When Southwest Airlines closed its $1.4 billion deal to buy AirTran on May 2, it did so knowing that AirTran’s tail would not cause any problems.
The tail in question was not on the back of a plane in the newly acquired fleet, but the extended reporting period—an insurance tail—being put in place to cover AirTran’s directors and officers for claims arising from events that occurred prior to the expiration of AirTran’s pre-merger, claims-made D&O policy.
The requirement for Southwest to purchase a six-year tail, or runoff policy, for AirTran’s directors and officers is nothing special, according to Peter Taffae, managing director of Executive Perils, a Los Angeles-based wholesale broker.
What is special is the unique coverage endorsement he devised to make sure the language of the tail policy would synch up with a worrisome provision of the merger-indemnification agreement.
Specifically, the merger agreement states that the tail policy must “have benefits and levels of coverage at least as favorable as [those in AirTran’s current] D&O policy.”
Taffae, who has worked on hundreds of runoff policies over the past 30 years, says that type of merger-agreement wording “is pretty standard.”
But what is never standard is the language of D&O policies. And because Southwest was purchasing the tail from a carrier that wasn’t AirTran’s current carrier, it was almost impossible to ensure the merger requirement specifying the same or broader coverage would not be violated, Taffae says.
“Each D&O policy is different. There’s overlap, but every single insurance company has its own form,” he says.
Referring to AirTran’s pre-merger carrier as Carrier A, Taffae reports that he found another carrier—Carrier B—that gave a runoff proposal. “We tried to make B as close to A as possible. We added a bunch of endorsements. We did everything. But still, it’s a 14-page document even without the endorsements” he says, stressing that a single word out of place could ultimately violate the merger requirement.
He gives the example of a bodily injury (BI) exclusion, which in some forms has the wording “arising out of bodily injury” and in others has the less-exclusionary phrase “for bodily injury.”
So “if A had the ‘for’ wording and B had ‘arising out of,’ then even though we added 30 endorsements to B, if a BI claim came up, it would clearly be less broad than A and that would be a violation,” he says.
FEAR OF THE INVISIBLE
Chris Thorn, risk manager for Dallas-based Southwest, says that there was no particular coverage provision that he was worried about as the programs were being compared.
“It’s really the invisible that we were concerned with—the things that are not necessarily obvious at the time you’re putting the program into place,” he says.
Thorn says Taffae’s expertise was especially welcome because Southwest was flying into new airspace—the airline had not done a merger since the 1980s.
Taffaer’s solution—which Executive Perils has branded as “trilateral coverage”—“provides a safety net” for Southwest, Thorn says. “It covers us for anything we might have missed.”
Explaining the first two sides of the “trilateral coverage” option, Taffae says the only way Executive Perils could give complete and absolute confirmation that there would be no breach of the merger contract’s “at least as favorable” provision was to get Carrier B to endorse its policy to reference Carrier A. In other words, Carrier B’s policy says, “In no event will this policy provide less coverage than Carrier A,” and specifically references A’s policy number.
“If a claim comes in, the claims adjuster will look at both the Carrier-B policy and the Carrier-A policy and will take the most favorable terms to the insured to settle the claim,” he explains.
Taffae notes that before his “aha” moment, he was confident that Carrier B’s policy was roughly 95 percent equal to Carrier A’s. Carrier B, in fact, was substantially broader on about 30 percent of the policy, he reports. “It was that 5 percent that we wrestled with because we didn’t want to ever be subject to any scrutiny in hindsight,” he says. “We weren’t going to get Carrier B to put Carrier A’s policy into the word processor.” The policy-reference invention was the only complete solution, he says.
BEST OF THREE
For the insured, “it even gets better,” Taffae says, introducing the last side of this “trilateral” coverage deal: “Carrier C”—the lead carrier on Southwest’s existing nine-figure D&O tower.
Taffae proposed that Carrier B’s runoff policy should reference Carrier C’s very broad, carefully manuscripted policy language as well, reasoning that any claim that surfaced after the merger would likely name the deep-pocketed owner Southwest as a co-defendant.
With the last of the three legs in place, he explains that if a claim falls under the AirTran runoff, it will be handled based on the most favorable language of all three policies.
Thorn notes that the safety net provided by this trilateral coverage was particularly important because even though the broker and risk manager were diligent in matching up policies to put together a six-year tail “on behalf of executives of a competing airline,” there were a number of challenges complicating the task—not the least of which was the fact that AirTran was a competitor up until the closing date.
That meant communication was limited, he says, pointing out that the AirTran policy was given to Southwest just 30 days before the merger closed.
Thorn adds that from Southwest’s perspective, the new coverage would not just shield AirTran executives, but also protect Southwest’s balance sheet from the indemnification that it provides to those executives. “So we wanted to make sure we were familiar with the coverage as well.”
“Not having direct communication [or] the same brokers, it was very difficult to get the information we needed to put a good quality program in place and have enough time to be able to study it,” he says.
Taffae adds: “Keep in mind that this is a six-year policy and it’s a one-shot deal. You never renew it. There are no little mistakes.”
SOME KEY QUESTIONS
All the care and attention given to making sure the “same or broader coverage” wording would not be violated begs one obvious question: Why haven’t brokers worried about all this before in other M&A deals?
Taffae says that up until about seven years ago, “it was an unwritten law that the incumbent got the runoff. No one would compete,” he says, chalking up the erosion of the unwritten rule to market conditions. “While it’s still a good idea in most cases to keep it with the incumbent carrier, in some cases you have to get a new carrier to write the runoff—either because the current carrier doesn’t want to do it or their terms are just horrendous.”
Thorn says he would have given preference to the incumbents on AirTran and Southwest’s D&O programs. “But when given such a great opportunity that outshines what “A” and “C” are willing to do, you’ve got to give that a look,” he says, noting that Carrier B’s willingness to think outside the box may enhance its relationship with Southwest going forward.
Carrier B, the two men confirm, has been a participant on Southwest’s D&O tower, but not the lead. Taffae says he doesn’t have permission to reveal the identity of the carrier, adding that the insurer may be wise not to broadcast this. “They’re going to get overwhelmed. Once people know about this, it’s going to become an industry standard. Every broker and every insured is going to want it,” he predicts.
Indeed, when asked if he’ll try to get “trilateral coverage” on the next large merger deal he places, Taffae says, “it would be compulsory. This is going to completely change how six-year runoffs are done.”
In a world where getting alternative bids on runoffs is commonplace, how have brokers helped their clients comply with the “at-least-as-favorable” warranty until now?
For years, as long as the coverage was cheaper or the retention was the same or lower, brokers would provide coverage that was “generally equal, but not specifically, not exactly,” Taffae responds. “No one really got this. No one [previously] appreciated the difference of the wordings on the policies or the wording in the merger agreement.”