It’s rare to read an industry magazine or attend an industry conference without the topic of mergers and acquisitions coming up. The issues addressed typically include the cost of acquisitions, tax implications, systems matters, when a consultant is needed and when the parties involved should be able to handle the transaction on their own.
While those topics are all well and good, there is a key — if not critical — issue that doesn’t seem to get much, if any, attention. Namely, how your errors and omissions liability (E&O) policy will address the potential liability issues that can make a good deal a nightmare without the proper attention.
This is not a simple issue, yet it’s also not a terribly complex one. Whether you are the buyer or the seller, proper planning and appropriate attention to detail are extremely important.
Consult E&O Carrier or Policy
Given the frequency of transactions like this, it is amazing how E&O coverage addresses them is rarely reviewed or considered. There is a tremendous lack of consistency among all E&O carriers on the options available and the process that must be followed. While the necessary coverage is available, the options regarding the number of years varies significantly from carrier to carrier. This definitely speaks to the need to plan ahead.
Do not wait until a month before the sale or purchase to educate yourself on some of the significant coverage issues. Any good E&O carrier “worth their weight” can provide some guidance and direction based on your specific scenario.
For example, will the E&O carrier treat the transaction as an acquisition or is it actually a merger? What additional information is needed? Are there any potential stumbling blocks? Contact the underwriter, agent or agents’ association that played a fundamental role in the purchase of your E&O coverage and explain the situation to them. Moreover, don’t hesitate to ask them all of the necessary questions.
Although it is rare, if you are buying an agency it is possible that the E&O carrier may not be willing to pick up and insure the new exposure. For example, suppose your agency is buying a wholesaler or an agency writing a specialized exposure like pollution, directors and officers liability (D&O), E&O, environmental coverage, etc. This may present a risk that your carrier does not want. Find this out before the sale because it can impact whether you want to proceed.
The E&O carrier may require additional paperwork, copies of the proposed transaction documents, applications, etc., to make this determination. If the agency has had some prior E&O problems, your E&O carrier will probably want to have some assurances regarding the level of due diligence to ensure that “the future is going to look better than the past.”
When You’re the Buyer
For the buyer, the traditional approach is to have your E&O policy endorsed to provide coverage for the new agency. The coverage, referred to by many E&O carriers as a purchased entity endorsement, will provide protection against errors made by the new agency starting with the effective date of the acquisition. Tail coverage should be secured to protect against any errors made by the new agency prior to the date of the sale.
Be sure to ask whether there is a premium charge for the purchased entity coverage. There could be a charge, which will likely depend on how that E&O carrier has filed to handle this transaction and what it uses as its rating basis (premium, staff, revenue, etc.). In some cases, there will not be a charge as some E&O carriers look to address this additional exposure at the next renewal.
Some of the more preeminent E&O carriers provide 90 days of automatic coverage when you buy an agency. This is a significant issue and benefit. If you think your agency will be making some acquisitions over the next couple of years, factor this into the purchase of your own E&O coverage.
When You’re the Seller
If you decide to sell your agency, contact your E&O carrier and advise them of your plans. Don’t hesitate to ask questions regarding cost, options, timeframes, etc. This is an important decision and should be carefully planned.
The traditional approach involves the seller purchasing an optional extended reporting period endorsement (a.k.a. “tail”). While most E&O policies provide an automatic 60-day grant of coverage, this is truly minimal.
The purpose of this optional “tail” is to provide an additional period of time after the expiration of the policy for which valid claims will continue to be accepted, provided the wrongful act occurred before the end of the policy period.
While virtually all claims-made policies contain this provision, there is, once again, a tremendous lack of consistency as to the available options. Some policies only allow an additional one-year “tail.” Other policies may only allow options up to three years. Still others provide up to 10 years — or even an unlimited period.
The charge for this additional coverage comes with a hefty premium charge, so plan for this expense. For a 10-year “tail” it is common that the cost may run 200 percent of the last full annual premium.
Knowing the options and when the decision needs to be made are important. If you think you may be selling your agency in the coming years, “tail” options should definitely be part of the decision process.
If you are on the verge of selling your business, put your E&O carrier on notice of any potential claims that may arise. By reporting those potential claims, most E&O carriers will consider those claims covered regardless of when the actual claim is made. It essentially locks in the “date claim made.”
Timing and Cost
You only have one time to make the decision. This is not a cost that can be financed, so make sure you have the resources available. If you want to enjoy your retirement and not wonder whether you bought enough tail coverage, it is highly recommended that you buy the longest option available. History has shown that there is typically a significant amount of claims activity that occurs during the tail coverage period, so protect yourself accordingly.
Policy is Not Assignable
E&O policies are not assignable. Therefore, giving your E&O policy to the buyer and requesting that he or she keeps making the payments is not the solution. If a problem developed, this approach could very well leave both the buyer and seller with no coverage.
Looking to buy or sell? Consider the E&O issues early on and include your E&O carrier in the discussion. This is the key to ensuring you make the right decisions.
