Insurance That Covers You After the Fact
Do you see a public offering in the future for your company, or perhaps a merger or acquisition?
If so, schedule some time with your insurance broker to ask about something new and odd in the insurance world, in more ways than one--loss mitigation insurance.
Given the mushrooming number of start-ups and early-stage companies in Southern California, it’s a good bet that a wave of public offerings involving local firms lies just down the road, along with a wave of mergers and acquisitions.
Venture capitalists back many of these new companies, and they push these goals because they want the chance to cash themselves out. But whether you offer your stock to the public, sell to a larger firm or launch an acquisition campaign fueled by outside financing, you brave risks that can sink your enterprise.
If you go public and your stock tanks, for example, your stockholders may sue you, alleging that you misrepresented your prospects. If you sell to another company, your new owner may charge that you concealed the nature of the competition in your marketplace or that your intellectual property infringes someone else’s patent. If you acquire another company, you may discover a pollution spill in its past, exposing you to the wrath of the Environmental Protection Agency.
Now, to be sure, you can’t go public without braving the vagaries of the stock market, and you don’t sell your company or acquire another without doing your due diligence. But bad things happen even to the diligent. You can lose millions of dollars to a single claim involving securities law, and if your plaintiffs win class-action status, you can lose tens of millions.
Which brings us to loss mitigation insurance.
Seen strictly from the viewpoint of common sense, this coverage stands the idea of insurance on its head--the idea of insurance being that, in exchange for a premium, an insurer takes on the risk of loss to the unforeseen.
The word unforeseen is key: You buy insurance against the possibility that your house may burn today or that you may die tonight. Insurance protects you against uncertainty, and you buy it before, not after, disaster strikes.
None of this is true with loss mitigation insurance, which recently became available in the last year or two. For one thing, you buy the insurance after, not before, somebody sues you, and when you buy it, what you don’t know is not whether you will suffer a loss, but rather how bad it will be.
Loss mitigation insurance covers you against damages under securities law or for claims involving environmental pollution or product liability. As you might expect, it’s big-ticket coverage. Nor do insurers offer it to all who want to buy. After all, the insurance seeks to limit a loss already certain to occur, so insurers sell it only when they feel they have a good handle on the magnitude of the risk.
They divvy up that risk in complex ways. In one recently reported case, Oxford Health Plans of Trumbull, Conn., paid a $24-million premium for insurance covering 90% of any judgment or settlement over $175 million, to a limit of $200 million. Put another way, the insurance left Oxford Health Plans on the hook for the first $175 million and gave its insurer responsibility for 90% of anything over that sum to a maximum of $200 million.
A judgment of $250 million would hit Oxford Health Plans, already out $24 million in the form of a premium, with $182.5 million in all--that is, the first $175 million in its entirety, plus 10% of the remainder, or $7.5 million. Its insurer, having pocketed the $24 million premium, would have to cough up $67.5 million.
Those are big numbers, and by any measure, loss mitigation insurances is expensive. But don’t let all that throw you off track. So far, only big companies buy the coverage, for the most part, but that will change.
Why? Because any litigation involving securities law gets expensive fast, even for a young company selling stock to the public for the first time. Clearly, if you see big things ahead, it will pay you to make sure that the worst that can happen doesn’t, even if that means coughing up a chunk of money.
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Juan Hovey can be reached at (805) 492-7909 or at jhovey@gte.net.
