being purchased does not have the same systems in place as the company they are insuring. It is important, then, for the broker to mediate between the target and the buyer’s cyber insurer to make sure they either have all the necessary precautions in place or, alternatively, the target is being added into the acquirer’s system so that they are provided full coverage as soon as the purchase is completed.
In conclusion, insurance due diligence is one of the key steps in any effective process. Proper completion of the foregoing steps can assist your company in understanding the strength of your bid relative to other competitors and facilitate onboarding in a manner that has the most benefit to earnings of the acquirer.
This blog is intended to provide information generally and to identify general legal requirements. It is not intended as a form of, or as a substitute for legal advice. Such advice should always come from in-house or retained counsel. Moreover, if this Blog in any way seems to contradict advice of counsel, counsel's opinion should control over anything written herein. No attorney client relationship is created or implied by this Blog. © 2023 Brouse McDowell. All rights reserved.