This article first appeared in Wilson Sonsini Goodrich & Rosati’s The Life Sciences Report, Fall/Winter 2018 edition.
The Life Sciences M&A market shows no sign of slowing down. The 2018 total value of life sciences M&A should once again surpass $200 billion. The lull in biopharma deal-making last year and the passage of US tax reform increase both desire and need for growth by acquisition, via M&A.
We are also witnessing the emergence of disruptive firepower in tech leaders Amazon, Alphabet, Apple, Microsoft, Intel, IBM, and Samsung in addition to retail giants CVS, Walgreens, and Walmart all openly moving into the life science and healthcare space for the first time. This is fueling M&A in these sectors as these disruptive players seek to purchase existing companies, rather than organically develop, the healthcare and/or life science expertise needed to execute their strategy.
Fighting for market share in key areas is affecting growth. We see an attack on pricing power as generic drug approvals surge in the US and new products enter where pricing power had been relatively strong.
The likely increased consolidation activity and new types of buyers will inevitably lead to increased use of Representations and Warranty Insurance (RWI). As the head of the Woodruff Sawyer M&A Insurance Group, I have seen this already at play. RWI is breach of contract insurance. It covers the loss associated with discovering a breach of a rep or warranty after the deal has closed. Our experience is that corporate buyers use it more often when entering a new area. If we continue to see consolidation in a seller’s environment, it will become a standard request by bidders.
The RWI market has been cautious in life sciences, like most insurance carriers in this sector, because of phase three testing, the storage and usage of data, and the potential for very high payouts in the event of an issue. There are a couple of ways to minimize the risk of adding these exclusions to your reps policy.
The first option is to make sure it is included in the RWI coverage (and I will give some advice on that). The second form of protection is understanding what insurances are in place for the target already. (My colleague Chad Follmer, Woodruff Sawyer Healthcare Practice Leader will handle that section). These two strategies can and should go hand-in-hand.
In terms of risk, Products Liability is the principal insurable risk for most life science companies. In almost all Reps and Warranties policies, the coverage under the Reps policy is designed to respond after any existing underlying insurances of the target have paid out. However, for life sciences, carriers may still seek to exclude products liability. Make sure that at the quote stage the broker is focusing on markets that are willing to provide coverage that sits excess the existing target coverage.
This is a significant, ever-evolving concern for all industries, not just life science. It is particularly concerning for the life science industry because of the potential for large amounts of HIPAA-protected data and the emerging bodily injury concerns posed by the risk of hacked medical devices. Harmonizing your products liability, medical professional liability, and cyber liability placements with your R&W placement is of utmost importance to ensure you are getting the coverage you need.
It is important that your underwriter understand exactly what the target does, and how data is used and stored. Don’t assume that the underwriter understands your business. They are specialists in Reps and Warranties Insurance, not necessarily in life sciences. The more brokers can help them understand the business, the better. We recently had an underwriter who insisted on a HIPAA exclusion. Once we explained that the only testing done and the only records kept were for animals, they removed the exclusion.
Now, let’s turn our attention to Chad Follmer’s input.
Protecting Yourself From Financial Harm in a Purchase-Sale Transaction
The second way to protect yourself from financial harm in a purchase-sale transaction is to deeply understand the risk management measures taken and insurance program of your target. This can be achieved through a proper risk management and insurance due-diligence analysis, as performed by a knowledgeable Healthcare and Life Science specialist insurance broker. It’s important to be sure that the target company has adequate limits and coverage breadth for the traditional areas of life science industry risks, such as products liability, clinical trials, privacy liability and network security, supply chain, and inventory risks including spoilage. Questions to ask and areas to probe regarding these risks include:
- Do you have any overseas assets, operations, sales, and/or clinical trials? If so, how have you ensured compliance with any locally required coverages and limits? Have you considered the pros and cons of optional local placements, which may be advantageous even if not required?
- What steps have you taken to ensure business continuity in the event of a major supply chain disruption? What response measures exist and what coverage limits would apply if a loss is suffered due to a contingent business interruption of a supplier?
- Have you secured proper coverage for stock, both in-warehouse and in-transit globally, regardless of transportation means and contractual hand-offs?
- How did you determine the structure of your coverage limits and retentions? Are they adequate and efficient?
While these traditional sector risks are important considerations, it is also critical to consider the evolving risks facing the life science industry, such as:
- Potential for allegations of medical malpractice as genomic medicine and predictive AI modeling advance
- Regulatory liabilities associated with allegations of off-label use and/or false claim act allegations, as disruptive technologies are potentially prescribed for previously unanticipated applications
- Ensuring proper coverage for the constantly changing morass of regulatory bodies at several levels of government, rushing to enforce alleged HIPAA and Network Security violations
Finally, it is critical that your broker work in partnership with knowledgeable counsel to address the management liability risks associated with “the deal” itself, such as pricing, investor concerns, and disclosures, particularly for public companies. Add to this the unique regulatory concerns for the industry such as IP, FDA, and CMS compliance, and it’s clearly integral to have the right team of industry specialist brokers and attorneys on your side.
Right now is a dynamic time in insuring the life sciences, with literally life-changing opportunity in our industry. The scale and impact of successful market adoption is greater than ever before, as are the risks. A well-executed risk management diligence audit in combination with a properly structured R&W insurance placement are important tools for seizing the opportunities presented by strategic transactions.
This article was originally published in the Wilson Sonsini Goodrich & Rosati’s The Life Sciences Report.