Understanding Cybersecurity in Mergers and Acquisitions
In today’s digital landscape, cybersecurity has become a critical focal point in the realm of mergers and acquisitions (M&A). Despite meticulous due diligence, comprehensive representations and warranties, and stringent indemnification clauses, cyber risks can still jeopardize the value and success of a deal. Consequently, one additional layer of protection that buyers should contemplate is insurance—specifically, policies designed to safeguard against losses stemming from cyber incidents, including data breaches.
The Importance of Cyber Coverage
The financial implications of data breaches are considerable and diverse. These costs may encompass:
- Forensic and investigative costs: Determining the origin and magnitude of a breach typically necessitates specialized expertise and resources.
- Notification expenses: Legal obligations often require informing affected individuals and entities, a process that can be both time-consuming and costly.
- Legal liabilities: Breaches can precipitate class-action lawsuits, regulatory penalties, and various legal repercussions.
- Reputational harm: Erosion of customer trust can lead to long-term consequences for revenue and brand equity.
Given these potential financial burdens, obtaining insurance becomes essential for mitigating such exposures. However, securing the appropriate type of insurance necessitates thorough consideration and strategic planning.
Exploring Insurance Options
Representations and Warranties Insurance
These policies are designed to cover losses that arise from breaches of representations and warranties made by the seller within the purchase agreement. This coverage effectively transfers specific risks from the buyer and seller to the insurer. However, it’s important to note that not all policies automatically encompass cybersecurity-related breaches. Buyers must ensure that the policy explicitly incorporates cyber representations and warranties. Negotiating these additions may be necessary and could affect the premiums and terms of the policy. Moreover, insurers will typically conduct their own underwriting process, which may enhance the buyer’s due diligence efforts.
Standalone Cybersecurity Insurance
Standalone cyber insurance policies are tailored to cover losses from incidents such as data breaches, ransomware attacks, and other cyber threats. These policies can be customized to address specific cybersecurity vulnerabilities identified within the target company. Coverage may extend to direct losses incurred by the company—known as first-party coverage—as well as liabilities owed to third parties. A thorough assessment should be conducted to ascertain whether a buyer’s or target’s existing cyber policies are sufficient or if a new policy is warranted.
Tail Insurance for Existing Policies
Tail insurance extends the coverage period of an existing insurance policy beyond its expiration or termination date, thereby covering claims made post-policy period for incidents that occurred during the initial coverage term. This ensures that any issues arising before the transaction but discovered afterward remain covered. It is crucial to review the terms and limits of existing policies to evaluate whether tail coverage is advantageous. However, tail coverage can be costly and often requires negotiation with the insurer.
Key Steps in Mitigating Cyber Risks
Effective planning and assessment are vital for leveraging insurance to mitigate cyber risks during M&A transactions. Buyers should commence by evaluating the target’s current insurance policies to pinpoint any coverage gaps or limitations regarding cyber threats. Engaging with experts such as insurance brokers and legal advisors who specialize in cyber insurance can yield valuable insights and assist in determining specific insurance requirements based on the target’s risk profile.
Additionally, customizing insurance coverage to address the specific cyber risks identified is crucial. This process entails collaborating closely with insurers to incorporate endorsements or riders that specifically target the identified cyber threats. Negotiating suitable policy limits and deductibles that align with the potential exposure ensures adequate coverage. This tailored approach provides a safety net that corresponds closely to the actual risks involved in the transaction.
It is also essential to view insurance as part of a broader risk management strategy rather than in isolation. The interplay between insurance coverage and other safeguards, such as due diligence efforts, representations and warranties, and indemnification provisions, must be carefully considered. Integrating insurance considerations into the overall deal structure, including how they impact purchase price adjustments or escrow arrangements, contributes to a cohesive risk mitigation strategy.
Furthermore, insurance procurement necessitates due diligence. Buyers should be prepared for the insurer’s underwriting process, which may require detailed insights into the target’s cybersecurity posture. The accuracy and completeness of the information provided during underwriting are paramount, as inaccuracies can affect the policy’s efficacy. Misrepresentations or omissions may lead to claims being denied down the line.
Challenges and Considerations
A significant challenge in utilizing insurance for cyber risk mitigation in M&A transactions is the time constraints involved. Securing new insurance policies, particularly those tailored to specific risks, can be a lengthy process. The procurement journey entails negotiations with insurers, underwriting assessments, and policy customization, which can delay the deal if not initiated promptly. Therefore, it is imperative to commence the insurance procurement process as early as possible in the transaction timeline to avoid closing delays.
Policy exclusions and limitations also warrant careful consideration, as understanding these terms is crucial to ensuring that the insurance will function effectively when needed. Policies may contain exclusions for certain cyber incidents, such as acts of war or state-sponsored cyberattacks, which could result in significant coverage gaps. Additionally, retroactive dates can impact whether prior incidents are covered. Diligent review and negotiation of these terms are necessary to prevent unexpected claim denials.
Moreover, the costs associated with premiums and fees for cyber insurance can be substantial, particularly for high-limit policies or for companies with elevated risk profiles. These costs should be factored into the overall budget and economics of the transaction. The financial implications may influence negotiations between the buyer and seller, especially if the procurement of additional insurance coverage becomes a condition of the deal.
In the evolving landscape of M&A, where cyber risks are omnipresent and potentially catastrophic, insurance emerges as a vital component of a comprehensive risk management strategy. By thoughtfully selecting and procuring appropriate insurance coverage—whether through representations and warranties insurance, standalone cyber policies, or tail coverage—buyers can significantly mitigate their financial exposure to cyber incidents. However, the effectiveness of insurance as a protective measure relies on meticulous planning, accurate disclosures during underwriting, and seamless integration with other contractual protections. As cyber threats continue to evolve, the strategic use of insurance alongside due diligence, representations and warranties, and indemnification provisions becomes essential for safeguarding M&A investments.
Anjali Das is a partner and co-chair of the national cybersecurity & data privacy practice at Wilson Elser, based in Chicago. She can be reached at anjali.das@wilsonelser.com. Gregory Parker is an associate in the firm’s cybersecurity practice and can be contacted at gregory.parker@wilsonelser.com.
Source: Business Insurance
