What is M&A Insurance, and Do You Need It?

M &A transactions demand bespoke insurance solutions wherein risk is managed and mitigated through the strategic interplay of various products and strong broker/underwriter relationships.

Insurance due diligence, which is the process wherein under-insured or un-insured risks are identified and resolved, has become a critical component of the transaction due diligence process. Driven by factors such as the proliferation of M&A activity over the past few years, escalating deal values, and the growth of technology-focused or technology-dependent companies, the focus on sophisticated transactional insurance products continues to intensify. Interestingly, sound insurance solutions rarely rely on a single product but instead involve the interplay of various products perfectly formulated to fit the parties’ needs. And, just as no two transactions are identical, neither are two insurance solutions. Whether you’re a buyer or seller, your ideal solution is likely to be a carefully constructed combination of different products crafted by your broker and underwriter.

The Interplay Between Representations and Warranties Insurance and Your Commercial Insurance Program

Different insurance products produce different results and interact with each other to reach different risk management solutions. This complex interplay demands the expertise of a broker who has experience in M&A transactions. Take representations and warranties insurance (RWI), for example. While powerful, RWI – which protects against breaches of representations and warranties made by the seller in a purchase agreement and is generally meant to smooth the negotiation of indemnities between buyer and seller – is not meant to fill gaps in a company’s underlying insurance program. In the event a target company does not have adequate underlying insurance, RWI carriers may charge an additional premium to cover the risk or may be forced to exclude the risk from their policy altogether, which may result in more involved indemnity discussions between buyer and seller.

Further, in certain instances such as businesses with a heavy environmental footprint or heightened cyber security or privacy risk, RWI will only provide coverage to the extent that underlying coverage exists and will be subject to the terms and conditions of the underlying policy including any exclusions or limitations in coverage. In short, if there’s a problem with the underlying coverage, there will likely be a gap in coverage under the RWI policy, which may in turn impact the indemnities available to the buyer through the purchase agreement with the seller.

The Benefits of an Experienced Broker and Underwriter

Insurers in the M&A market will have differing risk appetites and it is important to work with a broker who will match the risk profile of the business with the risk appetite of the insurer. In certain industries, insurers may be more prescriptive with the types of underlying insurance that they expect a target to carry and in other circumstances may be amenable to a broker advocating as to what would be commercially reasonable for a target based upon a thorough review of the target’s insurance program. As an example, a target in the technology industry will be expected to have cyber insurance, and therefore could expect an exclusion in an RWI policy if the target does not have such cyber coverage. That said, in some situations, a broker could convince an underwriter to provide RWI without an underlying cyber policy. For instance if the target is a small manufacturing company, a broker could assert that while cyber insurance may be nice to have it is certainly not a material gap in coverage. The point is, regardless of the circumstances, it helps when the broker and underwriter enjoy a strong relationship built on trust. Both professionals respect the other’s high level of expertise as well as proven track record.

BFL and Liberty GTS draw on their established relationship to craft complex, bespoke insurance solutions that will protect your business during a merger or acquisition and afterward. We recommend that buyers and sellers contact BFL early in the transaction process to ensure that policies can be purchased prior to closing to eliminate any gaps in coverage.

Most Common Insurance Issues Buyer/Seller may face when preparing for a transaction:

Cyber Insurance – Not surprisingly, cyber insurance is becoming table stakes in M&A transactions and is required by RWI insurers for many industries to cover IT and cyber representations and warranties.

Environmental Insurance – Manufacturing or any business with an industrial footprint should consider stand-alone environmental insurance post-closing as a policy that can be placed for 1-10 years and cover changes in government regulations. This market also has greater flexibility than the RWI market to cover Recognized Environmental Conditions (RECs).

Carve-outs – Typically, a carve-out involves the sale of a specific subsidiary, division, unit or line of business where the insurance programs of the parent may not be portable to the carved-out target post-closing. Buyers may seek to secure a new program or integrate the “carved-out” target into its existing corporate insurance program. The seller may also look to bifurcate their insurance programs in order to let the carved-out entity stand on its own.

D&O Tail/Run-off – Most transactions will trigger a “change of control” provision in a target’s Directors and Officers (D&O) Insurance program. In these situations, the seller may be required to purchase an extended reporting period post-closing, that would cover claims or demands received post-closing for wrongful acts that occurred prior to closing. This is generally referred to as a “Tail” or “Run-Off” Policy. There are situations where the target may not have historically purchased D&O Insurance but may be required to purchase a “Tail Policy” in connection with the M&A transaction. The market for purely “Tail Coverage” (i.e., the target does not have an in-force D&O policy) is limited; however, an experienced broker can help navigate this insurance placement.