Sink or Swim: Making Agency Mergers & Acquisitions
It is often said that the two happiest days in a man's life
are the day he buys his boat and the day he sells it. The popularity
of this adage lies in the number of unforeseen headaches that boat
ownership causes for the once enthusiastic, but ultimately careworn,
captain of the ship. The same is true of the insurance professional who
views the impending acquisition of another agency through rose-colored
glasses – with one important difference: both the buyer andthe
seller of an insurance agency should be wary of lurking E&O headaches.
The Agency Seller
The liability of a boat owner is typically assessed on an
'occurrence' basis. Any accidents that happened pre-sale are covered by the
seller's expiring boat policy. Once the sale is signed, sealed and recorded,
any future accidents become the problem of the new owner and his carrier.
Very neat. Very easy to follow.
Not so with "claims made" E&O coverage. At
Swiss Re Corporate Solutions, we often see the situation where an error
that occurred prior to an agency sale is the subject of a claim that comes
after. Who is responsible for that claim? If the selling agency remains in
business, having sold just some of its accounts, it likely has
kept its E&O policy in force. That (absent some coverage issue) will provide
coverage for that late-developing claim. What if the agency effectively
ceases to exist once the sale concludes?
Those pre-sale errors and omissions must be covered in one
of several ways. If the agency merges into the buying agency with all of its
assets and liabilities, those claims will be the
responsibility of the buying agency and its E&O carrier (which,
presumably, knows of the acquisition and has extended coverage to the
acquired business.) That provides protection for the selling agency, but
comes with a caveat that also applies to the second option. The buying
agency simply takes over the selling agency's E&O policy (with the
carrier's prior consent.) Neither is ideal for the selling agency because,
if the buying agency decides to cancel the policy before the statute of
limitations has run, the selling agency will be exposed.
The third – and best – option from an E&O
standpoint: buy an "Extended Reporting Period," also known as an
"ERP" or "tail." Yes, there is a cost for
"tail" coverage, but the burden of paying for E&O coverage
for acts that occurred prior to the date of the agency acquisition can be
part of the negotiations. The benefit to the selling agency is peace of
mind knowing that its lurking E&O exposures will be covered once they
come to light after the sale.
The Agency Buyer
In our experience, the ERP is also the best option for the
buying agency from an E&O standpoint. In that scenario, the mistakes of
the selling agency that surface post-sale will be charged to that expiring
policy, not the buying agency's loss history. Simply absorbing the selling
agency may seem like a cost-effective approach, but that assumes that the
selling agency has no E&O skeletons in its closet. You did your due
diligence and looked at loss runs. However, the unreported claims are not
on the loss runs yet and those could keep you up at night.
The following five points make E&O sense for the buying
- Acquire assets only, not
- Have the selling agency
purchase an ERP
- Promptly notify its
E&O carrier regarding the acquisition
- If the acquired business
must be referenced in the E&O policy, it should only refer to
'Buying Agency d/b/a Selling Agency' (because the selling agency's
name is often used for a time as its business is transitioned over)
- Attach a retro date to
the acquired business to make it clear that no liabilities have been
These actions mitigate the potential for any 'inherited'
E&O, but not entirely. It is not enough for the buying agency to say
that, "the error was made on my predecessor's watch!" Not if it
continued, unabated, on yours. Once a customer/policy is taken over by the
buying agency, that ticking time bomb needs to found. How quickly? That
varies from state to state and case to case, but if the policy has gone
through at least one renewal at the buying agency? Both agencies will
likely be named in the complaint. If it has gone through several renewals?
The selling agency's ERP may have expired by this time, but it probably
won't matter, because the buying agency will be solidly on the hook.
How does that happen? Again, it varies with the nature of
the policy and the error, but one continuing theme has emerged: the blind
producer. This refers not to any actual deficiency in sight, but rather, an
inability to see one's own mistakes. Oftentimes the person who made the
original mistake is brought over from his former agency as part of the
acquisition to continue working the same accounts. That practice has many
benefits, but can be a serious drawback when it comes to ensuring that the
business practices of the selling agency and its personnel are up to the
standards of the buying agency. The best practice in these situations: a
second set of eyes – at least on an audit basis.
Experience has taught E&O claim professionals over and
over again that it is as important to sell to a good agency as it is
to buy from a good agency. Due diligence has its
limitations, so to be on the safe side, both parties to a buy/sell
agreement would do well to take steps to ensure that they are protected
from an E&O standpoint. That's why, before signing the deal, you should
consult with all your experts: your accountant, your lawyer and your
current E&O carrier.
That old saying got it right: when the dust settles, you'll
probably want to unload that troublesome boat that your brother-in-law
talked you into; but if handled properly, an agency
acquisition can be a win/win for both sides for years to come.
Matthew Davis is a vice president and claims manager at
Swiss Re Corporate Solutions, working out of the office in Kansas City,
Missouri.Insurance products underwritten by Westport Insurance Corporation,
Overland Park, Kansas, a member of Swiss Re Corporate Solutions.