Post-Merger D&O Cover

Poses Unique Challenges

By PEter Taffae

One lesson clear to anyone who's been involved in insurance fordecades is that time-honored coverages–even those seemingly as oldas S&H Green Stamps–need to be examined and tailored toindividual customer situations.

Directors and officers liability insurance runoff policiesaren't quite that old, but the first one I wrote was for Sperry& Hutchinson, a company founded in 1896, which (for those notold enough to remember) ran a popular rewards program that someview as the precursor to today's frequent-flyer systems.

Well-known to U.S. consumers buying everything from groceries togasoline from the 1930s through the 1980s, S&H sold stamps toretailers, who in turn gave them to customers as bonuses with everypurchase. Collect enough and shoppers could use them to claimvaluable prizes from the local Green Shield shop or catalogue.

Sperry & Hutchinson itself, after a long history in thebusiness, became the victim of numerous securities lawsuits arisingfrom a steep decline in the company's stock price.

In 1984, the company was sold. The current D&O underwriterwanted off the account and would not offer a six-year tail, asrequired by the merger agreement, allowing me to step in to offerterms after thoroughly underwriting the risk.

“Interrelated wrongful act” wording in our policy, thecomprehensive allegations in the litigation and the likelihood thatthe litigation filed would be covered under the expiring D&Ocoverage were factors considered at the time.

Twenty-five years later, working as a wholesale broker, we haveplaced hundreds of runoff policies representing acquirers as wellas acquired companies. Experience has revealed a number of uniquecircumstances that need to be addressed, and many that are oftenoverlooked when addressing the coverage of a D&O runoffpolicy.

PROCEED WITH CAUTION

Starting in the early 1990s, D&O insurers amended theirpolicies to include an automatic conversion to an extendedreporting period upon a change of control (of the board) for thebalance of the policy period following the change in control.

In other words, if a company that has a 12-month D&O policyin force is acquired midterm, the directors and officers of theacquired company are automatically covered for claims reportedduring the next six months for wrongful acts occurring before theacquisition date.

This is not enough, and additional time should be negotiatedwhen securing D&O runoff coverage. This means more than simplybuying a longer extended reporting period–extending several monthsbeyond the automatic conversion period.

More suitable is a separate tail or runoff policy secured toextend the same type of coverage for wrongful acts occurring beforethe acquisition but reported during the reporting period–somewherebetween three and 10 years, depending on the statute oflimitations.

In addition to the length of reporting time, the issue ofadequate limits needs to be decided early in the negotiationprocess. If the board was comfortable with $10 million for anannual period, how much is adequate for a six-year period?

Often, clients request excess limits over the original limit toinsure adequate protection post-merger. This can be challenging,but not impossible, if the primary limit is impaired because ofclaims. When appropriate, we have negotiated “reinstatements” tofurther insure protection against frequency and catastrophicevents.

While studies (including one by Tillinghast-Towers Perrin) havesuggested that one-in-three D&O claims arise out of mergers andacquisitions, if approached diligently, underwriters have adistinct advantage when writing the runoff of an acquisition targetover everyday D&O risk underwriting.

The advantage is that the “photograph” does not change. There isa known beginning and known ending. Any and all wrongful acts haveoccurred. Now the bet is if they will surface.

Ten years ago, underwriters would not quote a competitor'sD&O runoff–which has changed, in part, because of underwriters'attraction to the “still photograph” and potentially lucrativepremiums. Six-year runoff premiums range from 1.35- to 2.2-timesthe annual.

The merger agreement becomes the most important underwriting andbrokering tool. Specifically, the indemnification provision of theagreement will specify the required time period for the runoffpolicy–most often six years, but some are as short as three years,and others as long as 10 years. It also will often state coverage“no less” than currently in force.

It is critical that certain steps take place prior to a merger'sclose.

Since the primary objective is long-term protection of theacquired company's directors and officers, the policy must benoncancelable and earned at inception. This ensures the coveragecannot be altered or cancelled for any reason. (During the days offrequent hostile takeovers, the new board would cancel themultiyear runoff for the return premium.)

This means the policy must be paid prior to the merger date, andthe premium cannot be financed. Anything to the contrary violatesthe sole intent of this coverage–to protect the acquired firm'sdirectors and officers from claims for pre-merger activities–andjeopardizes this valuable protection.

We have occasionally seen other brokers amend the prior-actsexclusion on acquired subsidiaries under the acquirer policy,thinking that the new subsidiary will be covered for past acts.There are a few problems with this approach. One is that there isan insured-versus-insured exclusion that now removes coverage forsuits brought by the acquirer against the acquired.

There are a host of additional issues that require attentionwhen structuring runoff coverage for acquired companies and ongoingcoverage for acquirers:

o Is corporate reimbursement desired?

o Who does it benefit–the acquiring company or the target?

o Who are the named insureds? (The answers will likely depend onwhether the old company will legally exist post-merger.)

o How will the “presumptive indemnification” provision affectcoverage?

Under this provision, the insurer presumes the company willindemnify individual directors and officers to the maximum extentof the law.

As a result, any deductible that applies under the corporatereimbursement section of the D&O policy (insuring agreement B)may apply if a company is legally permitted to indemnify itsdirectors and officers but fails to do so. That would mean thatdirectors and officers might have to personally fund thedeductible.

Finally, a broker will want to consider the pros and cons ofhaving different insurers on the runoff and ongoing policy, and tooutline these fully for clients.

Peter R. Taffae is managing director of Executive Perils Inc., anational wholesaler solely dedicated to D&O, E&O, EPL,legal malpractice, insurance agents E&O, cyber/ digital andintellectual property. He can be reached at [email protected]

Pullquote:

“Underwriters have a distinct advantage when writing the runoffof an acquisition target over everyday D&O riskunderwriting…Any and all wrongful acts have occurred. Now the betis if they will surface.”

Peter R. Taffae