February 1, 2000

2 Min Read
INSURANCE: Innovative Insurance Equals Less Acquired Risk

Joseph Catanese

In the Wall Street Journal's list of 1999's hottest mergers, a Harvard University Professor of Finance Samuel Hayes was quoted as saying, "Whenever you buy another firm, you're buying a pig in a poke; you never know what you're buying until you open the bag and see the animal."

The Harvard professor's words ring true. Buying another firm entails many risks. But insurance programs protect the buyer and seller - thus addressing liability issues and concerns.

In the past, environmental liabilities were deal breakers. However, today's risk management strategies and insurance products prevent hidden environmental exposures from squashing deals. Now, insurance programs are as innovative as the transactions.

Insurance gives buyers comfort when closing a transactions. For example, a power utility recently purchased 12 bulk storage facilities and four propane distribution centers from a petroleum distributor. While an attractive buy for the utility, the facility required $10 million in cleanup. The buyer did not want to assume liability, so the utility suggested that the seller place $10 million in escrow. Anxious to sell, the distributor sought another solution.

With the insurance broker's guidance, the seller purchased a program that combined an insurance policy with a funding mechanism for known and unknown environmental liabilities. With a $75 million liability limit, the policy was comprehensive and protected the seller and buyer against future claims. The policy also offered several types of other insurance including Remediation Stop Loss, which capped known cleanup activity costs. Next, the distributor's insurer suggested that $4 million was placed in escrow instead of the originally requested $10 million.

The additional anticipated $6 million in cleanup expenses was "fronted" by the insurer, which would collect the money through the seller's insurance policy. The provider also could collect from the Underground Storage Tank state fund, which helps owners pay cleanup costs, remediation and more.

This insurance program benefited both parties by satisfying concerns and allowing the seller to transfer its liabilities to its insurance provider. It also protected the buyer by naming the seller on the policy.

Working with a qualified insurance provider allowed both parties access to better project management. For example, $4 million instead of $10 million was a fair allocation of the cleanup costs. This program could be used to reduce after tax costs, since some insurance premiums can be a tax deduction.

So as the solid waste industry faces deal-breaking obstacles, the good news is that insurers can help design solutions to help bring a transaction to fruition.

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