Carving Out Value: Why Insurance Due Diligence is Non-Negotiable in the Rise of PE Carve-Outs – Q3/25

The Allure of the Carve-Out

The recent slowdown in broad dealmaking has not dulled private equity’s appetite for value creation. Instead, it has sharpened its focus on targeted opportunities. Large conglomerates, often seeking to streamline operations and reduce debt, are willing sellers of non-core assets. For a PE firm, these carve-outs represent a chance to:

• Acquire a “Pure-Play” Business: They gain a focused entity with a clear market position, free from the bureaucracy of a large parent.
• Implement Aggressive Value-Creation Levers: With dedicated management and capital, PE owners can drive operational improvements, accelerate growth, and optimize the cost structure.
• Build a Platform for Add-Ons: The carved-out business can serve as a platform to roll up other smaller companies in the industry, creating a market leader.

Despite the attractive upside, carving out a business is far more complex than acquiring a standalone company. The process involves surgically separating shared services, IT systems, supply chains, and employees from the seller—a process fraught with operational, financial, and legal risk.

The Crucial Role of Insurance Due Diligence

In a traditional acquisition, insurance due diligence focuses on reviewing the target’s existing policies to identify gaps, exposures, and historical claims. In a carve-out, the exercise is fundamentally different and more critical. The goal is not just to assess the past but to build a future insurance program from the ground up.

Here’s how insurance due diligence still applies—and is, in fact, paramount—in the carve-out process:

1. Identifying Historical Exposures and “Tail” Liability

   When a business is carved out, who is responsible for incidents that occurred while it was part of the seller but are reported after the deal closes? This is known as “tail” liability. Diligence must scrutinize:

   • Claims-Made Policies: For policies like Directors & Officers (D&O), Professional Liability, and Employment Practices Liability (EPL), a claim must be reported during the policy period. The buyer needs to secure a “tail” policy that extends the reporting period for pre-closing acts indefinitely. Negotiating who pays for this (buyer or seller) is a key deal term.
   • Occurrence-Based Policies: For general liability or property policies, the policy in effect at the time of the incident responds, regardless of when the claim is filed. The diligence team must secure claims histories and confirm that the seller will maintain and respond under its old policies for pre-closing occurrences.

2. Unraveling Shared Insurance Programs

   The division likely did not have its own insurance program; it was covered under the seller’s corporate master policies. Due diligence must:

   • Determine Current Coverage: Understand exactly how the target was protected under the seller’s programs. What were the limits? What deductibles applied?
   • Assess Gaps Upon Separation: The moment the deal closes, that coverage ceases for the carved-out entity. The diligence process must identify every type of risk (cyber, fiduciary, product liability, etc.) and blueprint a new, standalone program to be active on Day One. Failure to do so leaves the new portfolio company catastrophically exposed from its first second of independence.

3. Evaluating Unique Operational Risks

   The act of separation itself creates new risks. Due diligence should assess:

   • IT and Cyber Security: As the business is disconnected from the seller’s IT infrastructure, what vulnerabilities are introduced? A new cyber liability policy must be a top priority.
   • Employee Transitions: The transfer of employees can lead to disputes over benefits, wrongful termination claims, or errors in payroll processing. This heightens the need for a robust EPLI policy.
   • Contractual Obligations: Many customer and vendor contracts may have insurance requirements (e.g., requiring a certain limit of liability or being named as an additional insured). The new company must have a program that meets these obligations to avoid breaching contracts.

4. Accurately Budgeting for Going-Forward Costs

   A clear financial model is essential for PE success. A standalone insurance program for a newly carved-out entity will almost certainly look different—and often cost more—than its allocated portion of a corporate master policy. Advanced due diligence allows the acquirer to:

   • Model Premium Costs Accurately: Avoid nasty surprises post-closing by getting quotes for new policies during the diligence phase.
   • Factor in Deductibles and Retentions: Understand the potential cash flow impact of a high-deductible program.
   • Negotiate from a Position of Knowledge: Armed with a detailed risk assessment, the buyer can better negotiate representations and warranties insurance (RWI) or adjust the purchase price to account for newly identified risks or the cost of tail policies.