Insurance policies might not be top-of-mind when undergoing a merger or acquisition – but if an unexpected occurrence pops up after your policy period ends, you’ll wish you gave this area more thought.
An Extended Reporting Period (also known as a “Tail policy”) can be purchased to extend the time in which a claim can be reported. This means that if a claim based on a wrongful act (actual or alleged) occurred within the policy period but was reported afterward, you will still be covered. When evaluating an acquisition target, a buyer needs to understand what types of Tail policies are in place, what risks are covered and how much coverage is available.
What Are the Different Types of Policies?
Most liability policies will either be written on an “occurrence” or a “claims-made” basis. Occurrence policies provide coverage for covered incidents that occur during the policy period, regardless of when the claim is made against the policy. Claims-made policies provide coverage for covered incidents if a claim is made during the policy period and if the incident occurred from the retroactive date to the end of the policy period.
It is important to understand this difference because many lawsuits are not filed until months or years after an incident occurs, potentially leaving a buyer less protected if their acquisition target has insurance coverage on a claims-made basis.
When Should You Consider a Tail Policy?
Tail policies should be considered and explored in both stock and asset purchases. A Tail policy for all lines – especially Executive Liability (Directors & Officers, Employment Practices and Fiduciary Liability), Cyber and General Liability – should be given the proper due diligence if a company is being purchased and is facing any of the following scenarios:
- The company is dissolved with the goal of establishing a new company
- There is a change in ownership or a change in controls
- The company is rolled up into an existing entity
What Coverage Lines Should Be Evaluated?
Generally, any coverage written on a claims-made basis should be evaluated during the diligence process of an acquisition. Directors and Officers (D&O) liability policies are most typically implicated in mergers and acquisitions. Employment Practices Liability, Cyber and Fiduciary policies are often implicated as well.
D&O policies are almost always written on a claims-made basis. A buyer will want to avoid the risk that a former shareholder, member or limited partner of the target makes a claim against the target’s officers and directors after the acquisition and expiration of the target’s D&O policy period.
It’s common within the Healthcare industry for the General/Professional/Medical Malpractice coverages to be written on a claims-made basis. Other coverages that could be possibly written on a claims-made basis include General Liability, Professional Liability, Umbrella, Cyber, Employment Practices and Fiduciary Liability.
In an asset purchase, even an occurrence-based General Liability should be given tail consideration. The policy is actually called a Discontinued Products & Completed Operations policy, which is designed to cover an occurrence (bodily injury or property damage) taking place post-close for a product that was sold pre-close. For example, a toy manufacturer sells a product, then sells their company in an asset deal, then years down the road a child gets injured by their product. Without a discontinued products policy there wouldn’t be coverage.
What Risk Factors Should I Consider Before Purchasing a Policy?
Five factors go into a proper assessment of risk/need:
- Cost – The cost of a Tail policy can vary, but a good rule of thumb is that a one-year Tail will cost between 100% and 125% of the annual premium. In many cases, a company that is being acquired will purchase a three-year or six-year tail and see costs increase to 250% of the annual premium for the longer extended reporting period it purchases. Of course, this rate can fluctuate based on the type and size of risk.
- Past Losses – Past losses will always play a role in determining the probability of obtaining a Tail policy from the insurance marketplace, obtaining favorable terms (i.e., coverage, retention, and exclusions) and the cost of a respective Tail policy.
- Exposure – Exposure will also play a large role in determining the items above. For example, if a company is highly leveraged, a Tail policy could include difficult language, restrictions, and exclusions that must be reviewed. Full market analysis and due diligence are always necessary when considering your broker partner for a transaction and subsequent search.
- Statute of Limitations – Many claims-made policies typically offer one-year, three-year and six-year extended reporting periods to cover various and different statutes of limitation. Cyber is pretty much capped at three years in the current market. The longer the tail, the higher the cost and the more time is available for the policyholder to report a claim.
- Risk tolerance of buyer and seller – Exploring a Tail policy should always be part of the due diligence process for all lines of coverage. It is important to discuss the risk tolerance of the buyer and seller to see if the budget will allow for such policies or if a company is able to self-insure.
What Are Naked Tail Policies?
It’s common for entities to purchase what are known as “Naked Tail Policies” for deals they are structuring. These policies are purchased when an entity being dissolved or acquired did not previously carry a respective line of coverage (most commonly, D&O, Employee Practices Liability, or Cyber insurance). The acquiring entity will want to ensure coverage for the subsequent entity, in which case a Naked Tail Policy would need to be purchased.
Where Can I Learn More?
Horton’s Mergers and Acquisitions team can work with you to evaluate your risk and help you determine which coverage options best suit your needs. Reach out today to schedule a consultation.
Material posted on this website is for informational purposes only and does not constitute a legal opinion or medical advice. Contact your legal representative or medical professional for information specific to your legal or medical needs.