By now I think we have all seen that Marriott was hacked. What I find astonishing is not that they were hacked but how fast the lawsuits have been filed. I have already read about numerous lawsuits, some coming just hours after the hack was announced. For an insurance broker, making a case of why clients need cyber insurance is not a tough case to make, but there is another lesson that can be learned.
The vast majority of companies I speak with believe there is a very low risk that they will have a claim and I tend to agree with them, but that does not mean insurance will not be used. There is very little that prevents your company from being drawn into lawsuits, even if you were not negligent. Getting pulled into lawsuits costs money, possibly a lot of money, even if you are eventually proven innocent. This is why insurance is important, if the allegation is a covered claim then your insurance policy should be paying to defend you.
There are a couple of things to be cognizant of when it comes to the insurance company defending you.
- It could erode your limits of insurance, meaning you won’t have as much insurance to pay claims.
- The insurance company may have the right to choose counsel and decide how to defend the lawsuit. For example, they could decide to settle the claim against your wishes.
- The amount you spend on defense may not start reducing your deductible/retention until you have put the carrier on notice.
- Most policies have some sort of provisions on when you need to provide notice to the carrier which if not followed could jeopardize coverage.
These are just a few things that you want to pay attention to when you are served with a lawsuit. The important thing to remember is that you should make the carrier aware of the claim sooner rather than later, even if you don’t think the lawsuit is going anywhere. I have seen some desperate plaintiffs drag lawsuits on for a long time making even groundless lawsuits quite expensive.
Today there was an article in STAT about the shortage of manufacturing capacity for gene therapy companies (find the article here). The article goes on to talk about how the problem might only get worse as companies pursue indications in larger patient populations and the trial sizes get bigger and bigger. There was also a comment about by the CEO of an immunotherapy company pointing out that immunotherapy companies are dealing with the same issue.
When I see articles on this subject I automatically think of supply chain risk, particularly for companies that are sole sourced, which is pretty much all gene therapy and immunotherapy companies. Some of these companies are trying to bring the manufacturing in-house as early as possible which alleviates some supply chain issues but not all. Companies that manufacture in-house or outsource manufacturing have the same risk if manufacturing is disrupted; if there is a fire or some other type of event that shuts manufacturing down companies will be negatively impacted, resulting in lower revenue or delayed clinical trials.
Insurance can alleviate this risk, but unfortunately companies do not usually have their policies setup correctly to protect against these losses. Most companies mistakenly believe that their business income will provide coverage, but this would only be true if a company manufactures in-house. If a company outsources their manufacturing then business income would not respond, dependent or contingent business income coverage would be needed to have protection. I talk to countless CFOs who incorrectly believe these two coverages are one in the same, but they are not. The CFO will point out that they have blanket business income, but that will only cover losses that occur at your locations and not third party locations.
If you are dual-sourced company or have a contingent manufacturing plan in place then dependent business income insurance is not nearly as important for you as a company that is sole-sourced but still something to be considered. If, on the other hand, you are sole-sourced (either manufacturing yourself our using a single CMO) you need to pay special attention to this coverage in your property policy or you could be putting your company at risk.
Today I had the privilege of attending the NJ Tech Council CFO Forum at EY in Iselin (Metropark), NJ. The featured speaker was Jim Mastakas (bio), the current Senior VP and CFO of Virtus Pharmaceuticals, and who previously worked at Amneal. Jim was there to speak about his time at Amneal and the deal he helped close with Impax Labs valued at approximately $7 billion.
Amneal was a private generic drug company that merged with Impax Labs earlier in 2018. Impax Labs was publicly traded company, but Amneal was the more valuable company. When the deal finally closed the split in ownership split was 75% Amneal and 25% Impax Labs, with the combined company retaining the Anmeal name and becoming a public company (AMRX). The deal was transformational for both companies as the combined company became the 5th largest generic drug company in the US, with expected revenues of $2.6 billion.
Jim talked about the challenges of getting the deal across the finish line and what he thought CFOs need to pay particular attention to. For a deal to close a lot of things need to go right and from an operational standpoint some of these are obvious. Some of the less obvious things a CFO needs to be aware of are:
- Making sure proper confidentiality was in place both externally and internally
- Knowing you will need to manage a CEO’s expectations when it comes to the numbers
- Assuming your company is like most, stretched pretty thin, being prepared to lobby for extra help in the due diligence
- Managing employees’ motivation in getting the due diligence completed. This can be done through compensation and because employees know there is someone who does a similar job on the other side of the transaction
- Making sure there is a person whose sole job is integration of the two companies so that those synergies are realized. You can expect this to be done correctly if this is a part-time job for a current employee, the person has to devote all of their time to this.
The one thing he would have probably done differently was not have updated Amneal’s forecast as frequently as he did. The reason for this was two-fold. First, a lot of time and effort was put into these forecasts every time they needed to be redone, time that he and his staff really did not have. Secondly, it could have possibly undermined the confidence that Impax had in the numbers since they changed so often. Ultimately, Jim did not feel that happened but felt it was a real possibility.
This was a great event and Jim did a wonderful job of walking through the transaction and what went down. Kudos to NJTC for putting it on and EY for hosting.
When designing an insurance program should we think about adding coverage or eliminating risk? Most brokers think about adding coverage while clients think about how they can curtail risk. You might think these opposing approaches would get you to the same place in the end but that is not necessarily true.
The problem I have encountered with new clients is that they were never aware of all of the different type of insurance coverages that are available in the marketplace. Couple that with brokers inclined to present only programs that they understand or are aware of and the result is an insured that is left vulnerable to having uninsured risks that otherwise could and should be insured. The conversation around risk management should first start with figuring out the risks that a client has and what their most valuable assets are. The risks should not be limited to what we think are “insurable” risks but all risks a company has.
Once we have identified what keeps a company CEO or CFO up at night we can then begin strategizing on the role insurance can play in reducing a client’s risk. I hear on a regular basis that a company’s patent portfolio is one of their most important assets but they have never had a discussion about insuring the portfolio despite the fact that commercial insurance is available to protect patents. Nowadays every broker and client wants to talk about cyber insurance, and everyone has that risk to some extent, but would a cyber breach or a patent infringement do more damage to your company? If you are a manufacturer is your broker talking to you about Manufacturer’s Errors & Omissions coverage? Is your company looking at acquisitions and if so how deep have the conversations gone in regards to tax liability and reps and warranties coverage? These are just a few examples and coverages that are not very innocuous but yet are still rarely talked about.
The point is, most brokers talk about coverage that is available and try to fit a client’s risks into the insurance box instead of designing the insurance program around the risks. Remember, an insurance broker represents you the client, and our job is to figure out your risks and then negotiate with insurance companies to get as much covered as we can. A broker’s job is not to take what an insurance company offers and make your risk fit into their product, but not negotiate with them to get the broadest coverage that is customized for what your risks are as a company.
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.
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.
I recently attended an event for CFO’s and one of the sessions was about insurance and who is the real beneficiary of an insurance policy – the insurer or the insured. For the most part insurance companies are for-profit entities, many publicly traded. They have shareholders to answer to and quarterly results to meet. The insurance company has the added advantage of writing the insurance policy, and yes, that 800 page policy is in fact a contract. Add these things up and it is clear that the intention of the insurance company is to make money and be the beneficiary of the insurance policy. On the micro they may lose money on a policy or two but on the macro they hope to collect more premium dollars than they pay out in claims.
How do insurance companies make money? The most obvious way is to insure the entities that they have deemed the safest or least risky and charge the maximum amount of premium that the market will allow. The problem with this is that all insurers want those same types of business so the premium is driven down and an insurer may not feel the premium is adequate for the risk. In addition, there are financial requirements set forth by regulators and rating agencies such as AM Best that insurance companies need to be mindful of. Because there are so many insurance companies it is hard for an insurance company to control premium, the market dictates what the premium should be. There are exceptions, such as high hazard industries or geographies where there are not as many insurance companies willing to insure, but for the most part there is enough competition that premium can be driven down.
Okay, so competition is fierce and as a result premiums are being driven down so why aren’t insurance companies going out of business? The answer, and what a consumer should be most concerned about, is that all insurance is not equal. A property policy from insurance company A is not necessarily the same as the insurance policy from company B and this is how companies can make money. That insurance policy is hundreds of pages for a reason, there is a lot of information in it. What insureds need to know is not what is included but what is excluded and there is a whole section on things that are excluded. In addition, there are “endorsements” that exclude coverage. There is another section called definitions and the objective here is to clarify what something is and that definition may not align with your definition. All of these different things are used by the insurance company to not pay claims. How crazy is this, there is a certain way claims need to be reported and if these procedures are not followed the insurance company can decline your otherwise covered claim.
An insurance policy is a unilateral contract. The insurance company has the enforceable promise and the insured simply needs to pay a premium to keep that contract in place. This allows the insurance carrier to set the rules and tilt those rules in their favor. Many times I find the insured does not know the rules because their broker never told them the rules. The broker told them that they saved them X amount of dollars, but really that was the market that saved them money. A broker should be telling their clients where they eliminated some of the “loopholes” that insurers use to get out of claims and where these loopholes might still exist. If a broker isn’t telling you what loopholes were eliminated, what loopholes could be eliminated at an additional cost, and what can’t be eliminated how can an insured properly estimate the financial risk that has been transferred off of one’s balance sheet? Even scarier, what risks are you self-insuring that you thought were covered by your insurance policy?