NU Online News Service, April 12, 3:02 p.m. EDT

With a rise in mergers and acquisitions expected to continue through 2011, unseen regulatory, legal and other risks can doom a potentially sound arrangement, according to an expert at ACE USA.

Following a merger or acquisition, the buyer—a company or private-equity firm— typically absorbs the liabilities of the acquired entity, Seth Gillston, senior vice president, ACE USA Mergers & Acquisitions Industry Practice, writes in his report, “M&A Risk Management: Avoiding Pitfalls, Finding Solutions.”

If a company has acquired numerous organizations through the years, some of which may no longer exist, these successor liabilities can be daunting from a risk-management standpoint, he notes.

Making things worse, he writes, is that the acquired company’s insurance policies generally either cease to provide coverage, or convert into run-off mode, essentially providing coverage for a short period of time. The adequacy of these insurance policies in terms of absorbing prospective and retrospective financial losses also comes into play.

If these successor liabilities are not identified, assessed, and mitigated, he writes, they can create latent issues for the acquirer. They also may create situations not accounted for in the purchase and sale agreement.

Understanding the self-insured/deductible obligations, accruals and collateral requirements of the target company is essential, he notes, adding that insureds with multiple captives after the acquisition, or that are looking to exit self-insurance, will find benefits in a loss portfolio transfer (LPT). The LPT can be used as a mechanism to close out the captive(s) or exit self-insurance for the retroactive liabilities.

When inheriting liabilities from global mergers and acquisitions, acquirers may want insurance to address the potential inadequacies of the target company’s local or admitted insurance policies issued, he writes. Are there certain international exclusions in the current program that need to be addressed? A certified master insurance policy (CMP) closes perceived gaps in coverages and/or financial limits, while at the same time maintaining the local insurance policies in force.

This may provide tax benefits, since locally paid premiums and insured losses are often tax deductible. A CMP also assures the efficient coordination of foreign insurance policies under one roof, with potential premium savings and additional cost-effectiveness from economies of scale, Gillston notes.

Questions M&A dealmakers may want to ask before finalizing a transaction include:

  • How is the M&A team positioned to address insurance items in the purchase and sale agreement?
  • Are there potential liabilities that will affect the overall purchase price or items that are delaying the transaction?
  • Do insurance partners understand the broader relationship?