Using Captive Insurance in Support of Merger and Acquisition Activity

Whether the goal is to scale operations, expand footprints, build market share, or any of the dozens of potential strategic objectives, mergers and acquisitions (M&A) continue to play a key role in the growth strategy of businesses. 

The captive insurance concept may intersect with M&A strategies in any number of ways. Sometimes, the acquiring company may use an existing captive to help it absorb similar risks within the companies being added. In other instances, captives can serve as vehicles to simplify the risk management aspects of combining two entities. There are also cases in which existing captives in companies being targeted have the potential to complicate the transaction. 

Even companies with extensive experience in operating captives and who view the captive strategy as a tool for simplifying risk management may discover unexpected complications when one or more captives are part of deal negotiations and plans for integration. That's why it's critical for those companies to understand, assess, and determine the best way to incorporate existing or potential captives within the larger transaction. 

While the M&A process is normally built around major strategic objectives, there is always a certain amount of foundational planning that must be addressed as part of the transaction. Common examples involve employee benefits, which are likely to be different at the two companies, or substantial increases in property exposures. An acquisition that comes with a large amount of risk that has been incurred but not yet reported is another situation. Transactions intended to create vertical integration may introduce risks that are unfamiliar to the acquiring company, while horizontal integrations may increase the amount of risk the company is already covering for itself and past acquisitions. Captives may offer a simple way to address these issues quickly and efficiently. 

There may be sound reasons for a company to operate multiple captives, and in those cases, consolidation may not be necessary. Most of the time, though, the goal of the transaction is to find synergies through simplification of the business structure. A key element of due diligence with multiple captives is understanding the business drivers behind the situation and considering alternative strategies. Additionally, business leaders need to be in front of answering the post-closing question: Will this captive add to value creation and efficiencies after the dust settles?

Another role captives can play is helping an acquirer structure purchases from which they intend to spin off elements that don't fit with their priorities. For example, if the company being purchased has a division related to a legacy operation the purchaser isn't interested in maintaining, coverage for that operation could be concentrated into a captive that would be divested along with the division.

One issue that can arise within companies that are serial acquirers is when they end up having to manage multiple captives. In some cases, that may be intentional, such as in a situation where the company has made the acquisition as an investment that it intends to divest in the foreseeable future. If the intent is to essentially operate the entities side-by-side, leaving an existing captive in place may simplify the future sale.

More often, though, operating multiple captives is not a desirable longer-term outcome, especially when those captives use different structures and domiciles. There may be an opportunity to reduce the number of captives, simplify operations and compliance issues (and likely reduce the costs associated with management), and release capital back to the parent company.

A captive might also be used to provide representation and warranty or contingent liability coverage related to unknown transactional liabilities or known and uncertain operational liabilities. This may be useful if the target company is part of a large settlement or has been involved in legal action that has yet to be decided but may lead to losses. The captive insurer could be used to provide a layer of coverage, with larger amounts brought to the reinsurance market.

As with any strategic business decision, developing a complete understanding of risks is critical. Assessing risks and identifying potential liabilities is a critical part of due diligence. Savvy companies seek merger partners and acquisition targets with an understanding of how their strategy for managing risk has the potential to create or improve the value of what they buy.

The importance of maintaining a solid risk management framework underscores the value of working with captive and M&A risk consultants with deep experience in creating solutions for a broad range of business solutions. Veteran risk managers achieve their longevity by recognizing that they may not have all the knowledge they need to make decisions with confidence. Drawing upon the expertise of a first-rate captive and M&A team can head off problems and increase the potential for a successful transaction and integration.