Rep & Warranty Insurance is a well-known tool to reduce risk and increase cash flow for the M&A industry. But what if your deal is too small (under $50M transaction value) for R&W?
There’s hope for one of the most active sectors in M&A – healthcare, where news of a lesser-known tactic for saving money is all the more important for physicians, owners of healthcare firms and their advisors.
The biggest expense for healthcare owners selling their firms is the cost of their post-deal malpractice insurance. While Rep & Warranty policies often exclude malpractice, there is a “workaround” that can save tens, if not hundreds of thousands of dollars.
Not My Problem…
When a physician group or healthcare company (target) is being acquired, the new parent company becomes responsible for the target’s medical malpractice exposure from the transaction date onward. What the parent company won’t cover is any malpractice incidents that occurred prior to the transaction date. This leaves the target with having to get their own protection for the pre-transaction exposures.
Medical malpractice insurers routinely offer their policyholders this very protection – called an Extended Reporting Period (ERP) or “Tail” policy. Tail policies are built to protect the policyholder from medical malpractice suits brought years after a physician retires or a company closes its doors.
These Tail policies routinely cost a multiple of a policyholder’s annual premium, are non-refundable and must be paid in full at the retirement or transaction date. Since the parent company is not inclined to cover the target’s pre-acquisition exposures, the target must bear the entire cost of the Tail, which can run in the mid six to low seven figures. This cost robs seller’s proceeds at closing.
The Continuity Hurdle
Malpractice Insurers for years were immune to competition on their Tail offerings because their policyholders were automatically eligible for the coverage without having to warrant or otherwise disclose any possible events that may lead to a future malpractice suit. This benefit of uninterrupted coverage is called “Continuity”. Any other competing insurer would require an applicant to make a very broad warrant of “no known facts, events or circumstances which may lead to a Claim”, which puts the new insurer at a great disadvantage.
The value of Continuity has been so strong, most companies don’t even bother seeking an alternative, leaving the incumbents little incentive to lower Tail prices.
The due diligence process in M&A eliminates the advantage of Continuity, because any physician or healthcare entity involved is compelled to make numerous broad representations and warrants of no known malpractice events as part of their agreement.
Should there be any such past incidents that come to mind, they’re fully disclosed BEFORE closing, and in turn, reported to the current malpractice insurer as possible insurable events. These disclosures create a “clean slate” for the target making it a ridiculously attractive risk for a new insurer, which is positioned to offer a Tail policy well below the cost of the incumbent Tail.
Imagine you’re an insurance Underwriter, and you’re presented with a risk that has just – 1) “laundry-listed” every possible event that could give rise to a future malpractice claim to another insurance company, 2) will have no future operations needing insurance because the risk is being acquired , 3) is facing a significant up-charge on their Tail premium by their current insurer, and 4) is contractually obligated to purchase a Tail policy – whatever the price.
Wouldn’t this reduced risk merit a discount? Particularly if the competition is charging a multiple of the expiring rate? This is exactly what alternative Tail insurers are doing. These markets are able to take on the lower risk clients at a premium that is a fraction of the incumbent insurer’s offering.
Examples of targets benefiting from securing alternatives include:
A 30-member physician group reduced their Tail premium from $1.2M to under $800K.
A network of 22 oncology clinics accepted a $200,000 Tail from a new insurer rather than the $375,000 offer from their incumbent insurer.
Too Good to Be True?
Skeptics of alternative Tail policies argue that changing insurers may result in less coverage. Not true. Today’s Tail policies are written to mirror the prior policy wordings, so there is no loss of coverage from such a change.
To ensure the coverage is consistent, Underwriters require a complete copy of the existing policy to review in advance of their offer to confirm coverage levels are maintained.
Others have objected that shopping the insurance will slow down the deal. Reviewing and quoting alternative Tail policies takes a couple of days, so as long as all the information is available from due diligence this task can be completed in short order.
The beauty of this approach is that there is very little time or effort required on the part of the target to get a proposal. The materials needed are already within the due diligence documents:
- Copy of the current malpractice policy
- Currently valued loss runs from the Insurer
- Copy of the incumbent insurer’s written Tail Offer
Keep in mind there is NO obligation to accept an alternative Tail proposal. Seeking an outside quote will not adversely impact the Tail offer from the incumbent insurer and if there’s not enough benefit in changing, the client can simply stay put. The client can’t lose!
How Much Can We Save on Our Deal?
Every deal is different, and the size of the savings can vary. The only real way to know is to have these new and solid med-mal tail insurers quote your deal. In just 15-minutes, we can help you understand your options and potential upside. And in about 2-days, you could have a completed tail policy, ready to plug into your deal.