Commercial Insurance Update – Insurance Ramifications of Mergers & Acquisitions

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Insurance Ramifications of Mergers & Acquisitions

Article by Jeffrey Cavignac, CPCU, ARM, RPLU, CRIS, MLIS, President, Cavignac & Associates – All Rights Reserved

A merger or an acquisition involves the combining of one firm with another, or the purchase of one firm by another. Whether a firm is merging, acquiring, being acquired, or if there is a majority change in ownership, there are risk management and insurance ramifications that need to be considered. Ideally, this analysis should be done in the due diligence phase. There are risk management issues that can be ‘deal breakers,’ and these should be identified before a deal is consummated.

Mergers

If two firms are merging into one firm, the insurance programs for each firm need to be evaluated and consolidated. This should be done by one broker who understands the insurance and risk management issues, and can coordinate the consolidation of both sets of policies.

The end product should be a single program for the combined entity that picks up the prior liabilities of both firms, and will also involve the cancellation of the unnecessary policies in the most favorable manner.

Acquisitions and Changes in Ownership

The first consideration is whether the acquiring firm is buying stock (assets and liability), or just assets.

It is critical that each party to the transaction understand “who is responsible for what” as it pertains not only to existing liabilities, but current and future insurance as well. In any corporate transaction, the buyer will want to know what it is getting. It will therefore require, from the seller, a long list of representations and warranties whereby the seller provides the state of affairs of the business or assets that are being sold. These “reps and warranties,” as they’re known, can touch on just about anything from accounts receivable to tax treatments, pollution conditions, etc.

Although traditionally buyers would ask the sellers to indemnify them for the breach of any representation or warranty, this has not always been effective. As such, several products have been developed by the insurance industry to transfer the risk of these reps and warranties to the insurance company. These reps and warranties can cover either the buyer’s or the seller’s risk in a number of different situations. (Note that this coverage is heavily underwritten and can be very expensive.)

Insurance Policy Assignment

Insurance policies are a contract between the insurance company and the insured, and they cannot be assigned without the insurance company’s consent.*  Certain types of coverages, such as Directors & Officers & Employment Practices Liability coverage go a step further and have what is commonly known as a “Change in Exposure” or “Change in Ownership” clause.  Essentially, when this provision is triggered, the coverage goes automatically into run off mode.  Coverage continues in force for the original ownership, but only covers circumstances which took place prior to the change in exposure or ownership.

It is important to review each policy to determine whether or not there are additional provisions pertaining to a change in ownership.  When in doubt, a specific discussion with the underwriter is recommended.

Standard Property Casualty and Auto Insurance

As mentioned above, insurance policies are not assignable without the underwriter’s consent.  If the acquiring entity is interested in retaining the seller’s coverage, approval by the underwriter is required.  The seller also needs to consider its future liabilities arising out of its activities prior to the sale. Even if coverage is written on an occurrence basis, accidents could happen post sale arising out of presale activities.  If this is the case, Discontinued Operations Coverage should be considered.  If coverage is written on a claims-made basis, an Extended Reporting Period (ERP) needs to be evaluated.

Workers Compensation

Workers Compensation also has a non-assignment clause, but when there is a change in ownership you also have to file an ERM 14, “Confidential Request for Ownership Information.”  This must be done within 90 days of the ownership change and be sent to the Insurance Company of Record.  Although, technically an underwriter could agree to assign the policy, most underwriters will want to cancel coverage and rewrite it under the new name.  Note that this could trigger different rates if there has been a rate change subsequent to the original policies’ inception date. 

 Recognize as well that if the operations of the selling company have not materially changed, then the experience of the selling company will transfer to the buying company. In other words, the acquiring company would inherit the experience modification of the selling company, or the experience of the selling company would be blended in to the acquiring companies experience modification. 

Professional Liability, Executive Risk, and Other Manuscripted Policies

The majority of these policies are non-standard or manuscripted and should be individually evaluated to determine the best way to coordinate coverage.  As mentioned above, most of these policies contain a  “Change in Ownership” provision.  This means the buyer must purchase a new policy and the seller would have to rely on an ERP to cover their future liabilities arising out of the pre-sale activities.  The claims-made nature of these policies (nearly all are written on a claims-made basis) reinforces the need for an ERP extension.

Conclusion

The Risk Management and Insurance ramifications of a merger or acquisition need to be evaluated as part of the due diligence process.

This requires the services of a knowledgeable attorney and insurance broker. All exposures need to be evaluated and coverages need to be reviewed to make sure a coordinated strategy is developed to cover not only existing, but previous liabilities.

*The applicable provision is usually found in the conditions section of a policy and is referred to as “transfer of your rights and duties under this policy.”

 

This article is provided for informational purposes only. Before taking any action that could have legal or other important consequences, speak with a qualified professional who can provide guidance that considers your own unique circumstances