Planning an Acquisition? Hospitality Companies Shouldn’t Overlook Insurance Risks in Their M&A Due Diligence

The hospitality sector continues to undergo significant consolidation as restaurant  groups expand their offerings and hotel and resort companies merge or make strategic  acquisitions around the world. While these transactions often strengthen both buyers and  sellers, successful outcomes require thorough evaluation of the potential partner firm.

 

Beyond the standard due diligence practices conducted by parties in a business  combination, a target company’s risk management and insurance program should be  evaluated carefully for potential issues that could affect the terms of a deal or, in some  cases, be deal breakers.

 

With respect to property insurance, acquiring companies might start by reviewing the  target’s real estate portfolio. First, they need to determine when the latest property  valuations were conducted and if property insurance limits cover the replacement values  of any buildings, furnishings, artwork and equipment. This may help identify any  underinsured properties.

 

Next, given the large number of severe weather incidents in the U.S. and elsewhere in  recent years, they should look for locations that may be in areas prone to hurricanes,  flooding, tornadoes, wildfires and other natural hazards. Similarly, they should consider  potential earthquake and tsunami exposures in light of the fact that in recent years the  U.S. Geological Survey updated its seismic map of U.S. earthquake zones, expanding the  areas throughout the U.S. that may be vulnerable to these exposures.

 

In addition to checking for appropriate building retrofits and reinforcement work,  executives at businesses evaluating a potential acquisition should check to make sure  appropriate property insurance coverage is in place and compare pricing and coverage  trends over the past five years.

 

Casualty risks and related insurance coverages also require careful review. Some  companies may have filed insurance claims for current or pending litigation for  employment practices, worker or customer injuries or illnesses, vehicular accidents,  liquor liability and other substantial exposures. Insurance limits should be assessed to  determine whether they are adequate to cover any current claims and future incidents.

 

Equally important, executives should also examine loss runs going back five years for  workers’ compensation and other exposures to spot any alarming trends that not only  could result in higher insurance premiums, but may also cause enduring reputational  damage. In assessing exposures related to companies with high-deductible plans,  self-insurance and captives, they should watch for inadequately funded, unfunded or  uncollateralized “tail” exposures, including general liability, workers’ compensation, auto  liability, and directors-and-officers’ (D&O) insurance runoff liabilities. If overlooked, buyers  may be left with substantial — and potentially material — exposures in the future.

 

If a review uncovers any uninsured or significantly under-insured exposures, the buyer  may require the seller to establish an escrow or the terms of the transaction may have to  be adjusted.

 

By including a thorough review of property-related perils, operational risks and insurance  as part of an acquiring firm’s due diligence of a seller, it may avoid costly surprises after  the merger is consummated.

 

For assistance in evaluating insurance and related risk issues in hospitality M&A  transactions, contact Restaurant Programs of America at (866) 324-1099.