The Insurance Gap: Why Your Old Policy Won't Cover New Risks

Throughout this week, we've peeled back the layers on the "unseen deal killers" – from cyber threats and the "green premium" myth to human capital challenges and the regulatory maze. Today, in our final installment, we address a critical, often overlooked, aspect of due diligence that can leave even the most meticulously planned deals vulnerable: the insurance gap. In an era of rapidly evolving risks, relying on outdated or insufficient insurance policies can expose buyers and new owners to catastrophic financial losses that their traditional coverage simply won't touch.

Many businesses and property owners operate under the assumption that their general liability, property, and business interruption insurance policies provide comprehensive protection. While these policies are foundational, they were largely designed for a different era, one where cyberattacks were rare, climate change impacts were less severe, and legal liabilities were more straightforward. Today, the landscape of risk has shifted dramatically, creating significant gaps in traditional coverage that can leave you dangerously exposed.

When conducting due diligence, it's imperative to scrutinize the target's insurance portfolio with a critical eye, focusing on these emerging areas of underinsurance:

•Cyber Insurance: This is perhaps the most glaring gap in many traditional policies. Standard commercial general liability (CGL) policies typically exclude coverage for cyber-related incidents, including data breaches, ransomware attacks, and business email compromise. Without a dedicated cyber insurance policy, a company hit by a cyberattack could face millions in costs for data recovery, notification expenses, legal fees, regulatory fines, and reputational damage. In M&A, the acquiring entity can inherit the target's cyber liabilities, making robust cyber due diligence and appropriate insurance paramount.

•Climate-Related Risks and Property Insurance: As climate change intensifies, properties are increasingly exposed to severe weather events, including floods, wildfires, and extreme storms. Many standard property insurance policies have significant exclusions or limitations for these types of events, or they come with prohibitively high deductibles. Furthermore, the concept of "physical damage" is evolving; for example, what about the financial impact of prolonged power outages due to extreme heat, even if there's no direct structural damage? Understanding the specific climate risks associated with a property and ensuring adequate, specialized coverage is crucial.

•Complex Legal Liabilities and Professional Indemnity: Beyond general liability, businesses today face a myriad of complex legal liabilities, particularly in specialized industries. Professional indemnity (errors and omissions) insurance is vital for service-based businesses, but the scope of what constitutes an "error" or "omission" is broadening. Furthermore, new regulations (like data privacy laws discussed yesterday) can create new avenues for litigation, which may not be covered by existing policies.

•Supply Chain Disruption Insurance: The pandemic highlighted the fragility of global supply chains. While business interruption insurance covers losses due to direct physical damage to your property, it often doesn't cover losses stemming from disruptions further up or down the supply chain. Specialized supply chain insurance is becoming increasingly important for businesses reliant on complex logistics.

•Directors and Officers (D&O) Liability: In an acquisition, the D&O liability of the target company's past and present leadership can transfer to the new entity. D&O insurance protects company leaders from claims arising from their decisions and actions. Ensuring adequate D&O coverage, including tail coverage for past acts, is critical to protect the acquiring entity and its leadership.

To close these dangerous insurance gaps, incorporate the following into your due diligence process:

1.Comprehensive Policy Review: Don't just ask for a list of policies; obtain and meticulously review every policy document. Pay close attention to exclusions, limitations, deductibles, and policy limits. Engage an insurance specialist to help identify hidden gaps.

2.Risk Assessment Alignment: Compare the target's identified risks (from cyber to environmental to operational) with their existing insurance coverage. Are there any significant risks that are uninsured or underinsured?

3.Claims History Analysis: Review the target's claims history. Frequent claims or large payouts can indicate underlying operational issues or inadequate risk management, which may lead to higher premiums or difficulty obtaining coverage post-acquisition.

4.Future Needs Assessment: Consider how the acquisition will change the risk profile. Will the combined entity face new or increased exposures? Plan for necessary adjustments to insurance coverage post-closing.

5.Tail Coverage and Run-Off Policies: For certain liabilities (like D&O or professional indemnity), ensure that appropriate "tail" or "run-off" coverage is in place for the target company's past actions, protecting the acquiring entity from future claims related to pre-acquisition events.

Insurance is not a one-size-fits-all solution, especially in today's dynamic risk environment. The "unseen deal killers" we've discussed this week—cyber threats, regulatory complexities, and evolving liabilities—demand a proactive and sophisticated approach to insurance due diligence. By identifying and addressing these critical insurance gaps before the deal closes, you can safeguard your investments, protect your clients from unforeseen financial burdens, and ensure a truly secure transaction. Don't let an outdated insurance policy be the final, fatal unseen deal killer.

An insurance specialist that I recommend in Florida is Cassandra Hanks at AAA Insure Solutions. She provides diligence in making sure you have the correct coverages you need and is independent so she can shop around for the best and most economical options. You can reach this specialist at 1-863-937-9401 or email: [email protected]

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