Insurance Due Diligence - Post Acquisition

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There are many important items and outside advisors to manage during the due diligence process.  Short exclusivity periods are commonplace, so the complexity of the process and pressure to close is intensified.  Ideally, a thorough review of the insurance and employee benefits programs would begin shortly after you have signed the definitive Letter of Intent.  The reality is that it can be difficult to include a pre-close insurance review in such a competitive and compressed deal process.

"The overwhelming majority of claims that are reported post-close for pre-close wrongful acts rise to the surface shortly after close"

 

Some insurance related items can be reviewed post-close just as well as they can pre-close.  Those items are outlined below.  However, there are several very important items that can only be sufficiently addressed prior to close. This is due to macro changes in the insurance market that are negatively impacting rates and restricting underwriting authority.  In addition, some findings can impact the valuation of the company. The items that must be addressed prior to close are as follows:

  • Directors’ & Officers’ Liability (D&O):  Irrespective of whether or not you acquired the stock or assets, how you changed the board, and/or whether or not the pre-close management team is still intact – it is important to purchase a policy to protect your company and D’s & O’s from claims that are tied to pre-close wrongful acts that are reported post-close.  Otherwise referred to as a “tail” or “run-off” policy.  The proper structure of the tail policy and new go-forward coverage is affected by a great number of factors.  However, one thing is clear: the overwhelming majority of claims that are reported post-close for pre-close wrongful acts rise to the surface shortly after close. Therefore, it is extremely difficult to get an insurer to agree to place a tail/run-off policy effective at close if the terms and conditions are not negotiated prior to close.

  • Changes in Law/Regulation:  Changes in regulation can result in government mandates to purchase new coverages or change business practices.  While they do not always begin at or prior to close, they can happen close enough into the future to impact the deal valuation.  Examples include the major overhaul to the healthcare system in the United States, and recent pension regulation changes in the United Kingdom. 

  • Uninsured Exposures: Entrepreneurs tend to take long-term risks that private equity investors avoid.  Many times this results in pre-close management leaving important exposures to loss uninsured even though there are insurance products that would easily address these items. Underwriters are more receptive to crafting policies to address these exposures if they can begin the process prior to close.

  • Efficient Replacement of Policies:  Some insurance policies have provisions that require the insured to contact the insurer after a change in control.  If a timely notice is not provided the insurer could have an argument to deny future claims.  Also, the deal structure might necessitate a complete change to the insurance program.  For instance, an asset transaction or a spin-out typically results in a replacement of all policies in conjunction with the close of the transaction. 

    Chris Ball is Vice President of Reliance Insurance Agencies, Ltd.  He can be reached at 604-251-8322 or cball@reliance.bc.ca 

    Mark Johnson is Account Executive at Reliance.  He can be reached at 604-251-8360 or mjohnson@reliance.bc.ca 

    Reliance represents Equity Risk Partners Global in Vancouer

     
  • Environmental Liability: There is constant change to legal precedent regarding who is financially responsible for historical environmental liabilities. More and more, the power of indemnification wording in a purchase agreement is being limited as the courts continue to focus on finding anyone to address contamination issues – irrespective of whether or not the party is to blame for the original incident.  Also, most environmental assessments are superficial, and they do not include ground water or soil testing.  An Environmental Liability Insurance policy can protect your balance sheet against legacy contamination issues that are discovered post-close. Whether you plan to backstop an indemnity agreement with insurance, or use insurance in lieu of an agreement, underwriters will provide input on how the indemnification is worded.  Reliance Insurance will craft the terms and conditions of the policy with interested underwriters in order to work in conjunction with the indemnity language.  If the deal has closed and the indemnity language is set, the effectiveness of the coverage may be reduced because prospective insurers may not be willing or able to address any gaps that their policy could potentially fill.

A post-close review can still be a useful tool with regards to budgeting and overall program design. The scope of the review will be slightly different, but the basic objectives will remain the same:

  • Budgeting: The aforementioned increase in rates and changes to underwriting authority have forced many companies to spend more for insurance at renewal – even for what is traditionally considered a favorable risk/industry.  Significant increases are occurring for companies that have had some loss activity.  This trend makes it more important than ever to understand the impact that this will have to your budget, and the amount of time that management will have to spend on managing the renewal process if a marketing effort is warranted. 

  • Post-close Deal Documentation: We can ensure that the proper attention is paid to the aforementioned change in control provisions. 

  • Growth Plans, Exit Strategy and Program Design:  We can determine if the current insurance program is scalable and properly structured to meet the needs of your growth plans and exit strategy.  

  • On-site Inspection:  Restraints on managements time make it difficult to visit the main facilities during the due diligence process. Management is usually more receptive to these visits after the deal closes, and the results of which can be incorporated into the final review.

An insurance review that takes place pre-close is the only way to ensure that important insurance and risk management items are addressed.  However, many worthwhile items can be addressed post-close, and is better than not reviewing the program at all. 

Chris Ball is Vice President of Reliance Insurance Agencies, Ltd.  He can be reached at 604-251-8322or cball@reliance.bc.ca. Mark Johnson is Account Executive at Reliance.  He can be reached at 604-251-8360 or mjohnson@reliance.bc.ca. Reliance represents Equity Risk Partners Global in Vancouver.

Equity Risk Partners Global is the first and only international insurance brokerage alliance focused exclusively on the needs of the private equity marketplace. Comprised of independent brokers in countries with a significant amount of private equity activity, this worldwide consortium is dedicated to improving the efficiency, structure and return of private equity transactions through a unified and consistent approach to due diligence and client service.  For more information, visit www.equityriskglobal.com.