In the second installment of this series we offered a brief review of cybersecurity provisions and considerations in M&A transaction agreements, and in the first installment of this series we offered a brief review of cybersecurity issues that can arise in the course of M&A transactions and discussed the importance of cybersecurity due diligence by the buyer. This third installment will focus on cyber-insurance and some specific considerations relating to cyber insurance that targets and acquirers should make in the context of M&A transactions.

As data breach incidents continue to rise and legislative regimes provide more and more stringent regulation of data breaches, including the proliferation of mandatory breach notification provisions, the expense associated with data breaches also rises. Estimated costs of dealing with a data breach, even to resolve a potential attack, or an attempted breach, have been as high as $5.3 million.1  Costs can be incurred as a result of forensic and investigative activities, assessment and audit services, crisis team management, and the necessary internal and external communications.  As cybersecurity breaches increase in number, scope, and impact, organizations are looking to transfer the risk associated with security breaches.2

The most common way of transferring risk is by obtaining insurance policies. Cyber and privacy insurance has been available for the last decade, covering an organization’s liability for a data breach in which the organization’s or customers’ information is lost or stolen.  Marsh Inc., a global insurance broker, has said that the number of organizations that purchased cyber insurance in the US increased by 33% from 2011 to 2012, and that cyber insurance is currently the fastest growing area of commercial insurance in the world.3 Policies vary, with cyber insurance offered as an add-on or included in more general policies, or sold as a distinct product.

Cyber Insurance Coverage

An important preliminary note on cyber insurance is that cyber insurance is often confused with technology errors and omissions insurance (commonly called “Tech E&O” insurance). Tech E&O insurance protects providers of technology services or products, such as software designers and manufacturers, whereas cyber insurance protects consumers of those products and services.4

Generally, cyber insurance is divided into first party coverage protecting the policyholder, and third party coverage protecting from third party claims against the policyholder.

First party policies may cover:

  1. the costs associated with investigating the scope of the breach and taking steps to mitigate against the damage caused by the breach;
  2. the costs of providing notice to individuals whose identifying information was compromised;
  3. public relations services to counteract the negative publicity that can be associated with a data investigation;
  4. the costs of responding to government investigations;
  5. the costs of replacing damaged hardware or software, or remediating existing systems;
  6. legal costs and other related expenses, such as regulatory fines;
  7. the costs of responding to parties vandalizing the company’s electronic data; and
  8. business interruption costs.

On the other hand, third party policies may cover claims:

  1. for permitting access to identifying information of customers;
  2. emanating from the impacts which a security breach may have on a third-party system;
  3. for transmitting a computer virus or malware to a third-party customer or business partner;
  4. for failing to notify a third party of their rights under the relevant regulations in the event of a security breach; and
  5. for potential “advertising injury,” i.e., harms through the use of electronic media, such as unauthorized use or infringement of copyrighted material, as well as libel, slander, and defamation claims.

Cyber insurance can also specifically cover the crisis stage of a data breach. This could include any expenses related to the management of the incident, such as investigation, remedial steps, required notifications, call and public relations management, credit checks for the subjects of the data, and any legal costs including fines or the costs of litigation.  A further advantage is that a qualified consultant, often a lawyer, may be assigned during a crisis stage.  In this way, clients may be able to better navigate the regulatory landscape following a data breach.  An updated awareness of privacy laws is particularly relevant with the passing of the Digital Privacy Act, SC 2015, c 32, in June 2015.5

M&A-Relevant Considerations

In the context of an M&A transaction, an acquirer will need to fully understand the target’s and its own existing coverages in order to determine how best to structure cybersecurity insurance coverage once the acquisition is complete. Acquirers should conduct due diligence to assess a target’s risk profile and whether the target has an existing and adequate cyber insurance policy in place, or consider implementing an appropriate insurance policy as part of the transaction to mitigate the costs of a cybersecurity breach of the target’s systems.

As all insurance policy coverage is dependent on the particular terms and conditions in the policy at issue, a review of existing policy coverage should consider a number of questions to better understand the risks involved in the target’s business, including:

  1. What security controls can be implemented that will reduce the premium?
  2. Will a security risk review need to be undertaken?
  3. What is expected of the target or acquirer to reduce or limit the risks?
  4. What assistance is provided to improve information governance and information security?
  5. How does compliance with organizational protocols affect future premiums?
  6. What support, if any, will be provided to assist in making the right security decisions for the industry/business the target is in?
  7. Given that the security/protection industry is very fast-changing, how can one ensure that the insurance policy is current?
  8. Do all portable media/computing devices need to be encrypted?
  9. Are malicious acts by employees covered?
  10. What if there is uncertainty around whether the incident took place a day before the coverage was in place or on the same day?
  11. Are court attendances to defend claims from others covered?
  12. Could a claim outside the coverage period be made if the intrusion was not detected until several months or years have elapsed?6

Every acquirer and target will face different challenges with regard to data breaches. The size, industry, type of data, potential exposure, business model, and many other considerations, will affect the scope and detail of the ideal cyber insurance policy.7   Acquirers should ensure that they have all the necessary background information from the target.  Conducting due diligence of cyber insurance policies is imperative, as policy language evolves rapidly.

A few of the specific due diligence considerations an acquirer should make include:

  1. Ensuring that the target’s response plan to a potential or actual breach is sufficient.
  2. Reviewing extensions of coverage that exist in other policies and whether there are any “other insurance” clauses in the different insurance policies that could leave different insurers pointing the finger at one another in the event different policies are triggered at the same time.
  3. An examination of service providers and the dove-tailing of incident response plans to fit the separate organizations. If separate incidence response plans are in place, it will be important to vet the service providers who will be in place with the insurer so that the triage process in the event of a claim is approved in advance.
  4. A review of the retroactive date to ensure that any existing conditions on a network before completion of the transaction could be covered if it develops into an incident.
  5. A contract review to assess whether any cybersecurity coverages are mandated and at what thresholds. This is especially important where the acquirer does not have a cybersecurity policy going into the transaction.
  6. A review of the applicable directors’ and officers’ coverage to ensure that the policies adequately dove-tail in the event a breach spirals into a class action to ensure there are no gaps and the policies provide the directors and officers with adequate limits to avoid paying out-of-pocket.
  7. In the case of add-on cyber insurance, consider a careful review of the exclusionary language with the assistance of a broker since this can be very limited.
  8. An investigation of the vulnerability of networks including, where feasible, vulnerability testing and table-top exercises.

For various reasons, acquirers who already have cybersecurity insurance may wish to retain their own policies going forward after the completion of the acquisition. In this case, the acquirer should consider the exclusionary language in their existing policy and, in particular, the acquisition thresholds contained within the wording and the associated reporting provisions.

Cyber insurance is a supplement to the overall risk management strategy of an enterprise, and should be considered alongside other insurance and risk management mechanisms that the acquirer and target may have in place, such as insurance for representations and warranties. The latter in particular may be an effective means of settling an impasse in the event of disagreement in the course of negotiating an M&A transaction.

Takeaway

Cybersecurity insurance is an important means by which organizations can transfer some of the risks of cybersecurity breaches to third party insurance providers and is becoming an increasingly important consideration in M&A transactions.

Acquirers in particular should begin to think about the post-acquisition cybersecurity coverage framework from the very early stages of an M&A transaction and should conduct specific and targeted due diligence on the target’s cyber insurance policies and networks.

The parties, and particularly the acquirer, should consider working with a knowledgeable insurance broker to identify specific areas of concern and develop a post-acquisition policy framework that will provide appropriate coverage in light of the relevant industry and business practices of the combined enterprise.