There is a tremendous amount of mergers and acquisitions activity going on in our industry. Every day, insurance news providers report on insurance acquisitions. The big agencies are not only getting bigger, they seem to becoming more diversified.
There are many issues involved for these agencies and others in the acquisition mode. What happens with the staff? What about the offices? How do they get the new agency onto the existing agency management system? Without a doubt, many other issues must be discussed and resolved. What about errors and omissions (E&O) for the buyer and the seller? Is this even on the list? Often it is not – and yet without the proper structure, agencies could find themselves, whether they are the buyer or the seller, without the proper coverage.
Bring in Your E&O Carrier
Both parties must realize that not all E&O carriers handle this transaction the same. The process could vary, depending on whether the transaction is a merger or an acquisition. So, it is important to know exactly what the transaction technically is. As a result, it is best to contact your E&O carrier and advise them of your intentions, letting them help guide you through the process and the issues. They will ask you the key questions and advise you of any paperwork that must be completed.
For the buyer, the traditional approach is to have your E&O policy endorsed to provide coverage for the “new” agency. The coverage, commonly called a Purchased Entity Endorsement, will provide coverage for errors made by the “new” agency beginning with the effective date of the acquisition. In other words, the policy will not provide coverage for errors made by the “new” agency prior to the date of the sale. More about this later.
Will the E&O carrier provide this coverage automatically? No. This is why you should bring your E&O carrier into the discussion early on. If you are a retail agency and are acquiring a wholesaler, or an agency that specializes in a tough class of business, your E&O carrier might not be so agreeable.
Buy the Longest Option
Is there a premium involved? Typically, there is – although some E&O carriers might not make a premium charge until the next renewal. This is another example that demonstrates that not all E&O carriers handle this issue the same. Some of the more preeminent E&O carriers in the market provide 90 days of automatic coverage when you buy an agency. This is a significant issue and benefit.
For the agency that is selling, although there are a number of approaches, some options can cause serious issues down the road. Once again, it is best to contact the E&O carrier and advise them of the plan to sell the agency.
The traditional approach involves the seller purchasing an extended reporting period endorsement (a.k.a “tail”). This provides an additional period of time after the expiration of the policy for which valid claims will continue to be accepted, provided the wrongful act occurred before the end of the policy period. While virtually all claims-made policies contain this provision, this does not mean there is consistency among carriers as to the available options. Some policies may only allow options up to three years, while some carriers provide up to 10 years – or even an unlimited period. There is a premium associated with this – 200 percent of the last full annual premium for a 10-year tail is common – so be sure to plan for this expense.
You only have a finite time to make this important decision, so don’t delay. You cannot buy a three-year tail, and then buy another three years, three years later. This is a one-time decision, so give it serious consideration. Buying the longest option available is highly recommended.
The Best Protection
E&O policies are not assignable. Giving your E&O policy to the buyer and requesting that they keep making the payments could very well leave both the buyer and seller with absolutely no coverage if a problem develops.
From time to time, a buyer agrees to provide coverage for the seller on an ongoing basis under the buyer’s E&O coverage. Is this a good deal? It may appear so on the surface, but it is fraught with problems. Consider the following:
- What if the buyer’s E&O policy is not as broad and thus does not cover all of the activities the seller had covered under its policy?
- If the deductible is higher or is of a different type (loss-only as opposed to a combined loss and expense deductible), the seller could find itself paying more if an E&O problem develops based on an error prior to the date of the sale.
- What is the E&O for the buyer that is non-renewed due to loss history and when the buyer cannot find coverage or finds inferior coverage? The seller is now at the mercy of this decision.
Whether you are the buyer or the seller, there are definite E&O implications that must be carefully discussed and resolved. Including your E&O carrier in the discussion should help you make the right decision.
The bottom line is that the seller has no control over its E&O coverage. Purchasing a tail under your own E&O policy provides the best protection.
Pearsall, CPCU, ARM, is president of Pearsall Associates Inc., a risk management consulting firm specializing helping agents protect themselves. He is also a special consultant to the Utica National Agents E&O program. Phone: 315-768- 1534. E-mail: firstname.lastname@example.org.