Corporate acquisitions involve considerable responsibilities, coupled with sizeable risks, primarily arising from past activities of the acquired business. Run-off Insurance and Warranties & Indemnity (W&I) insurance are two distinct forms of coverage designed to effectively manage such potential liabilities.
Unpacking Run-off Insurance
Run-off Insurance is essentially a risk management tool that offers protection for claims rooted in the activities of a business before it ceases operation. This coverage extends beyond the lifespan of the business, defending against potential lawsuits originating from historical actions, errors, or omissions.
Functioning as an augmentation to an existing Professional Indemnity insurance policy, Run-off Insurance comes into force when a company ceases to trade. Crucially, for a claim to be valid, an active policy must be in place at the time the claim is made.
Professional Indemnity insurance is essential across various sectors, some of which mandate Run-off insurance as well. The duration of the coverage can range, typically up to seven years, depending on the professional field and risk evaluation.
Run-off Insurance: The Where & When
The window of risk persists even after a business operation concludes or a critical player exits. This is where Run-off insurance becomes vital, safeguarding Directors & Officers from claims associated with historical work, regardless of the business's current state.
It is important to distinguish between Claims Made Liability and Occurrence Based Liability. The former provides coverage only for claims made while the policy is active, whereas Occurrence Based Liability covers an event that occurs during the active policy period, regardless of the timing of the claim. Run-off insurance proves indispensable for Claims Made policies, ensuring protection extends even after business operations cease.
Run-off Insurance: The Why
Without Run-off insurance, individuals or business entities could be exposed to significant personal liability for claims arising from past deeds, even after their tenure in the business. Scenarios warranting Run-off insurance may include retirement, business dissolution, management shift, acquisitions or mergers, compliance with industry standards, contractual obligations, or non-renewal of an insurance policy by an insurer.
Demystifying Warranties & Indemnity Insurance
As a vital component in Mergers and Acquisitions (M&A), W&I Insurance offers financial protection to either the buyer (through a buy-side policy) or the seller (via a sell-side policy) from losses resulting from a breach of warranties or indemnities as outlined in the Sale and Purchase Agreement (SPA).
W&I Insurance comes in three forms:
1. Buy-Side Insurance indemnifies the buyer for losses due to breaches of warranties or indemnities in the SPA. The premium for this insurance can be paid by either the buyer or the seller as agreed in the SPA.
2. Sell-Side Insurance offers protection to the seller when the buyer claims for losses arising from breaches in the SPA. In this scenario, the seller claims against the W&I insurance policy, and the buyer does not have direct recourse against the W&I insurer. The seller pays the premium for the insurance.
3. Sell-Side Flip is predominantly used in competitive sales situations. It starts with the seller engaging a W&I insurance broker to obtain indicative pricing and coverage terms. Once the preferred bidder is selected, the broker 'flips' to work with the bidder and the chosen W&I insurer to place the insurance and negotiate coverage terms. Usually, the buyer pays the premium.
Advantages of Warranties & Indemnity Insurance
W&I insurance offers numerous benefits to both buyers and sellers. For buyers, it simplifies the process of recovery against a W&I insurer, mitigates the need to assess the sellers' financial capabilities, uncovers additional risks, enhances a competitive sales bid, and it reduces the risk profile of a transaction.
Sellers, on the other hand, benefit from immediate access to funds, making for a clean exit, which is particularly beneficial in distressed asset sales or private equity exits. It also assigns a fixed, known cost to various transaction risks.
For both buyers and sellers, W&I insurance can accelerate deals by mitigating deal-breaking risks and preserving relationships, especially when the management remains in the business post-acquisition.
Run-off insurance and W&I insurance act as protective measures during business acquisitions. Not only do they provide protection to the stakeholders involved in the transaction, but they also facilitate the deal by mitigating potential hurdles. Engaging a professional insurance broker can help ensure you have appropriate protection tailored to your specific needs, helping you navigate the complexities of business acquisitions with confidence.
To find out more about using Run-off Insurance and Warranties & Indemnity (W&I) insurance to help to manage risks and cover unforeseen liabilities, feel free to reach out at any time.
Placement Manager - Professional & Executive Risk
Honan Insurance Group Pty Ltd (Honan) (Australian Financial Services Licence no. 246749, ABN 67 005 372 396) is an insurance broker acting as agent for insureds and intending insureds. Honan is not an insurer. The information in these articles are current as at the date of first publication and have been prepared without taking into account your objectives, financial situation or needs. Any advice provided in these articles is of a general nature only. Any statements concerning tax, accounting or legal matters are based solely on Honan’s experience as an insurance broker and are not to be relied upon as accounting, tax or legal advice. Before making a decision to purchase an insurance policy, please read the relevant Product Disclosure Statement to make sure the policy is right for you. Insurance cover is subject to policy terms and conditions including policy limits and exclusions.