VideoSo, Clark USA bought an EIL insurance policy through Marsh Inc., the New Yorkbased broker that put together the Lombard insurance deal, and from American International Group (AIG), which, perhaps not coincidentally, has a significant equity investment in Blackstone. While Maura Clark demurs on the details, she does say, "We got good coverage at a good price. The insurance provided additional comfort to Blackstone."
Buyer's Market
Lombard, Spirax, and Clark have all tapped an increasingly competitive market. Once considered so costly and restrictive that only companies required by law bought the coverage, EIL is currently a buyer's market. Prices have dipped, coverage limits are up to the hundreds of millions of dollars, underwriting terms and conditions are nowhere near as stringent, and, best of all, this is only the beginning.
Roughly one quarter of EIL business now stems from corporate restructuring activity: companies engaged in mergers, acquisitions, divestitures, and consolidations. The insurance plugs the holes that threaten to capsize the deal and, typically, is underwritten over a long policy duration, up to 10 years or more. The costs to remediate defined environmental issues generally are set aside as a de facto deductible in the insurance policy, above which resides more than ample coverage for unexpected pollution problems.
Most major insurers selling EIL products, a select group that includes ECS, Kemper, Zurich, and industry leader AIG (Lombard's carrier) have formed units focused on transactional-based EIL insurance, as have the brokers. Their goal is to offer companies an alternative to more hidebound ways of managing their environmental liability risks in an M&A context. Apparently, companies are opting for the new strategy. "We'll underwrite in excess of $280 million in premiums by the end of the year, up from $205 million last year and half that of four years ago," says William Kronenberg, ECS president and CEO.
ECS evaluated more than 100 mergers and acquisitions for environmental impairment exposures last year, booking well over two dozen for the coverage. Those numbers are growing at a 10-percent-a-month clip, Kronenberg says. "We're finding that virtually every M&A transaction now involves some element of environmental insurance," he says. "Consequently, this has become a major aspect of our business."
This adjustment to the M&A market has occurred swiftly. In the early 1990s, transacting partners typically exchanged equity securities to obtain the benefit of so-called pooling accounting techniques, helping companies avoid the need to write off the substantial goodwill associated with buying a company at a higher tax basis. Consequently, any liabilities that materialized post-transaction (read: pollution claims) would be borne and shared by the two companies, settling out in the wash between two sets of shareholders.
Five years ago, EIL began life as a transactional tool, as stock-based transactions began to eclipse cash deals. What we have seen is a softening insurance market intersecting with a different method of acquiring companies. Even M&A lawyers, who once scorned EIL for its high cost and minimum coverage, now routinely tout it. "We had found these insurance contracts in the past to be fairly inflexible and not as responsive as we would have liked," says Scott F. Smith, head of the corporate group and partner at New York law firm Covington & Burling. "Our view has changed markedly."
The firm recently advised a merchant-banking client eyeing an acquisition that was threatened by environmental issues. "We anticipated this would be a deal killer, based on the limited indemnity [to cover unknown EIL risks] that the seller was willing to offer," Smith says. "We worked with Marsh to find a solution for these known and unknown liabilities, putting together a 10-year insurance contract with $50 million in limits, using the seller's [known] indemnity as the deductible. It saved the deal and protected nearly $1 million in transactional costs already invested by our client."
Saving Graces
Because of lurking environmental hazards, some M&A deals teeter at death's door until the subject of EIL insurance is introduced. "We just bound an environmental insurance policy 48 hours before the deal was to close," comments Joseph Boren, president and chief executive officer of AIG Environmental Inc., in New York. "The buyer's due diligence unearthed what it argued was an $18 million environmental problem at the facilities about to be acquired. The seller disagreed strongly, tabulating those costs at no more than $6 million."
The buyer threatened to walk out unless the seller put $18 million in escrow. "The seller didn't want the deal to crater, so it came to us," Boren says. "We agreed to cover the $18 million, using the seller's estimate of $6 million as the deductible. The deal went through literally at the last minute." The seller paid for the insurance, an amount equal to roughly 10 percent of the limits provided.
Why not just put the $18 million in escrow and save what is still a significant insurance premium? "Most companies would rather make a one- time, tax deductible insurance payment and keep their capital to do their own thing," Boren says.
Peter Walther, a managing director at Marsh, concurs. "The key thing for CFOs is to manage risk in such a way as to permit predictability of cash flows for investors, bankers, and shareholders," he says. "Not only does insurance provide a clean balance sheet, but you also avoid tying up a big chunk of capital for many years, money that otherwise could be invested in R&D, new products or services, and even additional acquisitions."
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