E&O Issues relating to Mergers and Acquisitions

In the onslaught of M&A activity in 2010 we are seeing many issues relating to Errors and Omissions Insurance that we feel needs to be addressed. Below are some of the more prominent issues to be addressed in a merger or acquisition as it relates to your E&O insurance policy.

Change in Control Provisions

A change in control occurs typically when there is a change in ownership of more than 50% of the voting stock. However, some E&O policies may treat changes of more than only 25% as a change in control. When a change in control occurs, the policy triggers several changes which can include an outright termination of the policy. Highlighted below are some of the more prominent potential issues.

1. The E&O policy terminates effective immediately and will not cover any claims for services provided subsequent to the acquisition date.

2. The policy continues to stay in force, but will not cover any claims for professional services subsequent to the date of the change in control.

3. The policy becomes fully paid up. This means that there will be no returned premium in the event of cancellation of the policy. This is important since most carriers will allow the insured to use unearned premium to offset the cost of an extended reporting endorsement.

4. The E&O insurance policy may only allow an insured to purchase an extended reporting endorsement if the carrier cancels or non-renews the policy. It is therefore possible that an insured may not have the ability to purchase an extended reporting endorsement in the event of a sale, merger, or simply closing their business.

5. The insured will only have a specific amount of time to report the change in control to the E&O carrier and to pay premiums relating to any extended reporting endorsement. If you fail to report the sale/merger to your carrier and pass the time period allotted to report the matter (typically 30 days), then the insured may not have the ability to purchase an extended reporting endorsement. This means there will be not be any coverage available to pay claims reported in the future that may have occurred during the policy period.

Extended Reporting Options

Most E&O policies will provide the ability to purchase an extended reporting endorsement. This additional coverage allows an insured to report claims in the future for wrongful acts that occurred subsequent to the retroactive date in the policy and prior to the date of the acquisition for some period. This additional period of time to report claims is purchased in 12 month increments ranging from 12 to 60 months. The most common is 36 months. The cost of this additional time to report claims averages about 100% of expiring premium for 12 month to 200% or 250% for 36 months.

Insured Entities and Predecessor Companies

The acquiring company will typically up the E&O coverage for the acquired entity on its own policy. It is imperative that the acquiring company work closely with the broker and the acquired company to ensure that the policy provisions, named insureds and covered professional services are properly on the new policy. Often companies that were acquired or sold in the past are not listed on the new policy and are subject to future uncovered claims. A specific list of all companies, DBA’s, and predecessor companies should be provided to the new company and its broker.

Professional Services to be Covered

Each company is unique and so are their E&O policies. When moving Errors and Omissions Insurance coverage to the new entity it is imperative that the full scope of professional services of the acquired company be taken into consideration when adding to the new company’s policy. We often find that the acquiring company’s E&O policy is less comprehensive and they simply overlook the uniqueness of the Professional Services provided by the acquired company. It is important to make sure that these Professional Services are covered under the acquiring company’s E&O policy. Often such nuances are overlooked in the acquisition.

Entities/ Divisions Acquired

In some acquisitions, only a portion of a company is being acquired. This creates some unique issues since it addresses the issue of: “can you purchase an extended reporting endorsement for only a portion of the policy”. We have successfully provided options to do just that. Another issue to consider is that when a substantial portion of a company is sold, its liabilities may still remain. What this means is that the operations remaining will continue to have to pay E&O premiums based on the combined entity for about 3-5 years depending upon the nature of the business. The company remaining may not have taken into consideration that they would have to continue to pay for the risk of the entire entity subsequent to the sale.

The above are just highlight of some of the E&O insurance issues relating to acquisitions and your E&O policy. Call the Professionals at Axis Insurance Services, LLC to discuss how we might assist in the acquisition process.

Mike W Smith, Principal

Axis Insurance Services LLC

www.axisins.com

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