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Look before you leap: Insurance tips for a merger or acquisition
When it comes to insurance, surprises are never a good thing. The same goes for mergers and acquisitions: The more you know, the better off you are. That's the premise behind the growing field of "insurance archaeology" — you need to know what liabilities you're facing when merging with another company, and what sort of coverage exists. Recreating the company's insurance coverage history is the only way to get reliable estimates of future insurance costs and problems.
"A key component of standard commercial general liability policies is that they never expire," explains Sheila Mulrennan, president of the New York-based Insurance Archaeology Group. "If a claim is filed against a policyholder 20, 30, or even 40 to 50 years after property damage or injury occurs — as often happens in cases of environmental pollution — a policy that was in effect when the damage occurred is still effective."
Insurance professionals call this "long-tail" coverage, and it's a crucial consideration for companies evaluating a potential target for merger or acquisition. Generally, you won't need to wade through 50 years of insurance documents, but looking at the past five to 10 years of coverage can spare huge financial hassles later on.
Whether your internal resources or a professional auditor reviews the records, Mulrennan suggests these steps for a proper insurance audit:
- Locate the insurance records of the selling or merging company. They may be cleaning out their offices, and important documents can get tossed inadvertently. Look for primary and excess liability coverage, and keep an eye out for existing policies for which documentation has disappeared. Also, make sure to keep correspondence about past policies. In one instance in California, a letter from written by an agent to the company about their policy was the deciding factor for the court as to who was liable for payment.
The life span of M&A deals can be short — less than a week, in some cases. If this "historic coverage audit" can't be done ahead of time, get a written promise that all of the relevant materials will be saved, to be organized and reviewed at a later date
- Identify former owners of the merging or acquired company, noting who owned it and when. You'll need copies of liability policies to go along with any operations or real estate acquired, and evidence of any former owners' coverage. "Waiting until a claim arises may result in multiple entities competing for the same limits, where you'll have no documentation and no hope for cooperation," says Mulrennan
- Part of recreating the coverage history includes finding the "hidden liabilities" within the other company. Some liability considerations include environmental issues, workers compensation claims, claims related to discontinued products, international coverage, and employee issues like payroll and union contracts. If a claim arises after the merger and you're unprepared, you could be saddled with the financial burden
- Look closely at the policies you dig up to see what they actually cover. Some commercial policies are highly customized, containing endorsements, high deductibles, and expensive claims-handling arrangements. You could also be faced with nearly exhausted aggregate limits or insolvent insurers. All of this can spell inadequate protection against future losses.
- Transfer the insurance policies into your company's name before you buy or merge. Legally, policy transfers aren't required, but insurance companies can attempt to deny coverage on the grounds that an explicit assignment or transfer is missing.
- If you have an indemnification clause for claims arising out of pre-sale circumstances, review the coverage to verify that indemnification is within the scope of the policies. A clear indemnity clause is important because if you do encounter a "hidden liability," you'll need to decide who takes responsibility for it.