Tail Insurance – What Is It and Why You Need It – Video

If you’re in the process of selling your company, the buyer or buyer’s attorney may insist that you purchase something called tail insurance, which you’ve never heard of before.

What’s a tail?  What’s tail insurance?  Why do I need it, and why do I need it now that I’m selling my business?

Okay, so you’re in the process of selling your company, and the need for tail insurance has come up, and you’re not sure what it is or why you need it. Especially given that you’re now exiting the business, why do you need to buy more insurance?

Well, it’s not more insurance; it’s an extension of what you already have.

Tail insurance is sort of a weird name that’s been used to describe the more formal term of “extended reporting period” or ERP, and it will apply to claims made policies you may already have, such as E&O or Errors & Omissions Insurance, Cyber Insurance, and D&O or directors and officers liability insurance.

It may even apply to contractors’ E&O insurance if you’re in the construction trades.

Why do you need tail insurance for your company’s sale?

The policies I described are all written on a claims-made policy form, and one of the features of claims-made is that for a claim to be covered, it must be “made” or reported to the insurer of the policy, which is effective at the time of the reporting.

Another unusual feature of most claims-made policies is that they contain a change in control provision, which says that when 50% or more of the insured company is sold, merged, or consolidated into another company, the policy terminates as of the signing of that merger agreement.

There are some differing extensions in different policies in different states, but for now, assume that when you sell your firm, your claims-made policies automatically terminate.

So, what’s the problem or issue?

Well, due to the nature of a claims-made policy and the risks they insure, there is always the potential of latent claims – meaning something may have occurred before your closing date – it could have been 3 months ago, it could have been three years ago – which could give rise to a claim post-close.

As I mentioned earlier, for a claim to be covered in a claims-made policy, the policy must be in effect when it’s reported to the insurer, and given that your policy terminates at the closing, there’s now no active policy to report it to.

That creates an uninsured liability for the buyer, so they request that you purchase a tail insurance. The tail holds the window open to report claims post-close for acts that occurred pre-close.

Now, you may be saying, why doesn’t the buyer in this example just report this claim to their insurer post-close?

Good question.

The answer is that the claim did not involve the new owner, so it’s not covered under their policy. Again, this leads to the need for tail insurance.

So, how does a tail insurance or extended reporting period work?

Before closing on your deal, when you have a claim made policy or policies you should contact your broker to discuss this issue and coordinate this with your attorney as well to make sure you have everything buttoned up. But this is how it looks graphically:

You have an existing E&O or Cyber or D&O policy that is claims-made. It renewed on 1/1/22 in this example and will renew again on 1/1/23. On September 1 the company is sold and coverage terminates.

There could be claims lurking out there that haven’t been reported, so the buyer wants protection for those potential claims, so you’re required to purchase a tail of anywhere from 3 to 6 years. Often, that duration will be negotiated based on indemnity agreements.

The tail insurance or extended reporting period only permits claims that had their origin before the termination of the policy to be reported.

If somehow an act took place, say, 5 or 6 months after the policy terminates, the tail will not pick that up.

That’s likely a buyer’s liability and should be covered under the new policy they purchase for the company or the policy the buyer already had and merged the sold company’s exposure into.

What does Tail Insurance cost?

Most claims-made policies will indicate the cost of an extended reporting period or tail for one to three-year options, and the range for the three-year option is about 130% to 200% of the expiring policy’s annual premium.

So, if you’re paying $20,000 a year for an E&O policy, the 3-year tail will cost you anywhere between $26,000 to $40,000.

In some situations, you may need to provide a 6-year tail, and most claims-made policies don’t include their pricing options out this far, so your broker will need to negotiate that with your insurer, but expect it to be pricy.

Now, what if you don’t have E&O, D&O, or Cyber, and the buyer of your firm is mandating that you do?

It seems odd, but again, the buyer wants to push potential liabilities away from them post-closing, so here, you’ll need what’s known as a run-off policy.

I did a video on that, which goes into more detail, and you can view it here: D&O Run-Off Insurance. What it is, and why you may need it.

But it’s a one-day policy with a tail to cover your obligations in a deal.

Okay, I think that covers most of the topics regarding tail insurance in M&A, but if you have a specific question or issue I didn’t cover here, reach out, and let’s connect.  You can hit that “get insured now” button to connect.

Thanks!