When Southwest Airlines closed its $1.4 billion deal to buyAirTran on May 2, it did so knowing that AirTran’s tail would notcause any problems.

The tail in question was not on the back of a plane in the newlyacquired fleet, but the extended reporting period—insurancetail—being put in place to cover AirTran’s directors and officersfor claims arising from events that occurred prior to theexpiration of AirTran’s pre-merger claims-made D&O policy.

The requirement for Southwest to purchase a six-year tail, or runoff policy, for AirTran’sdirectors and officers is nothing special, according to PeterTaffae, managing director of Executive Perils, a Los Angeles-basedwholesale broker, who devised a unique coverage endorsement to makesure the language of the tail policy would synch up with aworrisome provision of the merger indemnification agreement.

Specifically, the merger agreement states that the tail policymust “have benefits and levels of coverage at least as favorable as[those in AirTran’s current] D&O policy.”

Taffae, who says he’s worked on hundreds of runoff policies overthe past 30 years, says that merger-agreement wording “is prettystandard.” What is not standard is the language of D&Opolicies. And because Southwest was purchasing the tail from acarrier that wasn’t AirTran’s current carrier, it was almostimpossible to ensure the merger requirement specifying the same orbroader coverage would not be violated, Taffae says.

“Each D&O policy is different. There’s overlap, but everysingle insurance company has its own form,” he says.

Referring to AirTran’s pre-merger carrier as Carrier A, Taffaereports that he found another carrier—B—that gave a runoffproposal. “We tried to make B as close to A as possible. We added abunch of endorsements. We did everything. But still, it’s a 14-pagedocument even without the endorsements” he says, stressing that asingle word out of place could ultimately violate the mergerrequirement.

He gives the example of a bodily-injury (BI) exclusion, which insome forms has the wording “arising out of bodily injury” and inothers, has the less exclusionary phrase “for bodily injury.”

So “if A had the ‘for’ wording and B had ‘arising out of,’ theneven though we added 30 endorsements to B, if a BI claim came up,it would clearly be less broad than A and that would be aviolation,” he says.

Chris Thorn, risk manager for Dallas-based Southwest, says thatthere was no particular coverage provision that he was worriedabout as the programs were being compared. “It’s really theinvisible that we were concerned with—the things that are notnecessarily obvious at the time you’re putting the program intoplace,” he says.

Thorn, who notes that Southwest was flying into new airspacewithout Taffae’s expertise because the airline had not done amerger since the 1980s, says the wholesale broker’s solution—whichExecutive Perils has branded as “trilateral coverage”—“provides asafety net” for Southwest. “It covers us for anything we might havemissed,” Thorn says.

Explaining the first two-sides of the “trilateral coverage”option, Taffae says the only way Executive Perils could givecomplete and absolute confirmation that there would be no breach ofthe merger contract’s “at least as favorable” provision was to getCarrier B to endorse its policy to reference Carrier A. In otherwords, Carrier B’s policy says, “In no event will this policyprovide less coverage than Carrier A,” and specifically referencesA’s policy number.

“If a claim comes in, the claims adjuster will look at both theCarrier-B policy and the Carrier-A policy and will take the mostfavorable terms to the insured to settle the claim,” heexplains.

BEST OF THREE

For the insured, “it even gets better,” Taffae says, diagrammingthe last side of this “trilateral” coverage deal for NUand introducing “Carrier C”—the lead carrier on Southwest’sexisting nine-figure D&O tower. He proposed that “Carrier B’s”runoff policy should reference Carrier C’s very broad, carefullymanuscripted policy language as well, reasoning that any claim thatsurfaced after the merger would likely name the deep-pocketed ownerSouthwest as a co-defendant.

With the last of the three legs in place, he explains that if aclaim falls under the AirTran runoff, it will be handled based onthe most favorable language of all three policies.

Taffae notes that before his aha moment, he was confident thatCarrier B’s policy was roughly 95 percent equal to Carrier A’s.Carrier B, in fact, was substantially broader on about 30 percentof the policy, he reports. “It was that 5 percent that we wrestledwith because we didn’t want to ever be subject to any scrutiny inhindsight,” he says. “We weren’t going to get Company B to putCompany A in the word processor.” The policy-reference inventionwas the only complete solution, he says.

Thorn notes that this safety net was particularly importantbecause even though the broker and risk manager were diligent inmatching up policies to put together a six-year tail “on behalf ofexecutives of a competing airline,” there were a number ofchallenges complicating the task—not the least of which was thefact that AirTran was a competitor up until the date of close.

That meant communication was limited, he says, noting that theAirTran policy was given to Southwest just 30 days before themerger closed.

Thorn adds that from Southwest’s perspective, the new coveragewould not just to shield AirTran executives, but also protectSouthwest’s balance sheet from the indemnification that it providesto those executives. “So we wanted to make sure we were familiarwith the coverage as well.”

“Not having direct communication [or] the same brokers, it wasvery difficult to get the information we needed to put a goodquality program in place and enough time to be able to study it,”he says.

“Keep in mind that this is a six-year policy and it’s a one-shotdeal. You never renew it,” Taffae adds. “There are no littlemistakes.”

But why not just use the AirTran’s pre-merger carrier for therunoff—avoiding the need to match up policy language? And whydidn’t brokers worry about all this before?

Thorn and Taffae don’t reveal specific reasons, reporting thatthey are confidential, but do say that in this particularsituation, there were a number of coverage-related reasons not togo with Carrier A. It was not an economic decision, they say,noting that the carriers involved were competitive on price.

Taffae says that up until about seven years ago, “it was anunwritten law that the incumbent got the runoff. No one wouldcompete,” he says, chalking up the erosion of the unwritten rule tomarket conditions. “While it’s still a good idea in most cases tokeep it with the incumbent carrier, in some cases you have to get anew carrier to write the runoff—either because the current carrierdoesn’t want to do it or their terms are just horrendous.”

Thorn says he would have given preference to the incumbents onAirTran and Southwest’s D&O programs. “But when givensuch a great opportunity that outshines what “A” and “C” arewilling to do, you’ve got to give that a look,” he says, notingthat Carrier B’s willingness to think out-of-the- box along withTaffae may enhance Carrier B’s relationship with Southwest goingforward.

Carrier B, the two men confirm, has been a participant onSouthwest’s D&O tower, but not the lead. Taffae says he doesn’thave permission to reveal the identity of the carrier, adding thatthe insurer may be wise not to broadcast this. “They’re going toget overwhelmed. Once people know about this, it’s going to becomean industry standard. Every broker and every insured is going towant it,” he predicts.

Indeed, when asked if he’ll try to get “trilateral coverage” onthe next large merger deal he places, Taffae says, “it would becompulsory. This is going to completely change how six-year runoffsare done.”

In a world where getting alternative bids on runoffs iscommonplace, how have brokers helping their clients comply with the“at-least-as-favorable” warranty until now?

For years, as long as the coverage was cheaper or the retentionwas the same or lower, brokers would provide coverage that was“generally equal, but not specifically exactly,” Taffaeresponds.