Buying a Local Business: What Are Your Insurance Issues?

Are you looking to buy another company? Folding its property, customers and employees into your organization is no small feat. Even if you plan to keep it as a subsidiary, you need to do full due diligence on the insurance aspect of the deal. This rundown can help you prepare so your transaction doesn’t fall through or saddle you with regret.

Total cost of risk

A primary concern you likely have when buying or merging with another business is your total cost of risk (TCOR). This includes things like:

• General liability
• Professional liability (especially in trades, and licensed or highly regulated professions)
• Property (intellectual and physical)
• Cyber liability (including vulnerabilities in the target’s network or systems)

It’s key to have this bird’s-eye view of your target’s overall insurance costs, claims history and potential future losses. You may be asked to take on all known and not-yet-manifest financial exposure. A simple look at your target’s past five years of insurance coverage, payments and claims is a good start to understanding your TCOR.

An insurance broker who specializes in mergers and acquisitions (M&A) is particularly valuable in getting the right data, asking the right questions and preparing a summary of your TCOR. You will want to know the total cost of insurance you will be absorbing, when renewals will occur, the projected cost of premiums at renewal and the insurance money you will need to bring to the table at closing.

It’s also important to know whether there are collateral requirements and long-term (tail) exposures. You may want to require the target owners to purchase coverage for those. You may also benefit from representations and warranties insurance, especially if the deal is high-value. This helps protect you from losses resulting from missing or misleading information provided by the entity you are buying. Your broker can advise you on all of these.

Special risks to highlight

There are some sectors of business and lines of insurance that have outsized loss issues. Commercial auto is one of these. If your acquisition includes fleets, transportation or commercial use of vehicles, you may want to have a deep discussion about risk management protocols, claims and insurability. The market for commercial auto insurance is challenging because of many high-loss claims.

Cyber risk is another area fraught with loss exposure. A look at historical claims might not be enough to gauge future risk. You may need someone with special skills to assess your target’s cybersecurity. Even small businesses are at risk. Don’t skip this evaluation based on the size or sector of the acquisition.

If the property you’re acquiring is  in a high-risk zone, you need a forward-looking review as well as the standard check on previous claims and current insurance coverage. Have a professional appraise the property.

Also, look into the insurers’ willingness to extend coverage for inventory, equipment, glass and various perils, such as theft, vandalism, and riots and civil disturbances. Research flood risks, taking into account dams and levees as well as bodies of water and public drainage systems.

For directors and officers insurance as well as cyber and other liability insurance, you likely will encounter “change in control” provisions in your target’s insurance policies. These terminate protection for members of your target company on or shortly after the date of the transaction’s close. There are ways to continue coverage, but those have to be worked out ahead of time and included in the M&A contract.

Your company also will need to get new certificates of insurance that show coverage for the acquired entity. And you will have to authorize a broker of record for the insurance policies of the target so changes in coverage can be placed.

Documents of interest

There are some documents your insurance broker can compile that may be of great help to your risk manager and finance officer.

A schedule of insurance for the target company can provide details on its coverage terms and costs. It might include the types of coverage, the insurer, the limit of insurance, the policy period, the premium and payment schedule, premium financing and policy numbers.

If there are layers of insurance, the details of those contracts are important. Your current insurance company and the target’s insurers might want to renegotiate certain provisions.

For workers’ comp, you will want to know about:

• The claims history
• The experience modification factor (the higher the ex mod factor, the higher the premiums),
• Post-accident drug testing results and policies
• Open cases
• Return-to-work modifications that have been made for current or past employees

Having this information will help ease the transition to new ownership.

Focusing on the details

Although property and liability issues are key, don’t forget about the employee benefits side of your transaction. Your insurance broker may be able to help you analyze that aspect or refer you to a trusted specialist who can. In some cases, your business insurance policies may allow fold-in coverage for new or acquired entities. You need to understand the terms of those clauses and the timing so you can notify your insurer of the acquisition or merger.

Even in friendly transactions like employee or management buyouts, insurance must play a central role. Getting it right from the beginning can prevent negative financial consequences in the future.