Cybersecurity has emerged as a paramount concern in the world of mergers and acquisitions. Despite thorough due diligence, comprehensive representations and warranties, and robust indemnification provisions, cyber risks can still threaten a deal's value and success. One additional layer of protection that buyers should consider is insurance — specifically, policies designed to cover losses associated with cyber incidents, including breaches.
Cyber cover
The costs associated with data breaches are substantial and multifaceted. They can include:
- Forensic and investigative expenses: Identifying the cause and extent of a breach requires specialized expertise.
- Notification costs: Legal obligations often mandate notifying affected parties, which can be time-consuming and expensive.
- Legal liabilities: Breaches can lead to class-action lawsuits, regulatory fines and other legal actions.
- Reputational damage: Loss of customer trust can have a long-term impact on revenue and brand value.
Given these potential costs, insurance is critical for mitigating financial exposure. However, procuring the right type of insurance requires careful consideration and planning.
Insurance options
Representations and warranties insurance
These policies cover losses arising from breaches of representations and warranties made by the seller in the purchase agreement. The coverage effectively transfers certain risks from the buyer and seller to the insurer.
The policies, though, can have limitations. Not all of them automatically cover cybersecurity-related breaches. Buyers must ensure that the policy explicitly includes cyber representations and warranties.
Adding cyber coverage may require negotiation with the insurer and could affect premiums and terms. In addition, insurers will conduct their own underwriting process, which may supplement the buyer's due diligence efforts.
Standalone cybersecurity insurance
Standalone cyber insurance policies are designed to cover losses from incidents such as data breaches, ransomware attacks and other threats.
Policies can be customized to address specific cybersecurity risks identified in the target company. They may cover direct losses to the company — first party — and liabilities to others — third party.
Assessments should be made to determine whether a buyer's or target's existing cyber policies are adequate or if a new policy is needed.
Tail insurance for existing policies
Tail insurance extends the coverage period of an existing insurance policy beyond its expiration or termination date, covering claims made after the policy period for incidents that occurred during the policy period.
The coverage ensures that any incidents occurring before the transaction but discovered afterward are covered. The terms and limits of existing policies should be reviewed to determine if tail coverage is beneficial. Tail coverage can be expensive and requires negotiation with the insurer.
Key steps
Early planning and assessment are crucial for effectively leveraging insurance to mitigate cyber risks during M&A transactions. Buyers should begin by evaluating the target's existing insurance policies to identify any coverage gaps or limitations regarding cyber risks. Engaging experts such as insurance brokers and legal advisers specializing in cyber insurance can provide valuable insights and assist in assessing specific insurance needs based on the target's risk profile.
In addition, customizing insurance coverage to address specific cyber risks identified is essential. This involves working closely with insurers to add endorsements or riders that specifically cover the identified cyber threats. Negotiating appropriate policy limits and deductibles that align with the potential exposure ensures that the coverage is adequate. Tailoring the policy this way provides a safety net that is closely aligned with the actual risks involved in the transaction.
Insurance should not be viewed in isolation but rather as part of a broader risk management strategy. It is important to ensure that insurance coverage complements other protections, such as due-diligence efforts, representations and warranties, and indemnification provisions. Integrating insurance considerations into the overall deal structure, including how they affect purchase price adjustments or escrow arrangements, helps create a cohesive approach to risk mitigation.
Insurance procurement also requires due diligence. Buyers should be prepared for the insurer's underwriting process, which may require detailed information about the target's cybersecurity posture. The accuracy and completeness of the information provided during underwriting are critical, as they can affect the policy's effectiveness. Misrepresentations or omissions can lead to coverage denials when claims are made.
Challenges and considerations
One significant challenge in leveraging insurance for cyber risk mitigation in M&A transactions is time constraints. Securing new insurance policies, especially those tailored to specific risks, can be time-consuming. The procurement process involves negotiations with insurers, underwriting assessments and policy customization, which can delay the deal if not initiated early. Therefore, starting the insurance procurement process as early as possible in the transaction timeline is imperative to avoid any delays in closing the deal.
Policy exclusions and limitations also need to be considered, and understanding them is essential to ensure that the insurance will be effective if needed. Policies may have exclusions for certain types of cyber incidents, such as acts of war or state-sponsored cyberattacks, that could leave significant gaps in coverage. Additionally, retroactive dates can affect whether prior acts are covered. Careful review and negotiation of these terms are necessary to avoid unexpected coverage denials when a claim arises.
In addition, the cost of premiums and fees associated with cyber insurance can be substantial, particularly for policies with high limits or involving companies with a high-risk profile. These costs need to be budgeted for and considered in the overall economics of the transaction. The cost implications may influence negotiations between the buyer and seller, especially if the procurement of additional insurance coverage is a condition of the deal.
In the realm of M&A, where cyber risks are ever-present and potentially devastating, insurance is a critical component of a comprehensive risk management strategy. Buyers can significantly mitigate financial exposure from cyber incidents by thoughtfully selecting and procuring appropriate insurance coverage — whether through reps and warranties insurance, standalone cyber policies, or tail coverage.
However, the effectiveness of insurance as a protective measure hinges on planning, accurate disclosure during underwriting, and integration with other contractual protections. As cyber threats evolve, leveraging insurance with due diligence, representations and warranties, and indemnification provisions is essential for safeguarding M&A investments.
Originally published by Business Insurance.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
