Due diligence is a major part of any corporate transaction, whether it is a stock purchase, asset purchase or merger. A review of applicable insurance programs—and the liabilities they may or may not cover—should always be a part of that due diligence because insurance is an important corporate asset. But there is much more involved in due diligence than just figuring out what insurance policies exist. Careful consideration of frequently overlooked aspects of the insurance program can help the buyer properly determine the value of that asset and protect against post-transaction liabilities.
As with most issues involving insurance, the buyer should begin with the policies. That means collecting all of the seller’s insurance policies, such as commercial general liability, property, environmental, directors and officers, errors and omissions, cyber, excess, umbrella, and any others the entity may have. This also means gathering the policies dating as far back as possible, especially if the business is one that could be subject to liabilities that occurred decades ago, such as asbestos contamination.
Once the policies are collected, the review begins, which should include nine important questions:
1. Does the insurance cover the risks? The first objective in any insurance due diligence review is determining whether the seller bought the right policies in the first place. This is not a given. Careful scrutiny of the risks and the loss exposure is critical. This requires close consideration of, and inquiry into, the seller’s operations, products, countries in which it operates, and the like. Once that is complete, the risk profile must be compared against the insurance coverage in place.
2. Who is insured? The seller is likely to be the named insured on the policy, but, depending on what is being acquired, it is important to determine if any of its subsidiaries are also covered. If the deal does not include purchase of subsidiaries named under the policy, post-transaction issues might arise over priority of insurance proceeds between the buyer and the non-acquired subsidiaries.
3. Are there any risk transfer agreements benefiting or obligating the seller? The seller might also be listed as an additional insured under policies held by third-parties to the transaction. Establishing this is critical to ensuring that the post-transaction entity retains similar insured status, if possible. For example, should the deal be structured in a certain way or is there a need for assignments or new agreements? Do claims need to be made?
4. What are the policy deductibles or retentions? Buyers must take note of particularly high deductibles or retentions because they might be responsible for bearing that amount post-transaction before the insurer starts to pay on a claim. Knowing if the seller has already paid any portion of the deductible or retention is also important because the buyer will not be responsible for that portion.
5. Does the policy say anything about assignments? Many insurance policies contain “anti-assignment” or “change of control” clauses that state that the insurer’s consent must be obtained before the insurance policy is assigned or where there is a change in control of the original policyholder.
In the first instance, the parties should evaluate whether such clauses have any effect on the transaction—that is, if there is an assignment or a change of control. For example, a stock purchase might leave the original entity intact, which may not require an assignment. (Policies sometimes include specific provisions regarding stock acquisitions, however, so each policy must be carefully evaluated.)
If there is an “assignment,” courts in some jurisdictions might not enforce an “anti-assignment” clause where the assignment occurs after the loss. Understanding the law for the particular jurisdiction is essential.
Of course, the surest way to deal with such clauses is to require the seller to assign its rights and obtain the insurer’s consent before the deal is finalized. In this process, the buyer should also make sure the seller informs the insurer of all known liabilities in order to later avoid arguments from the insurer that its consent was not properly informed.
6. Does the policy have any unusual or pertinent exclusions? Because insurers will likely argue that some policy exclusions negate coverage, either in whole or in part, knowing what exclusions are written into the policy, and evaluating whether any exclusions are pertinent to the buyer’s business or circumstances, can help the buyer identify where coverage might be challenging to obtain.
7. What is the seller’s claim history? It is critical to evaluate the amount of available coverage remaining under the various insurance policies. This requires getting information about the claims that have been made under each policy and the amount of money the insurer has paid (in defense costs, settlements, and indemnifications), which may erode the amount of available coverage.
Similarly, due diligence should include research into whether there are pending claims or if potential claims may or should be pursued. The likelihood of potential claims could similarly erode policy limits in the future, thereby lessening the amount of post-transaction coverage. Potential claims could also create a notice issue. If, for example, the seller was aware of a claim when it purchased the insurance policy but did not provide notice of this claim to the insurer, post-transaction coverage could be impaired by that failure to provide notice.
8. Are there retroactive premiums associated with the policy? Some insurance policies calculate the amount of premiums retroactively based on the cost of claims to the insurance company. If a policy has a retroactive premium component, the buyer might be responsible for paying the premium post-transaction. Retroactive premiums can devalue the insurance asset and present an unwelcome surprise to an inexperienced buyer.
9. Is runoff or tail coverage available? Where the transaction results in expiration or cancellation of the insurance policy, runoff or tail coverage can provide some cover for pre-existing wrongful acts, for example, that took place during the expired or canceled policy’s policy period. Purchasing this coverage is a cost of doing business.
Many other questions will arise in the insurance and liability review, especially depending on the businesses involved, the jurisdiction, and the specific policy language, but by asking certain foundational questions, risk managers can begin a productive conversation that helps to ensure the financial success of the post-transaction entity.
Insurance is a valuable asset that can have an impact on the price and value of the company, and thus should be given the same consideration as other assets and liabilities