If you’re considering buying a construction company, we’ve got more tips for you this week on the podcast. This episode focuses on insurance. Stephen and Wade discuss what you and your insurance agent need to know to analyze the risks before making the purchase.
Topics we cover in this episode include:
- What your insurance agent needs from the seller
- Insurance with stock sales vs. asset sales
- What happens with insurance rates when one company buys another
- The importance of the seller’s safety program
- Liability coverage for company vehicles
- Life insurance considerations for the company owner
- How much insurance is enough?
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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com
[00:00:00] Wade Carpenter: Welcome to the Contractor Success Forum. In this episode, we are talking about analyzing the risks from an insurance standpoint when purchasing a construction company. These are the best practices for new buyers that you really need to pay attention to. So if that’s of interest, stick around and let’s get into it.
If you’re new here, I’m Wade Carpenter with Carpenter Company CPAs, and here with me is my co host, Stephen Brown with McDaniel Whitley Bonding and Insurance.
Stephen, what are we talking about today?
[00:00:34] Stephen Brown: Well, we’re talking about a buyer of a new construction company, and we’re talking about the insurance side of things. What you need to know, what you need to prepare for when purchasing a company from an insurance standpoint.
Owning and operating a construction company is a risky business. So insurance is relatively expensive, but when you go in to buy a company, Wade, a lot of buyers they need the insurance and the exposures to be analyzed very quickly. So, they’re trying to minimize their risk. They want to know what risk is involved from an insurance standpoint, and some of our insurance carriers we represent have different departments we can work with that just are based on the fact that there’s speed involved and assets and merger acquisitions from an insurance standpoint.
And so that’s what I wanted to talk to a little, talk about a little bit today.
[00:01:31] Wade Carpenter: Okay, well, I know that you potentially are walking into a lot of different things. So, what in particular, is there a first one that they should consider number one?
[00:01:41] Stephen Brown:
What your insurance agent needs from the seller
[00:01:41] Stephen Brown: First thing is get your agent three things from the seller. That is an insurance certificate five year loss runs, currently valued loss runs. So, in other words, they’re within 30 days old, and they show the losses that you’ve had. And also the losses that may have reserves set up to pay claims on that, because a huge loss is going to make your insurance go up in the future. And if you’re buying a corporation, you are also buying those exposures.
And then the third thing from a workers comp standpoint, your experience mod. That goes with the company that you purchase. So, if it’s a high mod, you’re going to have to bear the brunt of that for three years. You’ve got that increased worker’s comp cost.
So if you’re not aware of these things and you buy a company, there could be big exposure to you and you could say, well, it doesn’t matter. I’m moving everything over to my agent. He knows how to keep the costs down. Well, he can’t keep the costs down when the company you’re purchasing have had a lot of claims.
That makes sense, doesn’t it?
[00:02:48] Wade Carpenter: Absolutely, and I think that’s something that, as we’ve been talking about buying and selling a company, I think a lot of people wouldn’t think to really look at that when they’re valuing a company and working through a deal. So I’m glad you brought that up because that obviously could be very expensive if somebody had a death or something on their worker’s comp, right?
[00:03:08] Stephen Brown: Right. And the most expensive part of job costing for insurance is your general liability and your workers comp insurance, because they’re based on an element of your payroll, whether it goes up or down. But the rate that you pay is based on historical claims that you’ve had.
And so any new insurance company’s looking at five years of loss runs or claims summary of that company on all lines of business. So the The lines of business that you want the loss runs for are your property, your liability your workers compensation, your equipment, your vehicle insurance, your builder’s risk, your umbrella. All these are coverages where you want to see if there’s been claims involved.
Also, you may have a company that’s selling to you, might be because of insurance purposes. So remember that you’re buying insurance from an insurance company, or you’re operating a captive, where you’re insuring the risk yourself.
Either way, that exposure goes with the corporation.
Insurance with stock sales vs. asset sales
[00:04:14] Wade Carpenter: We talked about a stock sale versus an asset sale. We do have asset sales, and I’ve had some asset sales where, you know, from a unemployment rate standpoint, they can sometimes carry those over or they may be forced onto those things.
And that’s a good thing if they have a good history on the unemployment. And I have seen that on asset sales. If you’re buying assets, does it flow through the same as a stock sale?
[00:04:41] Stephen Brown: I think it does, Wade, because, think of it as this, whether it’s asset or stock sale, how are you analyzing the risk? And I would say that a construction oriented insurance agent, that’s all we do. We look at risk. Our job is to minimize the risk. So when you have a risk, you can insure it, avoid it, separate yourself from it.
But if it’s an insured risk, you have contracts, you have policies, you have agreements, and also, the customer base have certain insurance requirements. They might require a huge umbrella. They may require a lot of endorsements. They might require design liability, pollution liability.
There’s so many different coverages involved, and this costs money. So when you’re buying a company, you can say, well, I can just look at the insurance costs and tell that. But you don’t know what contract that contractor may have obligated you to in the future that has high insurance limits.
[00:05:40] Wade Carpenter: Right.
[00:05:40] Stephen Brown: Does that make sense?
[00:05:41] Wade Carpenter: Absolutely.
What happens with insurance rates when one company buys another?
[00:05:42] Wade Carpenter: I’m thinking about one that I’m dealing with right now, HVAC mechanical, and so one company that actually is all over the southeast is buying another Atlanta based company. And they’ve already got a presence here in Georgia. Would that still carry over on those rates, or would they blend that together? How does that work?
[00:06:04] Stephen Brown: Well, from a general liability standpoint, if there’s enough premium involved, and there hadn’t been any losses, there’s no telling what what the buyer’s insurance agent can negotiate with a carrier as far as rates are concerned. And that’s the first order of business is to get that nailed down so you know what your costs are.
Remember in the construction industry, insurance is one of the few things that just can’t ever bank on in year two. The price is good for a year, you don’t know what it’s going to be next year. But again, that’s why I say look at the loss runs, loss summary. It tells you so much.
What if there’s a lot of auto claims? What’s going on? And that was leading me to the next subject.
Look into the company’s safety program
[00:06:47] Stephen Brown: You look at the losses, you look at the incident rates for lost time injuries, the OSHA log, and If the company you’re purchasing has a safety manager, you want to see whether they’re performing their job or not, and whether you want to keep them or not. If there’s not a safety manager, then you have to go and analyze how well they monitor safety.
Or if you implement your own safety program immediately, how that’s going to affect the operation that you’re purchasing. So, safety is the key issue. Also having the safety in place is the first thing that your insurance agent’s going to want to communicate to the buyer’s insurance company, is we’re buying this company, they’re going to want to know about the safety program. They’re going to want to make sure a safety plan’s in place. They’re going to want to make sure all these things are in place and they may want a loss control. You may want to ask your insurance agent, if you’re the buyer, to have your company come in and hurry up and loss control that exposure.
So, that’s something you can always work out with your agent.
Liability coverage for vehicles
[00:07:51] Wade Carpenter: Okay. Well, that was one thought I had with the the property and casualty side, because I know this is more on the personal and residential side, but you know, here in Georgia, auto rates are skyrocketing right now. I was told by one of the major carriers here that in the previous year, whichever, they were paying out 120 for every 100 they took in in premium, as well as right now they’re canceling a lot of people’s homeowner’s insurance if they can’t prove things like roofs have been placed in the last 15 years.
There’s a lot of talk about that, but, at some point, some of these risks are just not as, I guess, palatable by some of these insurance companies.
[00:08:30] Stephen Brown: What you were talking about, Wade, is we at McDaniel Whitley are an independent insurance agency, so we represent many, many different companies and brokers that we can go to. So, our job is to shop your insurance, and remember, the better information we have from you, the better rates we can get you, the better prices we can get you.
So, a lot of times in homeowners personal lines it’s just a completely different animal than commercial insurance. And so, leading into that, we were talking about autos. If you’re buying a commercial auto, you got to have higher limits.
Anytime there’s an accident and they find out that a company vehicle was involved, there’s an extra layer of liability to go after. That’s what the lawyers say. So they’re going to sue for higher limits. Generally, as a rule, the minimum that we get for our clients is a million dollar combined single limit auto liability, and then a minimum of a million dollar umbrella policy.
So the umbrella policies we talked about before picks up over the general liability and the workers comp and the auto limits. Well, it’s an umbrella of extra protection. The main thing driving umbrella prices is your vehicle insurance right now.
What are you paying for liability for the vehicles? They don’t care about the premium you’re paying for comp and collision coverage. They want to know what you’re paying for liability coverage. And let me tell you, on a pickup truck that in years past was 1,000 to 1,200 a year for average pickup truck liability coverage, we’re seeing that almost doubled six years later, so it’s serious.
And so you want to know , if you’re buying a lot of heavy trucks, you’re going to be paying a lot more money for insurance. It may be five to 8,000 a year insurance on those heavy vehicles. And if you’re buying a company that has a big service fleet of vehicles, vans, or pickup trucks, they’re going to run X amount a year.
And also the price depends on the age of the vehicle. So if you have a lot of older vehicles, the insurance is a little bit less. We’re talking about overall rule of thumb. So get a list of assets to your agent to say, these are the assets that this company has. So the agent can worry about the exposures you have from those assets.
I would say that’s the best advice I can get. A list of vehicles, and then the last thing, a list of all their drivers on the drivers list. So you can get your agent to run MVRs, Motor Vehicle Reports on all those drivers. You also want to look at the age of the drivers. Are there any drivers under the age of 21?
[00:11:12] Wade Carpenter: Right.
[00:11:13] Stephen Brown: It’s usually a family member or a family member of a real close senior employee in a construction company is what I’ve seen, and they’re hard to get at it.
Insurance, as a part of your job cost and as part of your overhead is always a good chunk of money. And it’s always a moving target of what the costs are involved. So if you do all these things and you have a good insurance agent you should be able to get through this just fine.
[00:11:40] Wade Carpenter: Depending on who’s buying the company, if this is like a brand new owner and they’ve never owned a business before, I could see that like an auto policy, if they knew what their F 150 costs on an individual policy versus a business policy, that can vary quite–
[00:11:59] Stephen Brown: Huge difference, Wade. Yeah.
Life insurance considerations for a company owner
[00:12:01] Wade Carpenter: Okay. And another angle I was sitting there thinking about, especially if they’re doing bonded work or something like that, is thinking about, if you’ve got employees and you’re trying to take care of your family, what happens if you die? And, maybe you thought about that from one standpoint as if you were an employee, but you’re now going to be an owner and you’re gonna be responsible for a lot more. Maybe you’ve taken a lot more debt to do this.
So can you talk about maybe some of the issues with life insurance and some of the considerations there?
[00:12:34] Stephen Brown: Yeah. A lot of companies will have key person life insurance policies on their key employees. And that’s something that at the company’s been paying the premiums on, that’s an asset of the company. And that’s something else that you need to look for. I’m glad you brought that up, Wade.
From an insurance standpoint also, what other life insurance policies might be in place that the company’s been paying for? And the owner may have a policy on themselves that the company owns. How are you going to work that out? It’s definitely got value to it.
[00:13:06] Wade Carpenter: Actually in the last week I was brought somebody, they wanted me to look over a company they were considering buying. And this company was doing $8 million, commercial construction. The owner died and they had a $250,000 policy. And they put that money into the company, but $250,000 did not support it.
The wife was trying to take it over and it was rapidly declining. That’s not something a lot of people want to think about. We have that conversation all the time, but you know, $250,000 in this case was a drop in the bucket. And unfortunately we’re seeing this company sink.
[00:13:45] Stephen Brown: Well, that’s a good point, Wade. If you’re buying a company and the owner of that company is going to continue to work and operate that business for X number of years, then it might be a good idea to get a key person policy on him that you own in case something happens to him during that time period that they’re supposed to be there.
A term policy might be just the answer, which is just simply buying coverage with no cash value. Problem is, is most of the companies will give you a 10 year policy. And you would just keep it and pay the premium or cancel it after that obligation is over.
How much insurance is enough insurance?
[00:14:24] Wade Carpenter: Well, going back to the situation I just had, and again, it’s, I don’t know all the situation, but in that case, I had no idea if these people had really grown it up to that point. But how would you evaluate how much is enough insurance?
Is that, I know that’s probably a loaded question.
[00:14:41] Stephen Brown: No, that’s a real good question.
In federal contracting work, the insurance requirements that the government require are pretty low. If that’s all you carry, then you could be opening up to a lot of exposures.
Most general liability policies are written on a occurrence basis, which means that they pay the claim whenever it occurs. So you have all these exposures in the past that you may not know about that may result in a claim. But again, that’s why you buy insurance.
[00:15:11] Wade Carpenter: I think it’s probably something that most people hate even talking about or bringing up the conversation, but I think it is something, especially when you’re buying a company, that you should think about. And it may not be something you’re worried about right that moment, but you really probably should be.
[00:15:26] Stephen Brown: Okay.
[00:15:27] Wade Carpenter: Any other wrap up thoughts on this?
[00:15:29] Stephen Brown: No, again I believe, and I’ll say this again, your financial board of directors as a construction company are your, your lawyer, your banker, your CPA, your insurance agent, and your bonding agent. We’ve preached that over the years on the Contractor Success Forum.
Always get the best person you can get. Get someone that knows construction insurance, construction bonding, construction accounting, which you do not learn in school. And a banker that understands the construction business. And a lawyer that works specifically in the construction realm. It’s the only way to do business.
I would close on that.
[00:16:10] Wade Carpenter: Okay, well you actually went where I was going to go with that next, myself, because, if you’ve been using one of these national brand companies for your personal lines, there’s a huge difference in having somebody that knows what they’re doing on the commercial side and especially the construction side.
So that’s why having somebody like Stephen in your corner is huge for your success and not just buying, but long term growth and success of the business. So, okay.
[00:16:40] Stephen Brown: Thanks.
[00:16:40] Wade Carpenter: We’ll end on that. Thank you all for listening to the Contractor Success Forum. If you’re listening on a podcast somewhere, check out the show notes at ContractorSuccessForum.com, or at Carpenter CPA’s YouTube channel.
Consider subscribing to the channel and follow us each week as we post a new episode. We will look forward to seeing you on the next show. Thanks.