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Mergers, Acquisitions, and Downsizing: The Risk Manager’s Role in Due Diligence
(Part 1 of 2)

There seems to be a precept widely taught at business schools across the country. I have labeled it the “MBS Theory: Management by Surprise.” Its basic point is this. When people are challenged, they will rise to the occasion. When they are challenged the most, they will outstrip your expectations. Therefore, wait until the last possible moment before announcing a change. The more people are surprised, the better the results.

Nowhere is this rule more strictly observed, more religiously upheld, than in mergers, acquisitions, or downsizing. Risk managers, quite often, are the last people to know. To a large extent, this is our own fault as we haven’t communicated to senior management the time and effort, not to mention the lead-time, needed to properly manage these risks.

Mergers, acquisitions, and downsizing are occurring so frequently today that the chances of your escaping at least one such event in your career is virtually impossible. So it’s something you should prepare for - and the best way to do that is to let management know about the role you will have to play. In one short meeting, you can show management how much is at stake for the company - and for them personally - and how much you do to protect it.

This article explains the risk manager’s role in due diligence when a merger, acquisition, or downsizing occurs. The article is divided into two parts: the risk manager’s role before the action and his or her role during and after the action.

Before the Action

Before a merger, acquisition, or downsizing, a risk manager should address issues such as the Worker Adjustment and Retraining Notification Act (WARN), workers compensation experience modifier, employee assistance program (EAP), severance options, claim record rights, directors and officers liability (D&O) and employment practices liability (EPL) coverages, work site security, and workers compensation coverage.

WARN

WARN is a federal law that deals with the issues of worker adjustment and retraining after an event such as a merger, acquisition or downsizing. It has very specific requirements for employers of more than 100 employees, including not only notification to the employees, but advance public notices such as newspaper notices. The penalties for violations include back-pay remedies to the employees, as well as substantial fines.

If you are an employer subject to WARN, you have no choice but to make the required notice.

Workers Compensation Experience Modifier

You'll need to review the effects of two types of claims on your organization’s workers compensation experience modifier: new claims and old claims. Obviously, a host of new claims can do damage. In one case, an organization’s modifier shot up to 5.09 after 490 claims were received within a month of a plant closing. The workers compensation cost increase completely obliterated the savings from the plant closing - and eventually put the company out of business. Old claims open before the announced merger or downsizing can also go bad. Careful planning for their handling is critical.

If you are selling an operation, it may be possible to structure the sale so that the experience of that operation is transferred to the new owner. To negotiate this as part of the sale, the experience will have to be translated into dollars on your side and on the buyer’s side.

If you are acquiring an operation, you must understand that the acquired experience comes with the purchase. Whatever the former owner had as payroll and losses, they are now your payroll and losses. And since you're now a larger entity, your credibility will increase, making larger losses more significant to your own newly combined rating.

The entire process may take a while. Explain to management that the information must be received from the rating bureau, and then someone has to verify it against audits and loss runs, which have to be obtained from insurers. Since the insurer is losing a client, they may not be cooperative about getting these documents out right away. Then, when you have all of this, you still have to add all of the experience up and run a new test modifier. At best, you're talking a month’s effort here, and senior management has no way to understand that unless you tell them beforehand.

Employee Assistance Programs

An employee assistance program (EAP) is a program that helps people cope with all sorts of problems, including family strife, substance abuse, death, poor credit and, yes, downsizing and mergers and acquisitions. If you have an EAP, alert the EAP counselor right before you tell your employees about any downsizing, so that the EAP staff can be prepared for calls. They can also offer you some helpful advice about the best way to announce a merger, how to deal with questions, and how to remind employees about EAP services.

If you don’t already have an EAP, you might consider setting one up in time for them to help you and your employees through a downsizing. Is an EAP a helpful workers compensation cost control method? Yes. When people stop bringing their problems to work, they are more likely to pay attention on the job. Do insurers know they are cost savers? Yes. For example, in Michigan, there are any number of quality insurers who will discount your premium up-front for having an EAP. In many cases, the discounts are large enough to pay for the programs. Several insurers here have recently installed EAPs in their own organization. They are also a great tool for supervisors and managers, as they keep them from having to get involved with the employee’s personal life.

Severance Benefits

Downsizing is all about severance, as some people are going to go. Showing a humane personnel practice can help mitigate damages in claims. Local juries may not be very tolerant of an employer who has left the community or who has dumped a lot of unemployed people on the local economy. Offering severance pay and other benefits is a genuine sign of good faith.

If severance pay mitigates future workers compensation costs, it can help pay for itself. It need not all be cash. Look at such things as advancing retirement benefits or extending health care benefits for a period, among other options.

Claim Record Rights

If you're closing down an operation, the bad news is that the experience usually stays with you. There are exceptions, but they are few. If you are selling an operation, determine who is going to retain the rights to workers compensation claim information - both open and closed claims. This should be determined by where the experience goes. If the buyer is getting the experience, the claims are the buyer’s; if the experience is being retained, the claims belong to you. This must be settled before the sale.

If you are buying an operation, recognize that you are buying the past experience. Your deal should make it clear that you have access rights to all payroll and claims information for the last four years (five in some states).

D&O and EPL

Workers compensation and employers liability coverages are only for bodily injury. Other coverages respond to claims for other than bodily injury. Alert your D&O and EPL insurers (if they're not the same), as these insurers may be able to offer you some good advice. Certainly, if your labor counsel has questions, they can be a resource. Put the insurers on notice that you want affirmative advice from them to help avoid claims. If you don’t have claims, great. If you do have claims, you want the insurers to be on your side. Getting to them early lets them know you're cooperating to the fullest.

Be careful here. Many D&O and EPL policies exclude claims arising out of any action where more than “X%” of a workforce has been affected. Take this into consideration when planning.

Legal Compliance

There are hundreds of legal pitfalls in any employment action. In addition to the WARN Act, legal counsel should check your compliance with such issues as the Family and Medical Leave Act (FMLA), the Americans with Disabilities Act (ADA), the Age Discrimination in Employment Act (ADEA), the Older Workers Protection Act (OWPA), and other state, federal, and local laws that may apply to downsizing your workforce. This information is necessary for checking coverage in these areas. Many D&O and EPL policies have specific exclusions for claims arising out of violations of these acts.

Site Security

A company announced that three hundred entry-level jobs were being transferred to a city four hundred miles away. The people in these clerical jobs weren’t “transferred,” just the jobs. The downsized employees secretly began “transferring” files. When the elevator cars started stopping six inches above floor level, the “transferred” files were discovered filling the bottom of the shaft!

Be aware that downsizing can create a set of workplace tensions you've never imagined. From secret sabotage to destruction of machinery in a fit of rage, from strikes to workplace violence that threatens the safety and security of employees - be ready for anything.

Assess the potential for problems candidly, but you should plan for the worst. If there is the slightest potential for problems, confidentially alert your local authorities. If they know ahead of time, they can be ready to respond. If you've got a crisis on your hands, you don’t want to have to explain the downsizing over the phone. Get it done ahead of time.

Do you need security personnel? Is security lighting adequate everywhere? Would installation of video monitors be advisable? You can’t be too careful here.

Alert Your Workers Compensation Insurer

Before you merge with another organization, do not make the assumption that the new operations fit the wishes of your workers compensation insurer or that they fit into your current programs. If you are a manufacturing firm acquiring a service firm that will now install and service your products, you may find that your workers compensation insurer has no appetite for anything other than a “four-walls” insured. If the new operations are out in the field, and the insurer doesn’t write field operations, you're going to need time to plan. You cannot assume that the acquired entity’s old insurer is going to want to continue insuring those exposures. A change in ownership is a major underwriting consideration in workers compensation.

For example, you're on a large deductible plan and you figure this new operation will just fit into that plan. Sorry, the new operation will have to be separately rated because the plan isn’t approved there. If you're on a retro, your plan factors are going to change with premium growth. Check these things out. Take nothing for granted.

If you're downsizing, your insurer should be involved as early as possible to set up special claims handling. If you're dropping enough premium, your plan factors in a retro, large deductible, or dividend program can be adversely affected and drive up your net rates in your surviving operations.

Everything you go through at renewal, you're going to go have to go through at the change. Failure to plan here is truly planning to fail.

Read Mergers, Acquisitions, and Downsizing: The Risk Manager's Role in Due Diligence (Part 2)

ABOUT THE AUTHOR

The Journal of Workers Compensation is a quarterly review of risk management and cost containment strategies published by Standard Publishing in Boston, Massachusetts. For more information, please visit our web site, www.standardpublishingcorp.com, or contact the editor at 800-682-5759, extension 222, or subscription services at extension 228.

riskVue | The webzine for risk management profesionals
July 2001