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Following an active 2017, merger and acquisition activity shows no signs of letting up this year. In fact, a recent survey by Deloitte found that corporate executives and private equity investors expect strong deal activity throughout 2018, with technology acquisition as a primary deal driver.
The survey results point to both increased deal flow and size. Bullish dealmaker sentiments are expected to drive M&A activity across industries and regions. The long-term success of these deals will depend on a variety of factors, including the quality of the due diligence performed in connection with the transactions.
Given the variety of risks confronting today’s enterprises — many of which are related to technological developments, including increased connectivity, interdependency, security, privacy, and compliance issues, insurance coverage should be a high priority focus of the buyer’s due diligence efforts.
Insurance policies are a valuable corporate asset, and thorough insurance due diligence can allow dealmakers to rectify insurance-related problems in advance of closing, adjust pricing to reflect the true financial impact of insurance issues, and avoid unintended acquisition of uninsured liabilities.
Insurance due diligence in today’s complex business environment should involve more than simply identifying the target’s insurance policies and checking for anti-assignment provisions. An in-depth due diligence review should also include:
Insurance Policy Reviews
Carefully review actual policy wordings, not just the title of the policy form and its limits. The precise terms of the policies, including conditions, exclusions, notice and extended reporting provisions, should be analyzed closely in light of the company’s risk profile and loss history. It is very possible that the target may be unaware of exclusions or other policy terms that preclude coverage for significant business risks. Buyers should take steps to become aware of any such coverage gaps in advance of closing. And, of course, all policy assignment provisions must be scrutinized early in the process so that they can be dealt with as necessary prior to closing.
The insurance policy review must be informed by a full appreciation of the target’s risk profile. It may be necessary, therefore, to review financial statements, SEC filings, and other documentation to get a full picture of the target’s business risks.
Policy Retentions, Deductibles, and Limits
To better understand the financial impact of the target’s insurance program on the true valuation of the transaction, it’s not enough to identify policy retentions, deductibles, and limits; the buyer should also understand the extent to which retentions and deductibles have been satisfied and limits have been impaired. In addition, buyers should determine if there are any potential limitations concerning future payment of retentions or deductibles by the acquiring company, as opposed to by the target/insured. For example, buyers should see if any policies state that retentions are satisfied only by payments made by the named insured. The existence of premium refunds due to the target also should be examined.
Related Entity Considerations
A company’s insurance policies often provide coverage for certain related entities, such as subsidiaries. To the extent those entities are not being acquired in the transaction, buyers should take steps to proactively understand how insurance proceeds would be allocated among all covered entities.
Additional Insured Obligations
Examine the target’s contracts for existing contractual indemnity obligations and additional insured coverage requirements to third parties. Also examine third party additional insured obligations to the target and take steps to ensure that coverage will stay in force after the transaction. This may require policy assignment in accordance with policy requirements or restructuring the deal. Consider whether claims under any such third-party policies should be made before closing.
Directors and Officers Coverage
D&O policies contain “change in control” provisions that may preclude coverage for claims made after the closing, even if the relevant acts occurred prior to the closing. The parties should determine whether the transaction at issue will trigger those provisions in the target’s policy and, if so, take steps to secure appropriate “tail” or “run off” coverage. Obtaining tail coverage from the target’s existing D&O insurer and paying 100% of the policy premium prior to closing may provide more complete protection for the insureds under the D&O form. In addition, all known claims and circumstances should be reported under the existing D&O policy prior to closing.
Although cyber insurance uptake continues to increase, it cannot be assumed that a target has a cyber policy or, if it does, that its policy appropriately covers the target’s cyber risk profile, including domestic and international regulatory exposures. If the target does not have any cyber insurance or if there are material gaps in its coverage, the buyer should consider the impact on insurance-related representations and warranties in the transaction agreement.
A review of the target’s existing claims should include consideration of their valuation, status of notice to insurers, insurer coverage positions, analysis of coverage, and prediction of insurance recovery. Issues associated with exposures that are under-insured, uninsured, or subject to coverage disputes can then be appropriately addressed in the negotiation process.
In addition to insurance due diligence, keep in mind that insurance can also be used to facilitate completion of the transaction. Under a Representations and Warranties (“Reps & Warranties” or “R&W”) insurance policy, the buyer can recover from the R&W insurer for unintentional and unknown breaches in the seller’s representations and warranties in the deal documents. Procurement of a R&W policy can remove sticking points from the negotiation process and expedite closing of the transaction.
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