Risk Management · Insurance · Financial Loss

Not Sure The IRS Agrees With a Tax Position Your Company Has Taken? Here is a Solution

I recently read that Illinois Tool Works (ITW) prevailed in a case against the IRS.  The IRS challenged that a loan from ITW’s foreign subsidiary to its parent company was a nontaxable return of capital as ITW contended.  The IRS dtermined that it was not a loan but a dividend and as a result a taxable event. ITW challenged the IRS and the case was brought to the US Tax Court.  In early August the court released their decision and sided with ITW.  A short write-up can be found here.

Why I bring this up is that many companies have tax positions they are aware of that could be challenged by the IRS.  Companies rely on their accountants to determine whether certain events have tax implications and then proceed accordingly.  Unfortunately, this is not foolproof strategy, the IRS can and will challenge these events even if you are using the best and biggest accountants.  What few companies are aware of is that there is an insurance policy that can protect them in these instances.

Tax Liability insurance can protect against many types of tax issues, including, but not limited to, spinoffs, M&A, multinationals, tax exempts, related party transactions, and foreign investors.  The policy can cover the taxes, interest, defense costs, in some cases fines and penalties, and gross-up.  What is different with this type of insurance compared to traditional property and casualty insurance is that we are covering a known event, or tax position, that may not be 100% clear cut but that we are confident is correct.

The underwriting process is specific to that event and coverage is tailored accordingly. Information is collected on the event and might include commentary from a tax attorney and/or an accountant.  After preliminary info is collected it is presented to the insurance market and the carriers come back with non-binding pricing and terms.  At that point a carrier usually identified that would be a good fit and a more exhaustive underwriting process commences.  At this stage an insured typically pays an underwriting fee that is used to pay for the due diligence (think lawyers and accountants that really dig into the info) that allows the insurer to put together the actual terms and pricing.  Assuming all is in order, the insured can then bind the policy that can have up to a 7 year policy term.

If you are a company and have uncertain tax issues then a tax liability policy is worth looking into.  There is no upfront cost to get a non-binding pricing indication, but be aware that policy pricing is in the 6 figures to start, however, it is a one-time premium and not annual.  The policy limits usually start at $5MM and can go up from there.

Financial Loss · Insurance

Employment Discrimination Lawsuits – What To Know About How Your Insurance Policy Will Respond

It was recently announced that Wells Fargo prevailed in an age discrimination lawsuit.  The claimant was convicted of a crime in 1963 but apparently was not found in the initial background check, but subsequently found when Wells Fargo implemented a new system at which point they fired the employee.  The employee turned around and sued Wells Fargo on the basis of age discrimination.  Wells Fargo won on the basis that federal law bars banks from employing people who have been convicted of crimes involving dishonesty.  More on the case can be found here.

Even though Wells Fargo won the case, the case went to trial so the legal bills were most likely quite large.  Because it was a discrimination claim their employment practices liability insurance policy (Wells Fargo may not have this type of policy but we will assume they did) should have responded and paid the legal fees after the deductible/retention was met.

How could this have played out differently from an insurance perspective?  The most common mistake we see with claims is late reporting, particularly when an insured believes their case is rock solid.  The insured will decide not to report the claim or report it after legal fees start to mount which could jeopardize coverage.  Late reporting can be grounds for a claim denial in the worst case scenario.  A delay in reporting a claim also means the insured incurs more legal fees that will not be reimbursed by the insurer.  The insurance carrier typically does not count any past legal fees against your deductible until the claim is reported.  For example, if you spent $10,000 on legal fees before reporting the claim and your deductible is $10,000 you would have to spend another $10,000 before the deductible is met and the insurance company starts footing the bill.  Most insureds are worried that their “rate” will go up for reporting a claim so they caution on the side of not reporting claims, but in actuality if the claim turns out to be nothing you insurance rate should not be adversely impacted.

What most insureds also do not realize is that their policy is set up as a “duty to defend.”  This means that the carrier is responsible for defense counsel and ultimately has control on how to proceed with the case.  “Duty to defend” is more common for private companies and can be a very sensitive situation when an insured feels they are right and do not want to settle.  The problem is that even when the insurance company agrees that an insured’s case is strong it could still determine that would be more economical to settle the case and move on.  This of course does not sit always sit well with clients, but the policy terms can be amended so that the insured has more of a say in how to defend a claim.  Often times there is a “hammer clause” in the policy as well, which further compels the insured to defer to the insurer.  The “hammer clause” is also something that can be amended.  The important thing is that you as an insured are aware of these coverage conditions so there are no surprises if you have a claim.

Wells Fargo being a large company and most likely having a large retention would not have “duty to defend” language in their policy which is part of the reason this case may have made it all the way to trial.  If there had been “duty to defend” language it may have never made it as far as it did, and probably would have settled a long time ago.  Just because an insured believes they are in the right and the case against them is frivolous does not mean the insurance company will defend it all the way to trial.  Remember, insurers are for-profit companies and their objective is to make money so they will be looking at it from an economic standpoint and what puts them in the best position to be profitable.  This is why it is so important to make sure the terms and conditions are understood and that your broker works to tilt the policy in your favor as much as possible.

Insurance · Life Sciences

How Do You Defend Your Patent?

You may have recently seen that Spineology lost a patent infringement case against Wright Medical.  Spineology sued Wright Medical in 2015 for infringing on their patent and the case went back and forth on appeals, finally ending in July of 2018 with Spineology on the losing end.  A high-level synopsis can be found here.

I bring this to your attention because patents are the life-blood of many companies in the life science industry and yet many companies are vulnerable to either having their patent infringed upon or being forced to defend their patent.  The cost for either is never cheap.  The case went on for three years and one can only imagine how much money was spent in legal fees.  What so few companies know is that there is actually an insurance policy that can insure your patents, it can be set up to both defend and enforce your patents.

Why is patent coverage important and what are the benefits?  Here are a few reasons:

  • If you are and R&D company with no revenue you may not have the financial strength to protect your patent.
  • There are plenty of patent trolls that have bought low-quality patents and use these patents as a basis for demanding royalty payments from you and a patent policy can help defend against these trolls.
  • If you are trying to raise money you can inform investors that you not only have a patent but it is insured which will give them some added comfort.

There are many other reasons to look at patent insurance, but one reason not to dismiss it is because you have hired great IP attorneys.  Having quality IP attorneys is important and recommended, in fact it could help lower the cost of IP insurance, but it can’t help protect you against a third party infringing upon your patent, having to defend your patent, and patent trolls.

What many clients are surprised to learn is how easy it is to determine the economics of the coverage and whether it makes sense to move forward and put it into place.  Many times the initial application can be completed in 15-30 minutes which allows us to get pricing indications.  The worst case is the pricing does not make sense but at least you can report to your board of directors that you did the due diligence on how to protect your patent.  The best case scenario is that you have taken the right steps to protect the patent and the terms and pricing of the insurance reflect that, resulting in an easy decision to put coverage in place.


The California Privacy Act is Coming – Is your Cyber Policy Prepared?

If you are doing business in California you might be unaware that the consumer privacy laws are becoming more stringent espcially if you are not domiciled there.  Failure to adhere to these rules could lead to penalties of up to $7,500 per day.  The good news is that it looks like companies will have until January 1, 2020 to comply.

The most common question I am getting from clients is how does this differ from GDPR?  I am no expert so I will defer to the law firm of Cooley who have done a great synopsis on the Act that can be found here.  Here is what they say are some of the differences:

  • “Obtaining consent under Act differs from the methods required in the GDPR. The GDPR requires affirmative opt-in consent. Under CCPA, consumers need not opt in, but they can opt out of the sale of their personal information. The Act requires new opt-in consent only for the sale of personal information of individuals under the age of 16.
  • ‘The GDPR requires companies to establish a legal basis for processing personal information.  The CCPA does not require businesses to establish a legal basis in order to process personal information, and all processing is legally permissible (subject to some limitations such as opt-in for sale of information).
  • ‘The CCPA requires a particularized disclosure process beyond what the GDPR requires.  This means that compliance with the GDPR’s disclosure process would not necessarily constitute compliance under the CCPA.
  • ‘The GDPR imposes limitations on cross-border data transfers and requires a legal basis for such transfer.  The CCPA does not have any similar requirements.”*

What I see as one of the most important things to be aware of is that Cooley expects regulatory action in the US to be enforced at a more robust level then what we are currently seeing in the EU.

The interesting thing will be how Cyber Insurance carriers handle this.  Will they increase deductibles for regulatory matters in CA much like we have seen with EPL?  Will carriers offer a lower sub-limit for regulatory action?  Will they have exclusions specific to CA or certain regulatory actions?  All of this is to be determined but it is something to be aware of as this could become as the renewal process starts for early 2019 expirations.  If you are doing business in CA your broker should be having these conversations with you.

*Cooley FAQ on CA Consumer Privacy Act – https://cdp.cooley.com/2018/08/02/california-consumer-privacy-act-faqs-1/#section-3


Financial Loss · Insurance · Risk Management

Your Insurance Broker Has No Incentive to Retain You as a Client!!!!

Skin in the game – that means your insurance broker actually having a vested interest in your success and the level of service you receive year in and year out.  Skin in the game does not mean your broker having a greater financial interest in year one compared to subsequent years yet that is how most brokers are paid. Most brokers get paid a set percentage for new business and then see that drop significantly after year one, and at some of the largest brokers that percentage might actually go to zero.  If your broker is always looking for the next deal to maintain their income how do you think that aligns with your interests?  You might say that the service team is incentivized to keep the account, but that is rarely the case, the service team’s is usually paid a salary and a small component of their bonus might be based on how well they service the customer.

At Alliant we believe that we should have a vested interest in your success and that your success leads to our success.  How do we do this?  We as individuals get paid the same percentage every year as long as we retain you as client, we don’t get paid more to bring in new clients or take a haircut after year one.  In fact, if we lose you as a client we feel that in our wallets because that income is gone.

Why am I telling you this?  I tell you this because it demonstrates that we value our existing clients just as much as our new clients.  A lot of brokers come in and tell you a story about service and how good their service is but can’t point to a reason as to why that service level will continue – we can.  We can point out that we actually get paid or, if the service is not good, not paid based on how we service your account – we put our money where our mouth is, we have skin in the game.  How many times has your service fallen off, even just a little bit in each year (cumulatively this could add up and you might not even recognize what good service is anymore), from the initial engagement?  Unfortunately, this is just considered part of how insurance works and what one can expect but it shouldn’t be.  That is why my firm strives to be different, we are not interested in a slow deterioration of service for our clients but a firm and consistent model of service that is the same in year one as it is in year eight.

I probably will get emails from brokers saying you shouldn’t be sharing this information but if we are being transparent about how much the firms are getting paid shouldn’t we be transparent about know how the individuals servicing your account are being compensated?  I am not saying W2’s need to be shared but knowing the structure and how it aligns with a service model I believe are good pieces of information to have because it can be a predictor of the future.  Maybe you are different than me, but when I deal with a “service” provider I want those individuals servicing my account to have repercussions if the level of service is not there but sadly in the insurance industry that is seldom the case.  With Alliant that is exactly the case, if the service drops we feel it in our wallet.


Why Benchmarking Should Not Be Used When Deciding on Directors & Officers Limit

The other day I discussed the rising number of Securities Class Action Filings (here) against publicly traded companies and how they are almost inevitable with just under 9% of all publicly traded companies expected to face a filing in 2018.  D&O insurance will or should respond to these filings which transfers much of the financial burden to the insurance carrier(s).  Almost every publicly traded company has D&O insurance so I am not here to make a case for why you need D&O insurance but instead want to briefly describe what this increase in filings means to the D&O market and take a deep dive on how companies calculate the amount of D&O insurance to carry.

So what is happening in the D&O insurance market?  From a high level, premiums are staying relatively flat unless you are still within the IPO window.  Certain industries, such as Life Science, are a bit more challenging due to claim activity and are seeing rates creep up.  Terms are staying pretty much the same (at least the ones that matter, your broker will always tell you how much your policy improved year over year even if those improvements were irrelevant to you), but I think we may see this evolve over the next 12 months with some recent judicial decisions, time will tell.  Finally, carriers are trying to push retentions (deductibles) higher as a way to remove themselves from trivial legal fees.  If you have experienced something much different than what I have described I would love to hear about it.

What I really want to talk about is how the vast majority of companies go about deciding on how much D&O insurance to buy and why it is probably not the best way to go about it.  So how do companies currently decide how much insurance to buy?  For the most part, they simply look at what they have now, and what their peers are purchasing and then buy accordingly.  Put simply they base the decision off of “benchmarking.”  I think this is the wrong way to go about it.  I have to admit, that this is how I have presented it in the past because it is how most brokers are taught to present D&O insurance.

This is something that I have always given a lot of thought to and deep down knew benchmarking was probably not the best way to go about deciding on the limit of insurance.  For other lines of coverage we take a more analytical approach and try to quantify what a company has “at risk.” We try to determine what a client’s probable maximum loss (PML) is and use this as a starting point for how much insurance to buy.  In D&O, the discussion of PML rarely enters the conversation especially with small and mid-cap companies and instead it is all about benchmarking.

The main problem with using benchmarking for deciding on limit is that benchmarking is a sales tool which is why it is in every broker presentation.  A broker is sales professional, we want you to buy more limit because that means more money in our pocket.  The benchmarking data can be manipulated to show you what the broker wants and that usually means showing that you do not have enough limit compared to your peers.  I am not saying the broker is dishonest or using fraudulent numbers but as we all know you can frame a story practically any way you want with data.  What this also does is artificially inflate the limit that is being bought.  Remember that the broker’s goal is to sell you more limit and every time a company buys another $5 million in coverage that skews the numbers up.

The broker also knows that as the CFO or Risk Manager you will need to present the data to the Board of Directors.  A CFO never wants to go in and have the benchmarking indicate you are underinsured compared to your peers which adds another line of defense for the broker in justifying buying more limit.  How many times has a broker come in and said the benchmarking indicates that you are buying too much D&O insurance and we recommend you scale back?  My guess is you have never heard your broker say that, but there are exceptions.  I can think of a few instance where a company had a large drop in market cap and probably had more limit in place than they ever needed to begin with.  Guess what happened with those companies, they did not come close to exhausting their D&O limits despite the fact there were shareholder claims because of the market cap loss.

How should we go about deciding on a limit?  Like all other insurance we need to focus in on two things – frequency and severity.  How often can we expect claims?  Claims are and should be rare for this type of coverage so we want to look more at how frequently your particular industry has claims to determine how prone vulnerable your company might be to a claim.  How large can a claim could we expect in the worst possible scenario? D&O insurance is driven by severity so this is where we want to drill down and figure out your PML.  What are the average, median and largest settlements for companies similar to yours, whether it be market cap or industry?  What is your company’s risk tolerance?  Do you have cash that could be used in an emergency?  What jurisdiction are you in?  What are the rates of the attorneys you would use and how does this compare to what your carrier is willing to spend?  The other variable is board members, some board members require that you carry a certain limit of insurance or they won’t sit on the board so that has to be brought into consideration as well.

Benchmarking has value, but in my estimation is deemed much more important than it actually is when deciding on the amount of D&O insurance to purchase.  Where I think benchmarking can be informative is on pricing, most companies want to know how they stack up against their peers and whether or not they are getting a good deal.  When it comes to retention it is less important because carriers are trying to always increase retentions so it could be a decision that is not in your hands.  The other variables when it comes to retention are risk tolerance and cash flow, these two things could be much different from company to company.

I doubt benchmarking will be abandoned but I think the conversation has to shift to trying to figure out what the worst possible scenario is for your company.  I understand that benchmarking is nice to look at, makes justifying a decision to your board easier, and that benchmarking is seen as the end all and be all of deciding on a limit.  That being said, with all the data available now shouldn’t we start grounding our decision on what your exposure is versus what your competitor is buying?