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Management Liability

Instill Confidence with Thorough Due Diligence

The Baldwin Group
Updated: April 24, 2024
6 minute read

Navigating the art of the deal

As the economy continues to experience a shifting global environment, mergers and acquisitions (M&As) continue in the middle market. During the M&A due diligence process, private equity firms should examine the seller’s operational, legal, financial, and accounting records, as well as its insurance program and employee benefits plan as early in the process as possible. Private equity firms should also take a close look at insurance and benefits trends that may impact the deal. This enables you to properly determine the value of a potential new asset, uncover any possible risks that can negatively impact a company’s EBITDA, and protect against post-transaction liabilities.

Property & Casualty Insurance Due Diligence Process in M&A(s)

The property and casualty (P&C) due diligence process begins by working with an experienced M&A insurance advisor to determine which of the target company’s exposures are properly insured, underinsured, or not insured at all. Your advisor will ask to see all the seller’s P&C insurance policies – commercial general liability, commercial property, environmental liability, directors and officers (D&O), errors and omissions (E&O), cyber liability, crime, excess liability, and any other policies the entity may have.

They will also ask for any information and records of policies dating as far back as possible, especially if the business is one that could be subject to long-tail liabilities. Long-tail liabilities are claims that can arise from incidents that occurred decades ago, such as asbestos contamination or sexual harassment.

After the policy review comes the vetting process, which includes the following (at a minimum):

  • Whether or not policies are aligned with the operation’s risk profile
  • The named insureds on the policies (for example, should any subsidiaries be covered?)
  • Additional insured status of the seller on third-party agreements
  • The inclusion of policy “anti-assignment” or “change of control” clauses
  • Policy deductibles and retentions
  • Relevant policy exclusions
  • Claims history, pending claims, and/or potential claims that may erode policy limits in the future
  • Retroactive premiums associated with a policy
  • The availability of runoff or tail coverage to provide some coverage for pre-existing wrongful acts, occurring prior to the deal close

The next step is to determine if any new additions or changes to the insurance program need to be implemented, depending on the merger or acquisition transaction structure and agreement language.

Understanding the current insurance market and your due diligence process

After an assessment of a seller’s existing insurance policies, your advisor will recommend any additional policies needed to address coverage gaps, with a keen eye on the state of today’s insurance market and the impact it may have on the transaction moving forward. Because the state of the insurance market regularly fluctuates, partnering with an experienced and well-connected team is critical in navigating challenges that are likely to arise while trying to place coverage.

Cybersecurity’s growing importance in due diligence

Since the pandemic, instances of cyberattacks skyrocketed around the world for businesses of all sizes and in all industries. Unfortunately, this is a trend that shows no signs of slowing down. Businesses witnessed a fifty percent increase in attacks on a weekly basis in 2021 compared to 2020, and according to IBM’s Cost of a Data Breach Report 2021, the average total cost of a data breach increased to $4.24 million. Ransomware attacks are a prevalent issue, with the United States Treasury Department reporting that the average ransomware transaction per month in 2021 was $102.3 million.

While attacks on larger targets make headlines, threat actors are constantly looking for anything that can make a potential target more vulnerable, regardless of its size. This is why ransomware groups are turning their attention to smaller targets in the middle of acquisition. They see newly acquired, midsize companies as easy targets for the picking with less geopolitical risk tied to attacking a large company.

Because M&As usually come with publicity, this is a signal to attackers that their target will soon have available funds that they can pursue. Additionally, part of the acquisition process includes the convergence of IT systems with the involved parties, and this transition can create cybersecurity vulnerabilities that attackers exploit. During the M&A process, involved parties are also probably preoccupied with a multitude of changes and thus less likely to stop an attack. Therefore, attackers see organizations involved in M&As as easier targets. Private equity firms that ignore these trends and fail to prioritize cybersecurity are taking a risk that could be financially devastating.

This trend has made cyber insurers even more stringent with the private equity risk they’re willing to take on. We’re seeing insurance companies ask for proof of cybersecurity measures for all parties involved in a transaction from day one. Insurance companies are less willing to offer coverage to companies who don’t already have proper cybersecurity measures in place before the M&A process even begins, highlighting the importance of cybersecurity in the baseline conversation in the diligence process. Our private equity team can help you navigate insurer requirements and implement missing security requirements to give you financial protection from cyberattacks.

Employee benefits critical in due diligence

Seller employee benefits programs often contain compliance or accounting issues that need attention. The seller should be able to provide the necessary documentation about its employee benefits programs, including its retirement plan, health and insurance plan documents (Wrap Plan, Section 125, etc.), Form 5500s, policies and procedures, renewal schedules, contracts with service providers, and more. The seller should also provide information about Internal Revenue Service (IRS) and U.S. Department of Labor (DOL) audits or other examinations that may have occurred in the past three years. After reviewing these documents, our team can identify if there is anything that may negatively impact you and determine a quick path to compliance before any transaction takes place. Special attention is given to provisions concerning potential post-employment and post-sale liabilities.

For example, before the deal is finalized, the seller may need to follow the IRS’s correction program (the Employee Plans Compliance Resolution System) or the DOL’s correction program (the Voluntary Fiduciary Compliance Program or Delinquent Filer Voluntary Compliance Program).

If a 401(k) is administered in-house, during the due diligence process, your advisor will take a close look at the timeliness of plan contributions, the available investment options, and whether any match or profit-sharing contribution has been improperly calculated and allocated. Our team will provide an analysis of the scope of any plan failures in terms of cost and time to resolve.

The rising costs of benefits

In looking at a potential M&A deal, our specialized team understands the impact of offering a competitive benefits package on a seller’s health care spend, the benefits currently provided, and how these may shift moving forward.

Another driving force behind rising employer-sponsored health plan costs is the dramatic increase in the utilization of specialty prescriptions. Although there is no silver bullet for specialty drug cost management, there are ways to bend the cost curve, sometimes with simple solutions, such as steering where the medications are delivered. During the due diligence process, we evaluate a seller’s total Rx spend, including the costs of specialty drugs, to determine how to manage formularies and claims pre-deal closing.

Ensure that P&C insurance and employee benefits due diligence are part of the M&A process to help protect against potential liabilities and bolster the value of the asset you’re considering acquiring. Involve your insurance advisor early in the deal process before any letter of intent is drawn so that potential issues can be addressed during the representations and warranties insurance (RWI) process. In obtaining an RWI policy, the insurer will want to review the seller’s insurance and employee benefits programs.

By proactively addressing insurance-related concerns with your advisor, you can navigate the complexities of M&A with greater confidence and help ensure a smoother path to achieving your strategic objectives.

Incorporating the expertise of an advisor from the outset not only safeguards your investment but also demonstrates your commitment to responsible and thorough due diligence, which can instill confidence in your stakeholders and potential partners.

Connect with our team for solutions that best fit your needs.

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Benchmarking D&O Cyber D&O Management Liability
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