Dealing With A Safety Net

More M&A-insurance products are helping prepare risk-ridden merger candidates before the honeymoon.

“This is insurance as a business tool,” says Bryan Carey, CFO of Aearo Corp., an Indianapolis-based manufacturer of personal-protection equipment, such as respirators, goggles, and hard hats. Carey bought M&A risk insurance for Aearo’s 1995 management buyout from its former owner, Cabot Corp. “We make the type of equipment that is long- lived and, therefore, relatively uncertain as far as future liabilities,” he says. “Anyone who has used our respirators over the years and who later develops a respiratory illness might seek legal redress against us. This was a huge unknown.”

Most of the concerns were in the funding arena. “The management buyout was structured as an LBO [leveraged buyout], so we needed certainty in terms of cash flows” to obtain private equity funding, Carey notes. “We had to figure out what our future liability risks were and, once assessed, determine whether or not to transfer pieces of [the risks] to a third party. For us, this was the deal breaker.”

Aon, Aearo’s broker, “quantified our product risks using intense data collection and modeling to measure the economics of the various product liabilities,” says Carey. “What they discovered figured into the contractual negotiations between the buyer and the seller. Some product risks were deemed best for transfer, while others were handled contractually,” to be absorbed by the seller or the buyer, or shared.

“Bryan was deathly afraid that when 10 private equity firms descended upon him for due diligence, he wouldn’t be able to quantify the purchase price, because of the liabilities,” according to Aon’s Krauter. The LBO candidate hadn’t kept accurate records to allow a full review to take place, he says, so Aon performed a 20-year forensic study of Aearo’s claims. “We reconstructed how these would have run through a P&L if done properly, and then projected forward for the next five years how these would play out.”

Panic Over Pollution

Other companies seek insulation against the threat of environmental liabilities that may have originated decades ago. The United Co. routinely relies on insurance to help it transfer the environmental liabilities of companies it is either buying or shedding. The private, Bristol, Virginia-based company, with $351 million in 1998 revenues, is involved in a wide range of enterprises, including golf- course management, oil and gas, financial services, construction supply, and merchant banking. It recently sold a mining-supply division and bought a roofing-supply company, in both cases using insurance to transfer potential pollution exposures emanating from the businesses. “Our two owners, in their past lives, were insurance defense lawyers who know full well how future litigation can ruin an otherwise sound acquisition or divestiture,” says Thomas Griffin, The United’s vice president of risk management.

ECS Inc., an Exton, Pennsylvania, managing general underwriter, underwrote The United’s insurance, which was brokered by Atlanta-based insurer Charter Insurance & Consulting. “Before United could sell off its coal-mining operations, it needed a way to transfer any unknown, future claims that could arise from past pollution at these sites,” says Scott Britt, ECS vice president. “The buyer wanted to be assured it would not be liable for pollution caused by something The United did in the past.”

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