Insurance Due Diligence is not an often-used tool in the M&A context. It is mainly utilized in infrastructure and more significant private equity transactions. However, any company can get benefits from it in certain situations, such as carve-outs. When a business or company ceases to be protected by the selling entity’s insurance policies, the buyer needs to understand how insurance policies respond in transition and what insurance protection is available for the target entity or business after the deal closes.

Legal due diligence workstream often reviews the insurance policies since they are contracts and thus generally in the scope of legal DD. However, legal due diligence review usually does not comment on the cost or availability of coverage on the insurance markets and other relevant factors in connection with the target’s insurance protection. For example, the target company’s loss history can potentially be important in an M&A context. Any buyer should understand the target company’s loss history and its potential implications on the go-forward insurance premiums for the target company. 

A particular use case for due diligence in Finland is statutory workers’ compensation insurance. Even though it is a mandatory insurance class in Finland, the premium can be highly variable. Only an appropriate due diligence review can uncover the true go-forward cost implications of this insurance policy.

What is Insurance Due Diligence?

In the M&A context, insurance due diligence is a specific investigation into the risk and insurance matters of the target company or business. This investigation goes beyond just reviewing the policy documents; the target risk profile, insurance program appropriateness, current and pro forma costs are considered in comparison to similarly situated companies. There are several different types of due diligence reviews. From “red flag” to a thorough risk and insurance due diligence investigation, it is essential to understand the practical applications of different types of reviews. Sometimes a red flag insurance report will reveal matters that can be investigated more thoroughly at a later phase.

The buyer usually commissions due diligence, but also the seller can commission an assistance report or even vendor due diligence. Vendor DD can benefit the seller in auctions, where the target entity is expected to garner lots of interest from prospective buyers. The buyer can do their top-up due diligence to complement the vendor’s due diligence report.

Why Conduct Insurance Due Diligence?

Legal due diligence, financial and tax due diligence are staples of any M&A transaction. Many other workstreams are often added, such as human resources due diligence, business, and technical due diligence, depending on the transaction particulars. Insurance matters are sometimes considered to “fix themselves.” However, issues concerning insurance often arise during the process or even close to the transaction signing or completion. In those circumstances, it may be difficult to remedy the problems on time. Commissioning an appropriate insurance workstream as part of due diligence investigation can help uncover the complicated problems sufficiently early to mitigate the implications. The insurance workstream can also reveal significant capital expenditure requirements for the target post-completion. Understanding such required capital expenditure prior to bidding could be critical for the buyer’s financial model.

Particularly in carve-out situations, insurance review helps estimate the pro-forma cost of the target’s insurance program post-completion, which also impacts the financial model. It may transpire that the future insurance cost is much higher than initially anticipated. In extreme cases, critical insurance protection is not available at all for the carved-out target business. This may indeed be the case in some specialized industries and can cause the buyer to reconsider the benefits and risks of the contemplated transaction.

1. Understanding the Target’s Business and Risk Profile

In all M&A transactions, the prospective buyers spend a lot of time and effort to understand the targets business and the potential for future growth. But any buyer – whether financial or strategic – also needs to understand the additional risk acquired with the target company if it is not appropriately covered by insurance. The buyer should understand the risk profile, what type of future claims can be expected for the prospective target company, and the insurance availability for these types of claims.

2. Determining the Insurance Loss History for the Target Company

It is essential to determine the number and amount of losses the company had suffered in the past and understand which types of incidents or activities were the reasons for those losses. From there, it can be understood how that could affect future insurance pricing for the target company.

3. Understanding the Existing Insurance Protection for the Target Company (and How the Contemplated Transaction will Affect it?)

This part of the due diligence review includes reviewing all the insurance products and services currently purchased by the target company and the potential insurances that could be acquired to protect the buyer’s investment in the target company appropriately. Such insurances are for example property damage and business interruption insurance, third party liability insurance (or general liability or public liability), product liability insurance and recall insurance, professional indemnity or errors and omissions insurance, environmental impairment liability insurance (in Finland the statutory environmental liability insurance does not protect the policyholder) as well as occupational and health insurances, including statutory workers compensation insurance.

Insurance policies don’t necessarily stay in force upon the completion of the proposed transaction. Due diligence investigation will reveal the change of control clauses in the insurance contracts and help the buyer to understand both the implications and the actions that need to be taken to ensure the target is appropriately protected post-completion. This could mean that an appropriate run-off policy needs to be purchased, or the problem is otherwise addressed. 

Generally, it is crucial to understand how the insurance policies are renewed based on the market and regulatory issues affecting the target company. There is a significant difference between ongoing and fixed-term insurance policies.

4. Ensuring That Insurance Coverage is in Place to Meet Regulatory Requirements

Regulatory requirements for insurance vary in each country. Finland, like most countries, has specific mandatory insurances and other statutory requirements that pertain to insurance. There are several compulsory insurances in Finland, which apply to all companies and entities employing people in Finland. These include statutory workers’ compensation and group life insurance as well as employment pension insurance. Failure to comply with these statutory rules may lead to sanctions and additional payments for the locally operational entity. Also, depending on the industry, other mandatory insurances may need to be considered. Companies that are required to take out an environmental license or which otherwise operate in activities considered to be environmentally hazardous are required to purchase statutory environmental liability insurance. Companies and individuals in the healthcare sector are required to purchase patient insurance. Patient insurance operates as a no-fault type medical malpractice insurance in Finland.

Any prospective buyer of a Finnish entity should carefully consider the regulatory requirements and ensure that the target company:

• 1. will be appropriately insured post-completion fulfilling all statutory and regulatory insurance requirements in Finland, 
  2. has complied with the regulatory requirements or that any potential liability arising out of a possible historical failure of the same is appropriately dealt with in the SPA negotiations between parties.

The SPA warranties, or if needed, indemnities, should reflect the situation. A thorough insurance due diligence will uncover these issues and suggest corrective action in both abovementioned situations.

5. In Project Finance, the Lenders, Sponsors, and Investors Require Thorough Understanding of the Insurance Coverage

Apart from M&A transactions, insurance due diligence also has other use cases. In project finance,  non-recourse financing creates the need for a proper understanding of the insurance matters in connection with the project. A typical example often called lender insurance advisory, or LIA is due diligence for renewable energy projects and infrastructure projects. Due diligence helps the key parties understand risk allocation of the project, the different requirements between the construction and operations phase of the project, understanding the risk treatment in the project and what type of insurance coverage is available to provide insurance protection, what are the insurance cost estimates and which assumptions are behind the estimated costs.  

Why is it Important to Conduct Insurance Due Diligence in Finland?

 In Finland, certain overdue insurance payments may be levied by the insurance company without a court order. Whilst this practice has become less common in recent years, a careful buyer will investigate before the transaction whether and to what extent it is applicable for the target company. Another insurance matter to understand is statutory workers’ compensation, a mandatory insurance line in Finland. For all but the smallest companies, workers’ compensation insurance premium is not based on a fixed tariff but instead can be steeply variable between insurance periods. The insurance provides cover with no deductible and no upper limit, but there can be very high self-insured retention within such insurance cover, which is invisible on the surface. If not appropriately considered in the financial model, this can be a very undesirable surprise for the buyer.  It is of particular importance in Finland to understand how this insurance functions and the implications of loss history for the statutory workers’ compensation insurance in Finland.

Conclusion

Due diligence is the process of using good judgment to identify and assess a target entity’s strengths and weaknesses so that a potential investor/buyer can find out the target company’s actual worth and secure a good investment opportunity. The insurance workstream should be a part of a thorough due diligence process. 

When considering insurance due diligence, a good rule of thumb would be a variation of the popular idiom, to read: “when in doubt, DON’T leave it out.” Insurance-related issues and problems do not go away by overlooking them. Instead, consider the following aspects:  

Any due diligence process should be broad enough to assess and characterize the target company’s strengths, weaknesses, and opportunities. It must be thoroughly transparent. The due diligence should accomplish to evaluate the targeted company, both short-term and long-term. Insurance due diligence can be a helpful tool in complementing the other workstreams of any M&A transaction or project financing situation. A professional insurance advisor will provide insurance review as a thorough but independent process, working within the requirements of the deal timeline and providing timely alerts to the buyer even during the review process when needed. A knowledgeable local insurance advisor will also offer local legal and insurance market expertise to provide comfort to the client operating in a new jurisdiction.

To successfully conduct insurance due diligence in Finland, consider the following:

1. 1. Appoint a locally knowledgeable insurance advisor, who knows the local insurance market practice, legal and regulatory environment,
   2. Mandate the advisor sufficiently early to ensure that there is time to address the potential findings in SPA negotiations and financial model,
   3. Agree on the reporting and information acquisition particulars, especially the Q&A process details, and let your insurance advisor take care of the rest.