Transferring, not acquiring, environmental liabilities
Source: https://axaxl.com/fast-fast-forward, April 23, 2019
By: Mary Ann Susavidge, Chief Underwriting Officer, Environmental Insurance, AXA XL
Environmental liabilities were once notorious for killing business deals. Most businesses didn’t know how to handle their own environmental liability issues, much less take on someone else’s. Fortunately, that’s not the case today. Given the abundance of merger and acquisition activity taking place across all industries these days, nothing seems to be standing in the way.
So far this year, public North American companies have announced 53 deals, according to data prepared for Axios by Dealogic. According to Deloitte’s 2019 M&A trends report: 76% of domestic corporate M&A executives and 87% of domestic private equity M&A executives expect the number of M&A deals to increase in 2019. While businesses may be eager to make M&A deals happen, they cannot be too quick to overlook potential pitfalls or the acquisition of problems that they had no intention of acquiring.
Kicking the tires
The risks of buying another firm are many. While no business jumps into merging or acquiring another company without careful scrutiny, there is always room for some hidden surprises. Potential environment liability continues to be one of the risks that can sneak up on a buyer or seller.
Given the current M&A momentum and with so many other details involved in such a transaction, it can be easy to overlook potential environmental concerns. The right due diligence can uncover or identify historic pollution incidents, potential liabilities or an operation’s non-compliance. And not all environmental due diligence is created equal. Businesses entering into M&A agreements need to be careful, especially when performing environmental due diligence, that their hired help is qualified and working on their behalf.
There’s always a chance that due diligence will fail to identify all environmental liabilities or the projected cost implications of identified risks turns out to be inaccurate or unacceptable to the buyer.
Transactional traction
Representations and warranties insurance has become an essential protection for those involved in M&A activity. Such insurance affords a means by which an M&A transaction buyer can recover directly from an insurer for losses arising out from breaches of the seller’s representations and warranties in the deal documents. And while reps and warranties insurance provides some degree of environmental protection, for many, standalone environmental liability coverage is seen as an equally essential protection in many business deals because it addresses potential environmental exposures more explicitly and comprehensively.
Today, transactional environmental insurance policies are available to offer protection against future environmental claims for both businesses — the one selling and the one buying. Available coverage today offers first-party discovery and third-party liability protection to address possible pollution cleanups and also includes coverage for legal defense, third-party business interruption, contingent transportation and natural resources damage. Coverage enhancements can be added to include other exposures such as risks of non-owned disposal sites, third-party business Interruption, abandoned materials or ‘midnight dumping,’ automatic coverage for newly acquired sites and excess indemnity coverage. Additionally, with policy terms up to 10 years, a standalone environmental policy can help address unforeseen environmental exposures a decade into the future.
Response to an environmental incident or exposures is also an added value of an environmental insurance in addition to reps and warranty coverage. Environmental insurance carriers, like AXA XL, have specialized environmental management/pollution expertise on staff to address the immediate need to remediation and the legal and regulatory issues that accompany environmental liability.
Lenders took notice
Because of the potentially high costs to settle environmental claims, in the past, many lending institutions would charge more on debt or choose to not issue a loan at all when potential environmental liabilities are suspected. Today, instead more lenders have made environmental insurance a loan requirement, giving them, as well as to buyers, tenants and others involved in a transaction added reassurance that the deal’s closing will not be derailed. With environmental insurance programs more available and affordable, lenders now see environmental insurance as an effective risk transfer tool that is less risky than merely relying on environmental due diligence and are more often requiring it as part of a loan agreements.
A successful merger or acquisition often hinges on how those risks are handled to protect the buyer, the seller as well as the future of the new combined enterprise. That’s why another key risk management consideration that is so often overlooked in M&A activity is the adequacy of a company’s liability limits.
Acquisition is certainly a growth strategy, but not adequately growing your insurance coverage to fit the size of a growing business can lead to trouble. A company’s insurance coverage, including its environmental coverage, needs to match its risk profile. And that risk profile can change significantly for larger or more diversified organizations following M&A transactions.
Another area that requires careful evaluation is each company’s mutual commitment to risk management. One company may implement aggressive risk management strategies and then they purchase a company that does not live up to its high-risk management standards. Should an accident or other claim occur following the deal, it could pose a significant risk to quick losses that could eat into the company’s limits of liability. That’s why quickly integrating corporate cultures – including attitudes about environmental risk management – is also an important part of managing the risks involved in M&A activity.
Final thoughts
Worrying about all the details of buying or selling a company, it is easy to overlook insurance needs, but that can only be detrimental to the profitability of the business. Insurance continues to be an important consideration in the process and a key tool in helping the deal move forward and stay a growth opportunity. Environmental insurance offers M&A transactions deal assurance, deal facilitation, long-term financial protection, cleaner exit strategies and claims expertise.
Exercising the same wise business sense that helps grow a business and make it an attractive acquisition or merger partner, more risk managers are taking advantage of innovative insurance programs that keep environmental concerns from ever becoming a deal breaker. Fortunately, with advances in overall risk management strategies, the presence or even the possibility of hidden environmental exposures is no longer squashing deals.
