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 October 22, 1999

New insurance solutions can reduce risk in mergers

In Denver and throughout the United States, a growing number of businesses are using mergers and acquisitions (M&A) to achieve growth, enhance profitability and increase competitiveness.

Overall, more than 9,000 M&A transactions involving U.S. businesses were completed in 1998; their total value exceeded $1.3 trillion, the largest amount ever. With blockbuster companies like U S West and TCI recently merging with other huge companies, this figure is even higher.

Despite these historic figures, it takes more than a handshake to complete a business combination. In fact, about one in eight M&A deals fail in the United States. Regardless of the reason, the price for a transaction gone awry is high. The painful effect on earnings, dividends, credit ratings or future borrowing ability often are magnified by a significant drain on management’s time.

Until recently, the risks of a deal falling through or of an acquirer failing to realize the anticipated benefits from a merger were simply a fact of business life that had to be accepted. However, today, new financial and insurance solutions can take much, if not all, of the sting out of these exposures — and enhance the value of a deal in the process.

For example, following are some new insurance coverages that can take the uncertainties out of mergers and acquisitions:

Aborted Bid Cost Insurance : This program can pay professional expenses associated with a failed merger attempt, including legal, accounting, stockbroker and investment banking fees, as well as costs for advertising, public relations, management consultants, lobbyists and proxy solicitors. These costs typically equal 1 percent to 4 percent of a merger’s value. The policy pays if the bid is unsuccessful due to failure to gain regulatory approval, the other party’s inability to meet closing conditions, loss of financing, or the other party’s acceptance of a higher offer, among other stated causes.

Litigation Liability Caps: The due diligence process frequently unveils pending litigation that can stop a deal. New insurance solutions can minimize these risks. The products enable negotiating parties to isolate potential liability from securities, patent, breach of contract, environmental and general liability litigation and remove it from the balance sheet.

Representations and Warranties Insurance: This coverage can be used to satisfy a transaction’s indemnification or escrow requirements, which often are the subject of difficult negotiations between buyers and sellers. The coverage can be structured to benefit either the buyer or the seller; it responds to the specific terms of the purchase-and-sale agreement while providing a blanket cover for the stated representations and warranties.

Environmental insurance: Environmental risks frequently stall mergers and acquisitions because cleanups and related costs can be substantial as well as difficult to estimate — but they must be reflected in the transaction price. There are several insurance solutions that can address these issues. One program allows companies to cap their expenses for cleaning sites with known contamination. It limits the cost of cleanups by eliminating the risk of related cost overruns.

Tax Opinion Insurance: M&A-related tax issues can be complex and the resulting uncertainties can make sellers and buyers alike walk away from a deal. In many instances, businesses procure an “opinion letter” from their tax adviser on the ability of a tax strategy to withstand review by the IRS or foreign revenue authority. However, the opinions generally offer limited comfort and no certainty. Tax opinion guarantee insurance reinforces the professional opinion of the company’s tax advisor and removes some uncertainty surrounding tax issues. The insurance can reimburse the company for denied tax benefits, related fines, penalties and legal costs to contest the decision.

In addition to insurance solutions designed for mergers and acquisitions, businesses involved in these transactions often must sharpen their focus on their traditional risks and related insurance. Directors and officers claims for businesses involved in mergers and acquisitions are double those of other companies. Employment practices suits related to mergers are on the rise and include claims for discrimination and wrongful termination. Fidelity losses and errors and omissions risks abound.

As part of their due-diligence, businesses need to examine both unfunded and underfunded liabilities, claims that have yet to be reported, low liability reserves, as well as product liability and environmental exposures. In addition, there are numerous financial risks, such as fiduciary exposures, credit and contractual risks and financial statement exposures. There are also exposures related to self-insurance, retroactive insurance plans, and insurance captives.

As mergers and acquisitions become increasingly complex, finding solutions to impediments will depend on the resourcefulness of deal-makers and the growth and flexibility of the financial markets. Changing economic variables and increasing pressures to get deals done will continue to lead to new approaches that address the growing areas of risk associated with business combinations.

Ed Healy is managing director at Marsh Inc., a Marsh & McLennan Company. J&H Marsh & McLennan is located at 1225 17th St., Suite 2100 in Denver. Phone is (303) 313-8300.

In Denver and throughout the United States, a growing number of businesses are using mergers and acquisitions (M&A) to achieve growth, enhance profitability and increase competitiveness.

Overall, more than 9,000 M&A transactions involving U.S. businesses were completed in 1998; their total value exceeded $1.3 trillion, the largest amount ever. With blockbuster companies like U S West and TCI recently merging with other huge companies, this figure is even higher.

Despite these historic figures, it takes more than a handshake to complete a business combination. In fact, about one in eight M&A deals fail in the United States. Regardless of the reason,…

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