Volume 8

Partners' Perspective

The Top Ten Most Common Insurance Due Diligence Mistakes

In order to perform a thorough review of a target company's property/casualty and health/welfare insurance programs, knowing what to look for is as important as steering clear of the most common due diligence pitfalls. Here are some of the most common insurance/benefits due diligence mistakes that we see.

Property and Casualty

  1. Target Company Contractual Obligations. Often customers and/or suppliers impose specific insurance requirements on the target company. Not examining the insurance requirements in these contracts not only puts these relationships in jeopardy, but it can also put the company at a competitive disadvantage. In addition, not enough attention is paid to determine whether the insurance requirements are reasonable (e.g., Business Income/Extra Expense levels).
  2. Historical Premium Audits. A common oversight is failing to analyze the results of premium audits and whether invoices for additional premium payments have been issued (and paid) and/or refunds given. As result, there is the potential for a hidden post-closing liability.
  3. Balance Sheet Reserves for Loss Sensitive Programs. Too often someone fails to determine whether there are adequate reserves set aside to cover the expected losses within layers of risk retained by the company, including possible adverse development. In addition, there is little (if any) consideration given to what the potential magnitude of the buyer's exposure to post-closing adverse claim development.
  4. International Exposure. Understanding how the company's international exposures are being covered (e.g., global policy, local policies, etc.) and confirming that all local requirements are being satisfied is extremely important.
  5. Large Claims. It is not uncommon for people to underestimate the impact a large claim will have on the company's go-forward premium at its next renewal.

Employee Benefits

  1. Impact of Divestiture on Benefits Costs. Having a good handle on the "number" is imperative during the due diligence process. What is the aggregate cost to the company of insurance premiums, claims, fees, etc. on an annual basis going forward as compared to what the company's current parent company is allocating to the business? Additionally, most people neglect to examine the impact on employee benefits choices (i.e. transition from an employer paid to voluntary vision and/or dental plan) for the spun-out entity given its smaller size.
  2. 5500s. Is the target company compliant with all Internal Revenue Services and/or Department of Labor rules and regulations? If not, be prepared to pay some large fines. For example, plan administrators filing a late report may be assessed $50 per day without a limit for the period of time they failed to file. Companies that do not file a report may be assessed $300 per day up to $30,000 per year until a report is filed.
  3. IBNR (Incurred But Not Reported) Reserves. If the company has a self-funded medical program, is the reserve for IBNR adequate? Some people do not determine how the IBNR should be treated post-closing by properly documenting whether the buyer or seller is responsible for any shortfall.
  4. Retiree and Executive Benefits Plans. There are numerous target companies that maintain one or both of these plans. Buyers need to understand what these programs cost and whether they should be maintained going forward.
  5. Employee Contribution Strategy. Not examining the costs associated with moving the contribution rates closer to the regional or national averages if the target company's current contribution levels are different from the averages can have a significant impact on employee retention and recruitment.

If you want to avoid these traps, please contact your Equity Risk Partners representative. Over the years, our firm and its professionals have provided meaningful advice to private equity investment professionals over on 500+ transactions.