Best Practices when reviewing Private Equity Insurance and Employee Benefits in Today’s Economy

Even with the continued struggle in the mid-market economy, mergers and acquisitions (M&A) are continuing. It’s important that as part of the M&A process, private equity (PE) firms add the insurance programs and employee benefits of the potential acquisition to their business review process. The earlier the review happens the easier it will be to ensure proper coverage and overall competitive cost. It’s also vital to review how business insurance and employee benefits trends are affecting the overall deal. 

At Insgroup we have an in-depth analysis process that within weeks, a PE firm can have enough validated data to properly determine the value of a new business deal as well as bring to light possible risks that could harm their EBITDA. The goal with this review is to not only bring awareness to the company’s value, but to also protect the company from post-acquisition liabilities.

Property and Casualty Due Diligence for M&A

At Insgroup, the Property and Casualty (P&C) due diligence process starts by working with a validated M&A insurance partner to analyze whether or not the organization’s risks are insured appropriately. The seller’s Property and Casualty insurance policies should always be reviewed, which includes:

  • Commercial General Liability
  • Commercial Property
  • Environmental Liability
  • Directors and Officers 
  • Errors and Omissions 
  • Cyber Liability
  • Crime, Excess Liability 

It’s also a good idea to ask for several years of loss-runs for all policies. This is especially important if the business in question could be subject to long-tail liabilities.

After all of the company’s policies are received, it is important to review and analyze all of the following:

  • Are the policies syncing with the business’ risk profile?
  • Are all business names and subsidiaries covered?
  • Review Third-Party agreements 
  • Review all policy deductibles and retentions
  • Analyze policy “anti-assignment” or “change of control” clauses.
  • Review any additional policy exclusions
  • Review all pending, potential, and historical claims

Once the program review is completed, it will be determined if any additional changes to the insurance program should be implemented into the M&A agreement documents.

Take Today’s Insurance Market Into Account in Your Research

Knowledge of the state of today’s insurance market and the impact it may have in the future is critical to understanding potential coverage gaps and how to bridge them. Today, the insurance market is identified by higher insurance premiums, tighter underwriting guidelines, reduced appetite for risk, and diminished capacity. This means that the current insurance costs of a business are likely not what they will be at the closing of an M&A deal. Any additional Management Liability policies that may need to be added at closing will likely be hit by higher rates as well as narrowing of coverage, reduced sub-limits, and increased retention. For example, D&O rates in Q3 2020 increased by an average of 11.5%, as well as Umbrella and Excess Liability, which are up by 8.5%. The insurance market has also been further strained by the COVID-19 pandemic, which has resulted in insurers clarifying policies that have been “silent” on certain exposures and adding new exclusions. Some insurers for D&O coverage, for instance, have introduced insolvency exclusions and– in some circumstances – require buyers to sign warranty letters because of potential COVID-related lawsuits.

Employee Benefits To Dos

Employee Benefits programs, compliance, or accounting issues are often forgotten in companies that are being acquired. The seller should be able to provide all the necessary documents about its Employee Benefits, including its retirement plan, health and insurance documents, Form 5500s, procedures and policies, remittance schedules, contracts with service providers, and more. They should also provide information about the Internal Revenue Service (IRS) and U.S. Department of Labor (DOL) audits or other examinations that may have occurred in the past 3 years. Reviewing these documents can recognize whether anything may negatively impact the company and determine a path to compliance before any transaction takes place.

Before the deal is finalized, the seller, for example, may need to follow the IRS’s correction program which is called the Employee Plans Compliance Resolution System, or the DOL’s correction program which is called the Voluntary Fiduciary Compliance Program. If a 401(k) is administered in-house, during the due diligence process, it’s recommended to take a close look at the timeliness of plan contributions. It is also important to research available investment options and whether any match or profit-sharing contribution was improperly calculated and issued. An examination of the scope of any plan failures in terms of cost and time to resolve.

The Rise in Costs of Benefits

Indications are that Employee Benefits costs are anticipated to rise in 2021 due to continued care for COVID-19 patients and a return to delivering previously deferred non-COVID-19 care. Another driving force behind rising employer-sponsored health plan costs is the substantial increase in specialty prescriptions. Forecasts for prescription drug plan costs in 2021 are expected to exceed 7% annually, primarily driven by price increases for specialty drugs, which are projected to increase by 11.5% on a yearly basis. During the careful examination process, a seller’s total Rx spend should be reviewed, including the costs of specialty drugs, to determine how to manage formularies and claims before the deal closes.

What Can You Execute?

Ensure that P&C insurance and Employee Benefits examination are part of the M&A process to protect against potential liabilities and to support the value of the asset under consideration. Request the help of a trusted 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.

If you are a Private Equity firm looking for an in-depth analysis of a potential acquisition’s insurance coverage, contact Insgroup today to schedule your Insight+ review. Click Here to contact Insgroup.

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