PI before you buy
Don’t leave yourself without adequate cover during the excitement of a transaction
This article is the first in a series on managing Professional Indemnity (PI) insurance during a transaction. It is designed to provide general guidance on the due diligence that should be conducted in relation to PI. It does not comment on the arrangements for specific types of business, for example law firms, which must take account of the successor practice rules.
The last three years has seen a high level of merger and acquisition activity across the professional and financial services sectors. While complex, transactional due diligence rarely includes a full assessment of PI arrangements, with insurance brokers to both parties often being the last ‘advisers’ to hear about a deal.
In the excitement of a deal, insurance arrangements can take a back seat. Good brokers and engaged insurers, however, can provide invaluable input during a transaction, from helping the acquirer understand the target’s approach to risk to ensuring that insurance policies are aligned to minimise gaps in cover. Careful handling of the insurances will help ensure that a circumstance which may lead to a claim, post-acquisition, isn’t omitted from the claims record and that all past liabilities and future liabilities are, from a PI point of view, insured. Omission in either area could be costly, particularly if insurers decline to provide cover for a future claim.
To be really effective, insurance due diligence should be conducted in tandem with a review of the target’s approach to risk management (the subject of a later article), as there is natural crossover between the two. Suffice to say, a poor approach to one is likely to be mirrored in a poor approach to the other. The insurance due diligence process should be completed before finalising where liabilities will rest, with the sale agreement clearly specifying who is responsible for covering past and future liabilities.
Much of this information will be included in the insurance schedule, the policy wording and completed proposal forms from the last six years. Typically, you would expect all of these documents to be kept on file by the firm being acquired, although your insurance broker will be able to assist with more technical queries, for example, understanding what is and isn’t covered by the policy wording.
It is often the case that a firm appears to tick every box in relation to their approach to buying insurance and managing risk. That does not automatically mean they will never be the subject of a PI claim or that their insurance cover is robust. As with every aspect of risk, business culture is the defining element in ascertaining a true understanding of a firm’s risk profile.
This article is not intended to provide guidance on the key business reasons for an acquisition, for example geographic expansion, diversification or growth, nor is it intended to comment on matters such as ensuring cultural fit or aligning management teams. This should not suggest that these issues aren’t critical to effective risk management, post-acquisition. Poorly thought through acquisitions will undoubtedly have a negative impact on a firm’s risk profile, whether that lack of forethought leads to a decline in employee motivation and engagement or the setting of unrealistic business targets.
Insurance due diligence should incorporate an assessment of the following areas:
1 — Do you understand the work the target firm has carried out over the past 10 years? Particular attention should be paid to higher risk work. A firm that appears to do nothing other than low risk work may once have been involved in far higher risk work.
2 — What impact will the target’s work have on the acquirer’s PI premium? If the target undertakes a lot of high risk work and the intention is to cover all liabilities under one policy, are insurers happy with the impact on risk profile?
3 — Does the last completed proposal form for the target firm accurately represent all work carried out, both now and over the past six years?
4 — Are claims records accurate? Do they reflect the insurer’s view or are they simply based on assumptions made by the insured? Have you interviewed the principals of the target to ensure that all notifiable matters have been disclosed to insurers?
5 — If the firm is required by its regulator to buy a minimum level of cover, does it comply with this requirement and has that always been the case?
6 — What requirements does the regulator impose in terms of cover for past liabilities? This will impact on the run-off arrangements.
7 — Does the policy schedule for the target firms list all current and past subsidiaries? If not, what insurance arrangements have been made?
8 — If the target firm has sold subsidiary companies or discrete trading divisions, do you understand the insurance arrangements for the past liabilities relating to these subsidiaries?
9 — Where the claims history shows a series of claims relating to one employee or a series of employees, are these employees still with the business and what steps have been taken to improve the quality of their work? Is there a need to block notify in relation to other work they’ve undertaken? If yes, how will this block notification be managed?
10 — What is the target’s current excess? If this differs from the acquiring firm’s excess, what arrangements will be made?
11 — What limit of indemnity does the firm buy? If this is greater than that purchased by the acquirer, what arrangements will be made to cover a claim greater than the acquirer’s limit of indemnity?
12 — Has the firm ever conducted any activities excluded from their current PI policy? If yes, what’s the potential impact of a claim in relation to these activities and how will that claim be managed and settled?
13 — What extensions to cover are included in the target firm’s existing PI cover? Are these also present in the acquirer’s PI cover? If not, are these extensions required and are the acquirer’s insurers willing to provide them?
This article was submitted to be published by Howden UK Group Limited as part of their advertising agreement with Today’s Conveyancer. The views expressed in this article are those of the submitter and not those of Today’s Conveyancer.