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M&A Insurance Due Diligence Checklist

By Douglas H. Hartman, ARM

Read the Sales/Purchase

Agreement and find out the

following

9 Is this a purchase of stock or netassets?

9 Will the business resumeoperations with currentmanagement (same tax EIN?)and operate on a stand alonebasis?

9 If sand alone, will a newinsurance program have to bedesigned and placed?

9 Or, will/can the insurance andemployee benefits exposures be

absorbed into the insuranceprograms of the buyer?

9 What is the approximate value ofthe transaction?

9 Will the seller provideindemnification to the buyer forself-insured or uninsuredliabilities?

9 What provisions are made forpost-retirement health andwelfare insurance benefits?

Before getting started, the risk managementspecialist should gain an understanding of theoverall situation and the timeline. Forexample, if the proposed transaction is beingconducted as an auction, you may have toget by with the documents in the data room.After the buyer has signs a letter of intent,you should insist on getting whateverreasonable information you think you'll need.

Five process planning items:

1. Sign a confidentiality agreement.2. Obtain the index of the documents in the

data room (get ID and PW if a virtual dataroom).

3. Make sure you know what your scope willbe. (Who is doing the Employee benefits,environmental compliance, etc?)

4. Compile the names and contactinformation of those with whom you will bedealing (buy-out firm partners andassociates, heads of risk management andemployee benefits at the company,insurance broker(s) of the company andyour client's attorney.

5. Decide if you will need to visit the businessto be acquired to observe operations and

conduct interviews.

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Learn from the Information

Memorandum and other availableinformation about the company

9 In what business (es) is thecompany?

9 What are its products/services?9 Where are its plants and offices

located?9 How many does it employ and

what are the occupationalclassifications?

9 What were the revenues andEBITDA over the past threeyears?

9 What is projected for the rest ofthis and next year?

9 What are the approximate valuesof the raw materials, inventory,plant and equipment on thebalance sheet?

9 Who are the company's majorcustomers and suppliers?

9 Are there any disclosures inregarding to legal compliance,enforcement or tort litigation?

Look for potential deal-breakers, such asbusinesses with asbestos claim and productliability legacy issues. If necessary, search

the Internet for information about thecompany, its competitors and the industry.

Other red flags to look for are uniqueexposures that may require special types ofpolicies - or insurance for which there may belimited availability due to changing marketconditions. These should immediately bediscussed with the buyer.

Compile the financial information for later usein calculating the cost of insurance per

$1,000 of revenue, conducting the insurancebenchmarking and testing the reasonablenessof total insured values.

Review insurance company claimreports or "loss runs"

9 How many product liability losseshave they incurred -- and howhigh or severe have they been?

9 If a provider of professionalservices, how many errors &omissions claims have they hadand how severe?

9 How many workers compensationaccidents do they incur annually?

9 How many automobile andgeneral liability accidents do they

incur?9 Have they had any material

property, crime, cargo and marineclaims.

Copies of the actual loss runs are preferred,because they are primary sources ofinformation about the sellers risks andfinancial obligations -- even if they show fewor no claims. Use the loss runs to developquestions about large or unusual claims andlosses.

If the company incurs enough claims, youshould prepare to do some loss-trending,especially of the workers compensationclaims.

Secondary sources include compiled loss

statistics, often prepared by the sellers riskmanager or broker, or projections preparedby a casualty actuary. Ask if these areavailable.

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Get a copy of the sellers

insurance policy schedules datingback at least three years and get

copies of all property/casualtyinsurance policies currently in

force.

The Schedules of Insurance should list

the following for each policy:

9 What did/does the policy cover(e.g. commercial property)?

9 Who was/is the insuranceCompany?

9 What were/are the policynumbers?

9 When did/will they expire?9 What were/are the per occurrenceand aggregate limits of liability?9 What were/are the insured values

for real and personal property andbusiness interruption?

9 What were/are the deductibles orself-insured retentions?

9 What were/are the annualpremiums?

Often the data room will only have thecurrent schedule of insurance. Always ask forprior years' schedules and complete copies ofeach current insurance contract -- and READTHEM!

Look for

9 Inadequate umbrella limits9 Claims-made policy forms.9 No management liability policies (D&O,

EPLI, ERISA)9 Insurance companies with AM Best Ratings

less than "excellent."9 Expired policies (or policies due to expire

before closing)9 Gaps or lapses in insurance coverage.Make a table summarizing their premiumhistory. Calculate the cost of insurance per$1,000 of revenues and submit to the RIMSBenchmarking Survey.TM

If the business is self-insured or

insured by a retrospectively rated"retro" policy, obtain a five to

seven year history of thefollowing:

9 What are and were the retentionsper claim or per occurrence?

9 Standard Premium?9 Basic Premium?9 Loss Conversion Factor?9 Interstate Experience Modifier?9 MA, PA, NJ Experience

Modifier(s)?9 Maximum Premium?9 Loss Limit?

If a purchase of assets and the seller will be

retaining the liabilities for workerscompensation and other liability claimsincurred prior to the sale, carefully read theindemnification agreements in the purchaseagreement to see if there are any dollaramount or time limits.

If a purchase of stock transaction, the buyerwill usually be expected to retain the liabilityfor self-insured losses and future retropremium payments. Estimate howmuch these losses and retros adjustmentscould cost. Ask how much management hasaccrued and determine if they may beundervalued.

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Employee Benefits Insurance

Documentation

1. Employee benefits handbookoutlining human resources

policies and procedures.2. Sample insurance brochures and

applications given to newemployees.

3. Employee census4. Health insurance plan documents5. If applicable, 125 plan document6. IRS form 5500 for each employee

benefit plan7. Health insurance company's

monthly premium statements forthe most recent month -- datingback three years (e.g. December2003, 2004 and 2005)

If the risk management specialist is notqualified to review employee benefitsinsurance, find out who will or can review thisimportant aspect of the transaction.

The principal issues are going to be:

9 Will we need to design a stand aloneprogram?

9 What have the company's health insurancepremium rates been -- and are theyvulnerable to a material change in theirrates?

9 What kinds of employee benefits insurance(e.g. long-term disability and lifeinsurance) do they not offer or buy -- andhow much will it cost to buy these?

9Does the company have adequate policiesand procedures governing employeeconduct in the workplace, responsibility forsafety, etc.?

Copyright Montclair Risk Advisors, Inc. 2001, 2006