RISK MANAGERS' FORUM
A risk management perspective
By Steven B. Steinberg, CPCU
Prior to any merger or acquisition, the management of an organization must perform the necessary due diligence. The purpose of this due diligence exercise is to determine that the information about the company to be acquired is correct, accurate, and properly disclosed. During this process, the parties need to determine that all critical issues have been identified and that key assumptions used in the investment proposal are accurate.
The process of due diligence is carried out by a team whose members have expertise in various functional areas. These team members are usually employees of the acquiring company unless a particular expertise is needed that cannot be found within the company. The team will request documents from various departments within the company which will assist in obtaining the desired information and reaching the desired goals.
The team may include members from the following disciplines:
1. Financial/Accounting
2. Tax
3. Risk Management
4. Management Information Systems/Information Technology
5. Human Resources
6. Environmental
7. Legal
8. Actuarial
9. Operations
10. Sales
The broad scope of the due diligence process makes it useful for a variety of situations:
1. An agent or broker can apply these methods when writing a new account.
2. A new risk manager can use this approach to determine that all exposures to loss have been identified and addressed. It will also assist the new risk manager in gaining instant credibility.
3. A risk management consultant can use the tools of due diligence to assist in program design and implementation.
These three groups might employ a checklist similar to the one at the end of this article.
The due diligence process is accomplished in four steps. The first is the Identification Phase, which involves information gathering and risk identification. During this phase, the risk management team will spend time reviewing current risk management department operations and assembling all loss data. The second phase involves the analysis of all loss runs, identification of pending and prior litigation, and reviewing insurance policies and environmental issues. The third phase involves summarizing the data collected and analyzing the exposures compared to existing insurance coverages and submitting recommendations to the due diligence team. The fourth phase is performed after acquisition and involves visits to new locations, consolidating the insurance program, and addressing administrative issues. The acquisition of an insurance agency offers similar challenges and presents other areas of concern:
* When buying an agency, markets are an important issue. Request at least five years of company loss experience. These numbers will indicate how well the carrier has done with this agency and foreshadow any impending problems.
* It is necessary that carriers be aware of the possible sale and pre-authorize the transaction so that the carriers will stay.
* Ask the seller to list his/her largest 25 accounts. Buyer and seller should jointly call on the clients to discuss the pending sale of the existing agency and to introduce the new owners.
* Require the seller to provide five years of financial statements including IRS filings.
* Examine the employment contracts of all producers. Make sure there are non-competitive covenants in place prior to change of ownership.
* Determine ownership of business. Does the agency own the business or do producers own the business they write?
* Arrange for an escrow account so that audit changes can be accounted for.
* Obtain an indemnification agreement from the seller for prior acts and make sure that the seller's errors and omissions policy provides for "tail" coverage.
* Obtain employment contract(s) from owner(s) or written agreement(s) that they will be available for a period of time.
The pitfalls of a bad acquisition can be mitigated by use of the attached checklist, common sense, and products provided by the insurance industry. Recognizing the risks associated with mergers and acquisitions, risk management professionals look to the insurance market for newly developed products that will help treat these exposures. These coverages include but are not limited to:
* Representation and Warranty Insurance
* Aborted Bid Insurance
* Tax Opinion Insurance
* A variety of Pollution Liability Insurance policies:
--Clean Up Cost Gap. Top loss for the financial side of remediation covering overruns of expected cleanup costs.
--Pollution Legal Liability. Site-specific coverage for unknown, pre-existing (and new) pollution conditions at insured sites.
--Environmental Protection Programs. Risk transfer and self-funding (with claims and loss control support) to assist with costs applicable to compliance with environmental laws governing hazardous waste treatment, storage and disposal operations.
DUE DILIGENCE CHECKLIST
Prior to our scheduled meeting to complete our exposure questionnaire, please gather the following information and data:
General:
1. Names of all operating entities with a list of owners and officers and ownership percentages
2. Most current audited financial statement(s)
3. Most current annual report and Form 10K
4. Copies of current insurance policies
5. Loss Control/Safety/Hiring/Testing/Maintenance manuals, procedures, etc.
6. Insurance company issued loss runs for current year and four (4) prior years
7. Description of, and details about, any individual loss in excess of $5,000 paid or reserved
8. Details of any planned significant change in operations over the next year
9. Insurance carriers, policy numbers, limits and premiums for four (4) years. (The insurance company final audits are excellent source documents.)
10. All brochures, advertising copy, pamphlets, etc., used to describe your business
11. Additional/Named Insureds, Loss Payees and Certificate of Insurance holders
12. Copies of any Hold Harmless Agreements in effect
13. Details on fire/theft protection systems, safeguards, procedures, etc.
14. Details on any foreign operation(s)
15. Copies of current Experience Modifiers for Workers Compensation and Automobile
16. Copies of all leases and contracts
Workers Compensation:
1. Payroll and number of employees by classification for next year
2. Description of any operations involving exposure under the USL&H Act, Jones Act, FELA (rail)
3. Form 941 for last two (2) completed quarters
4. Federal Employer's ID# and SIC code
General Liability:
1. Gross revenues expected this year and next
2. Gross revenues for past five (5) years
3. Details on any discontinued product or service
Automobile:
1. List of drivers by full name, date of birth, driver's license number, state of issue, and date of hire
Property:
1. List of all locations including occupancy, type of fire protection, square footage, and construction
2. Details on any changes in insured values compared to current coverages
3. Details on any bailment or property in your care, custody or control
(Used with permission of Entrust Risk Management Services, Houston, Texas) *
The author
Steven B. Steinberg, CPCU, has served in risk management capacities for a financial services company, a wholesaler, an environmental services company, and a staff leasing company. He is now part of Entrust Risk Management Services, a risk management, insurance, benefits, claims, and safety-consulting firm. He has been actively involved with insurance and risk management education for many years and is currently on the faculty of Certified Risk Managers International, teaching courses leading to the CRM designation. For more information on the CRM program, part of the National Alliance for Insurance Education & Research, call (800) 633-2165 or visit the Web site at www.scic.com.