Editor: Would each of you tell us something about your professional experience?
Potts: I began my legal career as a corporate and regulatory generalist, but on-site assignments with insurance company clients directed me towards the insurance industry. Today I handle a variety of insurance industry transactions, including the acquisition and disposition of insurance companies and insurance producers and the development of complex insurance, reinsurance and self-insurance programs.
Gillston: For 13 years I have held various insurance and risk management underwriting positions and for the past eight years I've been with ACE. ACE has been involved in private equity and strategic mergers and acquisitions for many years, and last year we formalized our efforts by establishing a specialized practice to provide comprehensive risk management solutions and insurance coverage to buyers and sellers of organizations navigating the merger and acquisition transaction process. I lead this practice.
Editor: What are the kinds of insurance-related risks and issues that commonly arise in M&A transactions?
Potts: There are risks associated with known but unquantified target company liabilities. These might include unsatisfied environmental cleanup or toxic tort liabilities or a pending litigation claim where liability or the magnitude of damages is difficult to ascertain. There are also risks associated with unknown liabilities arising out of claims that have not been asserted and the potential for which has not been identified.
In addition, there are risks related to the target's insurance coverage, particularly where the buyer is expecting to receive the benefit of that coverage. The buyer must question - among other things - whether the coverage is with financially sound insurers, whether holes exist in the coverage due to limits on the scope of the insurance, applicable exclusions or exhaustion of limits and whether there are any grounds for a carrier to rescind coverage or deny a claim for late notice. Potential retroactive premium adjustments and prospective obligations to provide an insurer security for self-insured exposures may also be a risk. The buyer should determine whether any of these issues are present.
Finally, the buyer should evaluate post-acquisition insurance costs because the target's loss experience and the risks associated with its business could significantly impact the buyer's future insurance costs.
Editor: What roles can insurers play in complex M&A deals?
Gillston: Whether a deal is a private-equity transaction or a strategic buyer is involved, these deals are always changing and are typically conducted within a compressed timeframe. As a result, there is heightened pressure for organizations to undertake due diligence and to consult with a specialized legal advisor and/or insurance broker to review their insurance needs.
A carrier that has specialized expertise in this process can assist an organization through the due-diligence phase by providing access to claims administration and engineering resources, consulting on which options to consider for the mitigation of insurance concerns and assisting in the risk-transfer phase by addressing both retrospective and prospective insurance liabilities. A carrier can facilitate the deal by providing primary and excess casualty insurance liabilities solutions prior to the transaction closing. Since the buyer and seller may become adverse in their relationship, making a clean break with respect to their liabilities is essential. One option would be a Loss Portfolio Transfer that addresses the primary liabilities within a deductible, captive and/or self-insured program. This can help reduce the overall prospective collateral costs, address allocation and indemnity issues and provide protection from adverse loss development. The buyer may want to replicate the excess liability insurance tower to provide protection and stand-alone excess capacity for the new company, as the seller may not allow access to the current excess limits or the prior carrier may be insolvent or have a poor financial rating.
Editor: What should a buyer typically look at when reviewing the target's historic insurance coverage?
Potts: Addressing this complex question should be coordinated with other due-diligence efforts concerning pending litigation and exposures to environmental, products, toxic tort, workplace safety and other potential liabilities.
The buyer - especially in a stock transaction or an asset transaction in which some or all of the rights to insurance coverage will be transferred to the buyer - should ask for copies of all insurance policies covering the target's business or property. If the target has prior exposure to liabilities including asbestos, lead paint and environmental issues arising out of conduct or property ownership, the buyer should know all it can about the insurance covering those periods.
The buyer should determine the type of coverage - claims-made or occurrence - and any significant exclusions. The buyer should determine the limits of coverage available under the target's insurance and whether defense costs erode limits, whether any of the policies have been released by the insured as part of a buy-back or claim settlement and the current financial condition of the target's insurers.
If the policies cover multiple insureds, the buyer may need to resolve their respective rights to insurance coverage. It is better to do this up-front rather than wait until a disagreement arises or coverage is exhausted.
The buyer should know if the target has had any disputes with its insurers along with the circumstances. Insurance applications should also be reviewed to assess accuracy of the insured's disclosures.
The buyer should know of all deductible, co-insurance, premium and loss funding obligations and whether obligations to make payments have been timely satisfied. Often these obligations are contained in agreements ancillary to actual insurance policies. If a policy provides for policyholder dividends, are the dividends subject to retroactive adjustment? I am aware of an insurer that, as a business practice, credited anticipated dividends toward its insureds' premium obligations. Many of its insureds were not aware that their premiums had been reduced due to these credits. When the insurer's board later failed to declare a dividend as a result of financial difficulties, the carrier billed its insureds for the amount of the prior anticipated dividend credit, to their dismay.
Editor: Is there anything else buyers should be asking?
Potts: If the target is self-insured, are there any state deposit requirements, and is the target subject to guaranty fund or other assessments? How are claims being administered, and who is responsible for the costs? Has the target paid all surplus lines and self-procurement taxes applicable to its insurance? The buyer may also wish to review loss control/safety manuals. If a carrier is insolvent or in weak financial conditions, is guaranty fund coverage available for the policies it issued?
After completing a full review, the buyer should evaluate whether remaining insurance coverage is adequate for historical risks associated with the operation of the target's business.
Editor: Are there other legal issues beyond due diligence?
Potts: Certainly. Frequently, insurance coverage is addressed in the purchase and sale agreement in a cursory manner. A representation might say:
Schedule X lists all insurance policies that currently insure Company's business or any of its assets against loss, including each insurer's name, type of coverage, deductible, coverage limit, expiration date and premium. Each insurance policy listed in Schedule X is in full force and effect, all premiums have been paid through the closing date, and no notice of cancellation or termination has been received with respect to any such policy. True and correct copies of all insurance policies have been provided to Buyer.
This type of standard representation fails to address a number of factual issues. It does not address loss history, exhaustion of limits, the financial condition of insurers, the details of deductibles and retros, disputes over coverage, timeliness of claim notices, notices of non-renewal, notices of premium increases and self-insurance reserving. It also does not identify policies where the target may be a beneficiary, such as a life insurance policy or those on which it is a loss payee.
Editor: What are some of the legacy liability insurance issues and risks that an insurer can help address?
Gillston: A carrier can provide the buyer or seller - whichever entity retains historical liabilities - with a dedicated products-completed operations policy in the name of the responsible entity. This policy should provide a dedicated limit of liability for all products manufactured by the target prior to the acquisition date, with a multi-year policy term and listing the buyer as the first named insured. This policy allows the acquiring company to:
Isolate liabilities from the acquired company and not disrupt its existing go-forward insurance programs;
Identify insurance expense related to the acquisition and factor costs into the purchase and sale agreement;
Resolve any concern relating to adequacy or availability of the acquired company's existing insurance; and
Have confidence that potential acquired liabilities will not adversely impact financial results.
Editor: What types of insurance products are available to address risks arising in M&A transactions?
Potts: There are several categories of products. One is loss-mitigation coverage - also known as Loss Portfolio Transfer. This type of product is normally tied to a known, but unquantified, existing or potential liability. Examples include pending litigation and environmental cleanup obligations where the cost of the cleanup is not yet known and the buyer wants to obtain a level of certainty about its exposure. Another category is representations and warranties insurance. This coverage indemnifies the buyer when certain of the seller's representations and warranties turn out to be inaccurate. A third category is tax indemnity coverage, which addresses risks associated with uncertainty concerning the tax treatment of the transaction.
Editor: What are some of the M&A-related insurance products you frequently underwrite?
Gillston: We have issued products that address:
Pre-closing liabilities, such as Environmental Remediation Cost Caps;
Difference-in-conditions or difference-in-limits coverage to assist the transaction until the insured's property values are assessed; and
Runoff or tail D&O coverage for runoff exposure, such as a tail policy that is structured to cover acts not covered under the existing D&O policy or any go-forward/prospective D&O policy.