Risk Management and Pre-Acquisition Due Diligence
Banham, Russ, Risk Management
In 1990, Thyssen Carbometal Co., the New York-based subsidiary of Germany's giant steel manufacturer, Thyssen Group, was shopping for a U.S. construction company. Thyssen had its eye on a particular company that seemed to fit its acquisition priorities of synergy and growth. However, Thyssen had some reservations about a few workers' compensation claims filed against the company that were still unresolved. Added up, the claims totaled in the hundreds of millions of dollars. Would Thyssen be buying future financial headaches along with buying the company? Or would the claims be reduced by U.S. courts and [all within the company's insurance coverage?
"The realization [of the potential cost] almost made us change our minds about the acquisition," says Wilfried Roggenbau, Thyssen Carbometal senior vice president. Rather than throw in the towel, Thyssen decided instead to add one more professional to its pre-acquisition due diligence team: insurance broker Johnson & Higgins.
Johnson & Higgins scrutinized the validity of the workers' compensation claims and pored over all other related insurance matters. Shortly thereafter, the broker reported back to its client the news it had hoped to hear. The claims were, for the most part, frivolous and, if reduced to their actual value, would be covered by the target company's insurance. Thyssen went ahead and acquired the company.
The fairy-tale ending to this story, unfortunately, is not always the norm. Even the best-laid acquisition plans go awry. One broker estimated that 10 percent of all companies are significantly unde-rinsured in one of four areas: products liability, environmental impairment liability, current and postretirement health care liabilities and workers' compensation. What may appear to be a neatly wrapped corporate package becomes, upon buying, a Pandora's box of financial hardship. "insurance is an asset you are acquiring when you buy a company," says Kenneth S. Zignorski, a vice president at Johnson & Higgins. "If the insurance policies are with a bankrupt insurer, or are rife with coverage exclusions, they could be worthless assets," he adds.
Examples of insurance-related acquisition horror stories abound. Johnson & Higgins, for example, once found a situation where a company had insurance policies with two bankrupt insurers, H.S. Weavers Underwriting Agencies and Mission Insurance Co. The revelation of the potential losses that could arise from the lack of insurance stunned the broker's client and, subsequently, played an important role in the ongoing merger negotiations.
Sometimes the discovery of hidden liabilities or underinsurance can kill a deal altogether. Toronto-based CCL Industries, a manufacturer of household products, had its insurance broker evaluate the insurance aspects of a potential acquisition in the United States. CCL's director of corporate real estate and risk management, Maurice J. Smith, says the broker's findings played a "definitive role" in the company's decision to back out (declining, however, to name the company or elaborate any further).
The unearthing of hidden liabilities and underinsurance, when it doesn't terminate acquisition plans, frequently results in reducing the acquisition price. R. Patrick Thomas, senior vice president and director of the Global Business Development Group for New York based broker Alexander & Alexander Inc.,
which handles 40 to 50 preacquisition due diligence examinations a year, recalls finding "significant underfunding of pension liabilities" in a U.S. company targeted for a $1 billion purchase by a German buyer. The revelation "eventually allowed the German company to reduce the purchase price by some $70 million," he says.
Another time, on behalf of a foreign client, Alexander & Alexander researched a third-party liability policy written for a U.S. company in 1973. Its examination revealed that one of the several insurers involved in the multi-layered policy was insolvent, resulting in a $5 million hole in the coverage. …