When Southwest Airlines closed its $1.4 billion deal to buyAirTran on May 2, it did so knowing that AirTran's tail would notcause any problems.

The tail in question was not onthe back of a plane in the newly acquired fleet, but the extendedreporting period—an insurance tail—being put in place to coverAirTran's directors and officers for claims arising from eventsthat 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'sdirectors and officers is nothing special, according to PeterTaffae, managing director of Executive Perils, a Los Angeles-basedwholesale broker.

What is special is the unique coverage endorsement he devised tomake sure the language of the tail policy would synch up with aworrisome provision of the merger-indemnification agreement.

Specifically, the merger agreement states that the tail policymust “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 thepast 30 years, says that type of merger-agreement wording “ispretty standard.”

But what is never standard is the language of D&O policies.And because Southwest was purchasing the tail from a carrier thatwasn't AirTran's current carrier, it was almost impossible toensure the merger requirement specifying the same or broadercoverage would not be violated, Taffae says.

“Each D&O policy is different. There's overlap, but everysingle insurance company has its own form,” he says.

Referring to AirTran's pre-merger carrier as Carrier A, Taffaereports that he found another carrier—Carrier B—that gave a runoffproposal. “We tried to make B as close to A as possible. We added abunch of endorsements. We did everything. But still, it's a 14-pagedocument even without the endorsements” he says, stressing that asingle word out of place could ultimately violate the mergerrequirement.

He gives the example of a bodily injury (BI) exclusion, which insome forms has the wording “arising out of bodily injury” and inothers has the less-exclusionary phrase “for bodily injury.”

So “if A had the 'for' wording and B had 'arising out of,' theneven 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 aviolation,” he says.

FEAR OF THE INVISIBLE

Chris Thorn, risk manager for Dallas-based Southwest, says thatthere was no particular coverage provision that he was worriedabout as the programs were being compared.

“It's really the invisible that we were concerned with—thethings that are not necessarily obvious at the time you're puttingthe program into place,” he says.

Thorn says Taffae's expertise was especially welcome becauseSouthwest was flying into new airspace—the airline had not done amerger since the 1980s.

 Taffaer's solution—which Executive Perils has brandedas “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 givecomplete and absolute confirmation that there would be no breach ofthe merger contract's “at least as favorable” provision was to getCarrier B to endorse its policy to reference Carrier A. In otherwords, Carrier B's policy says, “In no event will this policyprovide less coverage than Carrier A,” and specifically referencesA's policy number.

“If a claim comes in, the claims adjuster willlook at both the Carrier-B policy and the Carrier-A policy and willtake the most favorable terms to the insured to settle the claim,”he explains.

Taffae notes that before his “aha” moment, he was confident thatCarrier B's policy was roughly 95 percent equal to Carrier A's.Carrier B, in fact, was substantially broader on about 30 percentof the policy, he reports. “It was that 5 percent that we wrestledwith because we didn't want to ever be subject to any scrutiny inhindsight,” he says. “We weren't going to get Carrier B to putCarrier A's policy into the word processor.” The policy-referenceinvention was the only complete solution, he says.

BEST OF THREE

For the insured, “it even gets better,” Taffae says, introducingthe last side of this “trilateral” coverage deal: “Carrier C”—thelead carrier on Southwest's existing nine-figure D&O tower.

Taffae proposed that Carrier B's runoff policy should referenceCarrier C's very broad, carefully manuscripted policy language aswell, reasoning that any claim that surfaced after the merger wouldlikely name the deep-pocketed owner Southwest as aco-defendant.

With the last of the three legs in place, he explains that if aclaim falls under the AirTran runoff, it will be handled based onthe most favorable language of all three policies.

COMMUNICATION COMPLICATIONS

Thorn notes that the safety net provided by this trilateralcoverage was particularly important because even though the brokerand risk manager were diligent in matching up policies to puttogether a six-year tail “on behalf of executives of a competingairline,” there were a number of challenges complicating thetask—not the least of which was the fact that AirTran was acompetitor up until the closing date.

That meant communication was limited, he says, pointing out thatthe AirTran policy was given to Southwest just 30 days before themerger closed.

Thorn adds that from Southwest's perspective, the new coveragewould not just shield AirTran executives, but also protectSouthwest's balance sheet from the indemnification that it providesto those executives. “So we wanted to make sure we were familiarwith the coverage as well.”

“Not having direct communication [or] the same brokers, it wasvery difficult to get the information we needed to put a goodquality program in place and have enough time to be able to studyit,” he says.

Taffae adds: “Keep in mind that this is a six-year policy andit's a one-shot deal. You never renew it. There are no littlemistakes.”

SOME KEY QUESTIONS

All the care and attention given to making sure the “same orbroader coverage” wording would not be violated begs one obviousquestion: Why haven't brokers worried about all this before inother M&A deals?

Taffae says that up until about seven years ago, “it was anunwritten law that the incumbent got the runoff. No one wouldcompete,” he says, chalking up the erosion of the unwritten rule tomarket conditions. “While it's still a good idea in most cases tokeep it with the incumbent carrier, in some cases you have to get anew carrier to write the runoff—either because the current carrierdoesn't want to do it or their terms are just horrendous.”

Thorn says he would have given preference to the incumbents onAirTran and Southwest's D&O programs. “But when  givensuch a great opportunity that outshines what “A” and “C” arewilling to do, you've got to give that a look,” he says, notingthat Carrier B's willingness to think outside the box may enhanceits relationship with Southwest going forward.

Carrier B, the two men confirm, has been a participant onSouthwest's D&O tower, but not the lead. Taffae says he doesn'thave permission to reveal the identity of the carrier, adding thatthe insurer may be wise not to broadcast this. “They're going toget overwhelmed. Once people know about this, it's going to becomean industry standard. Every broker and every insured is going towant it,” he predicts.

Indeed, when asked if he'll try to get “trilateral coverage” onthe next large merger deal he places, Taffae says, “it would becompulsory. This is going to completely change how six-year runoffsare done.”

In a world where getting alternative bids on runoffs iscommonplace, 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 retentionwas the same or lower, brokers would provide coverage that was“generally equal, but not specifically, not exactly,” Taffaeresponds. “No one really got this. No one [previously] appreciatedthe difference of the wordings on the policies or the wording inthe merger agreement.”