Insights

  • What Is Insurance Diligence…and Why Should You Care About It?
    POSTED 10.26.21 M&A

    When evaluating a target company for acquisition, the Buyer conducts a thorough check of financials, IP, tax obligations, contracts, customer lists, and other key aspects of the business.

    That’s due diligence.

    But to make an informed decision on whether or not to move forward and close the deal, there’s another aspect of diligence that I recommend…that some don’t seriously many do not consider – insurance diligence.

    You get some insights on the mindset of management and the caliber of operations from the amount of insurance and the quality of that coverage they have in place.

    Also, digging deeper, if they have had a lot of insurance claims, that could provide a red flag or at least insight on a problem area in either operations, management, or even both. Every insurance policy can deliver an up-to-date report on any claims that have been reported and the amounts that were paid. That’s called the loss run report, which is available for each respective policy.

    Having that information in your back pocket can be helpful in deal-making when asking a target company about private litigation. They could dismiss a claim that was paid by their insurer and maintain the issue in question was not a big deal. They say they just gave it to the insurance company to take care of.

    But when you are looking at the loss history and that the insurance paid a multi-million-dollar settlement …it shows you it actually was a pretty big deal. It provides unique insight into the management of the company and how they handle issues.

    When first conducting insurance diligence, you’ll first discover how a target is insured and what specific policies are in place, whether it be Directors and Officers, IP Infringement Defense, General Liability, Product Liability, Property Insurance, Professional Liability, or some other type.

    When looking at what coverage lines are in place, you also have to check to make sure the coverage is adequate or appropriate for the risk out there. For example, is it a $100M revenue company with a $500,000 limit policy? Not good.

    You should also look for other potential gaps. You might be surprised that many technology companies do not carry Cyber Security & Privacy insurance. It’s counterintuitive, but it happens a lot. So don’t that for granted.

    Likewise, many management teams do not carry D&O insurance because they are privately held and it’s not required. But even small companies should have D&O coverage in place as it is so important to protect the personal assets of the directors and officers (not to mention their spouses and estates) if they are personally sued for actual or alleged wrongful acts they’ve committed in managing the company.

     Who Are They Insured With?

    After examining the types of insurance and coverage levels the target company has, you should consider the quality of the insurance companies they are doing business with. They are not all created equal, by any means.

    Are they financially solid, secure brand-name insurance companies with good reputations?

    Or did the target try to go the cheap route and pick whatever company quoted them the lowest premiums?

    It is very common that start-ups will get very small policies at the lowest cost possible in the beginning but then forget to scale up their protection as they grow over time. Also, insurance companies used by start-ups are entry-level carriers, which is why they are so cheap.

    While appropriate at the start-up phase, these insurers aren’t equipped or qualified to handle larger policyholders.

    Again, this is all too common. In their rush to grow, these start-up companies don’t make sure that insurance keeps up with where they are at the moment. Insurance needs can change quickly and can’t be left out.

    Other Types of Insurance

    The insurance in the target company you should be examining is not only that which covers the company and its management team, or the property and casualty coverage for the assets of the business.

    If they have personnel, there is the health plan, benefit plan… any of those types of lines need to be considered, particularly when planning the transition. The last thing you want to do is cancel the employees’ health insurance.

    Where to Go From Here

    A huge benefit to this process, besides gaining insight into management and operations, is that the insurance diligence report can also provide advice on how to transition the target company’s insurance exposures into the Buyer’s existing program…or, if it makes sense, to create a new standalone program for the new company.

    The bottom-line is in the overall world of due diligence don’t forget to do specific diligence on the potential acquisition’s insurance coverage.

    This insurance diligence process does take time. But it’s well worth it.

    A lot of attorneys look this information over. But you can fast-track the process if you work with a reputable commercial insurance broker who is familiar with all these lines of coverage, not just management liability and property casualty but also benefits plans.

    Brokers provide this service on a fee-basis. But many brokers can waive the fee if they have an opportunity to either place coverage on a go-forward basis or participate in M&A transactional coverage.

    My firm, Rubicon M&A Insurance Services, a member of the Liberty Company Insurance Brokers network of companies, can provide such services. Just get in touch with me, Patrick Stroth, for more details: pstroth@rubiconins.com.