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Risks to consider for a smooth merger or acquisition

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A complete analysis of a company's risk management and insurance program is critical to a successful merger or acquisition. Risk management analysis involves evaluating a company's entire operation to determine exposures to loss. The objective is to understand the firm's risk profile and avoid assuming unknown and potentially costly exposures.

To begin the process, you will need to provide your broker with complete copies of all current insurance policies; copies of the most recently completed insurance applications; 10-year loss history; and financial statements for the most recent fiscal year.

The following exposures should be evaluated:

1. Workers' compensation. Generally, the experiences of an acquired company and its parent are combined, and a new experience modification applies. This can greatly impact insurance costs and should be evaluated prior to an acquisition. Determine whether or not the entity being acquired has been written on a retrospectively rated plan because cancellation of such plans can result in heavy penalties. Additionally, adverse loss experience can result in significantly higher premiums.

2. Residual liabilities. Occasionally, a company may only buy another firm's assets, and the entity being acquired must arrange coverage for their residual liabilities, done with an Extended Reporting Period (ERP) Endorsement.

If the parent company acquires the liabilities of another company, it must insure those liabilities. The parent may also have to specifically endorse its policy to provide prior acts coverage for the company being acquired.

3. Liability exposures for Directors and Officers (D&O). Typically, mergers and acquisitions involve a number of different parties, often leaving expectations unfulfilled and provoking stockholder lawsuits against directors and officers. D&O liability insurance policies usually exclude coverage for the acts of a subsidiary's directors and officers that occurred prior to an acquisition.

Additionally, an acquired company may need to purchase an Extended Reporting Period Endorsement to cover its residual liabilities under its D&O coverage.

4. Merger or acquisitions involve representations and warrantees made by one party to another. This usually involves the seller's indemnity or escrow obligation to the buyer. The seller may also need to put a portion of the value of the indemnification agreement in an escrow fund as a guarantee.

Several insurance companies offer "Representations and Warranty" insurance, a policy indemnifying an insured for loss due solely to "a breech of a representation and warranty" (an untrue, false or materially inaccurate statement of material fact). The policy gives an insured the right to subrogate against any party to the transaction. Many terms and conditions for this type of coverage exist, and the underwriting is quite thorough. Consider this type of policy especially if the representations and warranties are significant.

5. Consider merger and acquisition expense insurance to cover a firm's outside expenses on a deal that didn't work out. Covered expenses include attorney, accountant, stockbroker and investment banker fees as well as public relation consultant, proxy solicitor and advertising agency charges. Coverage applies only if the deal fails for reasons specified in the insurance contract.

Merging with, being acquired by, or acquiring another firm creates complex exposures to loss. Performing a thorough risk management and insurance analysis helps identify those exposures and facilitates a successful transaction.

More information is available at www.cavignac.com.

Submitted by Jeffrey Cavignac for Cavignac & Assoc.

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