Authors: Emily Maier Damion Walker
One of the quickest ways to spot whether someone works with insurance every day is to ask them to explain the difference between an occurrence policy and a claims-made policy. It sounds like insurance jargon, but it's one of those concepts that quietly drives some of the biggest coverage decisions you'll ever make, especially in an M&A transaction. If you misunderstand it, you can end up buying the wrong policy, cancelling the wrong policy, or discovering years later that the claim you thought was covered … isn't. Also, the cost of run-off or new go-forward coverage can be significant enough to impact EBITDA in unexpected ways, which can affect the success of the deal and the integration. So, before we get into D&O, Cyber or just about any other claims-made policy it is worth understanding what those terms mean.
Occurrences policy
An occurrence policy looks at when the insured/insurable event occurred (hence the name). If the incident occurred while the policy was in force that policy responds — even if nobody discovers the problem or makes a claim until years later. For example, a manufacturing company installs a faulty electrical panel in 2018. The commercial general liability policy is written on an occurrences basis. Nothing seems wrong for years. Then in 2026 the panel overheats, starts a fire and causes damage. The customer sues the manufacturer in 2027. Even though the claim was made nine years after the policy expired, the 2018 occurrence policy is the one that responds, because the damage arose from an occurrence during the period that the policy was in force.
Claims Made policy
This is the other way around. A claims-made policy looks at when the claim is made, not when the underlying event occurred. However, there is one important detail to note, the wrongful act must have taken place after the policy's retroactive date (the date at which coverage began, which can be decades prior to the claim date) and when the claim is first reported while the policy (or extended reporting period) actually providing coverage is in force, that's the policy that responds. Also, this cover must be continuous for there to be full prior-acts coverage. That's why D&O, E&O, cyber all need careful handling.
How does this relate to RWI?
RWI underwriters do not believe their policy is designed to cover deficiencies in sellers insurances. So, they expect all claims made policies to be put into run-off, aka extended reporting period, so that if there is a claim that triggers a RWI policy but would/could also trigger the claims made policy the buyer turns to that policy before the RWI policy. What this means is that if there isn't a tail policy in place, underwriters will seek to either exclude claims that should have been covered under standard insurances or add a separate retention to any claims that would have been covered under those policies had they existed and that retention is likely to be at least several million dollars. How this is handled also depends a lot on the structure of the M&A transaction.
Share or full entity acquisition
When one company is acquiring an entire company through a share sale the process is often more straightforward in theory.
Most agreements will have some language specifying that D&O tail, aka run-off, aka extended reporting period will be purchased. Often unanswered questions, however, are
- Who is paying for the run-off
- What about EPL, Fiduciary, Cyber
- How long is the tail/run-off/ERP going to be: three years or six years
While most companies coming to the market have D&O coverage, many do not have EPL, Fiduciary and most importantly Cyber. It can be very difficult to buy a Cyber policy just to run it off and getting last-minute coverage can cause a hiccup in the deal timing, as it's not an overnight process. Some form of coverage can usually be achieved but it's best not to leave it to the last minute.
Carve-outs
There are multiple types of carve outs and each has its own issues
- Carve-out of a subsidiary
- Carve-out of a business unit
- Carve-out of assets
Also, all three of the above have different concerns depending on whether it's a public company that sells or a private company that's selling.
In a public company scenario, a D&O policy can have the ability to buy run-off for the carved-out sub, business unit or asset by endorsement. However, that potentially dilutes the seller's limits and costs money. The same is not generally true of a private company D&O policy and none of this is possible under EPL, Fiduciary or Cyber. It's also worth noting that carve-outs often come with transition services agreement meaning shared liability may continue for some time.
The other option in a carve out is for the sale agreement to have a covenant stating that the seller will continue to purchase the D&O, Fiduciary, Cyber and EPL, or put the policies into run-off, for a period and that the buyer will be allowed to co-ordinate any claim with the seller. Again, this is not something that is standard and needs to be agreed. We find many sellers just want a clean exit. That is why they are turning to RWI and are often unwilling to grant this.
Also, as it is a covenant between the seller and buyer, and the RWI is a contract between the buyer and insurer the RWI insurer may feel that they are powerless to enforce this and therefore we are back to square one.
This leaves the buyer the option of rolling the new sub/assets/unit into its existing policies with a back date/retro date to cover the prior acts of that sub/asset/unit. Depending on the nature of the buyer's insurances this can also prove tricky, or in many cases not possible. Maybe the buyer has much higher limits and so adding this acquisition might be prohibitively expensive. Also, we are faced with the issue of time being added to the deal, as this will require buyer to gather the appropriate data and go through the underwriting exercise. Another reason for the buyer to get their broker involved early on.
Separate sign and close
Whatever kind of risk transfer is agreed upon, one must also consider timing. Some deals are simultaneous sign and close deals therefore, the insurance solution must be in place at signing. Some deals have a gap between sign and close. The buyer cannot transfer insurance until the moment of close because until they own the asset/unit they don't have insurable interest in it. The separate sign and close means we sometimes have time to solve these problems between sign and close. With a simultaneous sign and close it is vital that this issue is tackled long enough ahead of close that the plan is in place in time.
Final thoughts
This issue is tricky, nuanced and impacts deal negotiations, integration and overall EBITDA. Insurance is often an afterthought in a transaction, which is understandable with so many other work streams.
It is vital when picking an RWI broker that you pick one who also has experience and technical expertise in these diligence areas to protect you.
