Pharmaceutical M&A

Diligence Due

Despite heavy regulation, many pharma acquisitions fail from a lack of due diligence.
By: | February 22, 2016 • 6 min read

Pharmaceutical and life science companies plowed billions of dollars into acquisitions over the last two years, just to maintain revenue growth and stay ahead of the competition.


Additional pressure from shareholders seeking a quick return, a surplus of cheap capital and persistently low interest rates only fueled the growth in mergers and acquisitions (M&A) activity.

Meanwhile big corporations are selling off or divesting the slow-growing and less profitable parts of their business in order to focus on their core market instead. The result is that brokers and attorneys in the life science/pharma space are staying very busy.

“In the last couple of years we have seen really good deal conditions in terms of the cheap financing available because of low interest rates,” said Damian Arguello, a partner at law firm Davis Graham & Stubbs.

Damian Arguello, partner, Davis Graham & Stubbs

Damian Arguello, partner, Davis Graham & Stubbs

“Many companies are also looking to get away from a focus on short-term profitability and to refocus on their core business and divesting those parts that aren’t core.

“At the end of the day, it comes down to a feeding frenzy — everyone’s doing something so what opportunities are you missing out on if you are not acquiring or divesting your assets?”

Since the start of 2014, more than $860 billion worth of pharma M&A deals have been announced, according to analysts Dealogic.

In the last year alone, the industry spent a record $677.5 billion on M&A, led by Teva’s announced $40 billion purchase of Allergan’s generics business, and Pfizer’s $160 billion merger with Allergan.

“In the last couple of years we have seen really good deal conditions in terms of the cheap financing available because of low interest rates.” — Damian Arguello, partner, Davis Graham & Stubbs

That trend is set to continue through 2016, with companies taking advantage of lower valuations and access to new geographical areas, lines of business, products and customer bases.

Other benefits include the cost and efficiency synergies that can be gained through building scale and tax inversions if the target operates in a more favorable jurisdiction.


However, experts warned that at least 75 percent of companies that bought a new business over the last year failed to execute proper due diligence.

That has left them exposed to a host of unforeseen risks including shareholder lawsuits and directors and officers (D&O) liability claims, or worse still, the collapse of the deal.

Due diligence has, therefore, become a vital part of the M&A process, with risk managers being required to carry out thorough checks at every stage of the deal.

Due Diligence Risks

Arguello said that the biggest risk for the acquirer was overlooking a key part of the due diligence process because of the pressures of a short timeframe to get the deal done.

Alexander Moscho, managing director, Bayer UK/Ireland

Alexander Moscho, managing director, Bayer UK/Ireland

He said that risk managers also have to be aware of the increasing risk of class-action lawsuits resulting from products in the development pipeline that fail to deliver on their initial promise or to gain regulatory approval.

Product liability claims can also extend to design and manufacturing defects, and failure to warn customers about the possible side effects of a drug or product after it has been developed, he added.

“This industry, in particular, faces a lot of regulatory risks, as well as safety issues that won’t necessarily reveal themselves until further down the road,” he said.

“There are any number of long-term product claims that could come out that are only exacerbated by insurance companies pushing to limit the ability of corporate successors to tap into their predecessor’s insurance.”


Arguello estimated that less than one-quarter of companies do their proper due diligence when acquiring a new entity or product.

The worst case scenario for companies if they get it wrong, he said, is an asbestos-type fallout with serious long-term or intergenerational effects for the customer further down the line.

Alexander Moscho, managing director of Bayer’s UK and Ireland business, estimated that two-thirds of all M&A deals over the last year have failed to deliver on their initial financial targets because of post-merger integration problems — a knock-on effect from not having done thorough due diligence.

“It’s really the big picture issues that you need to look at when doing your due diligence, such as the company’s culture.” — Gordon Zellers, Colorado practice leader, Woodruff-Sawyer & Co.

He cited the example of Daiichi Sankyo’s acquisition of Ranbaxy for $4.6 billion in 2008, shortly after which the U.S. Food and Drug Administration launched an investigation into the newly acquired company over concerns about its manufacturing processes.

A year later, Daiichi was forced to write off $1 billion, and in 2013 it paid out $500 million to settle claims with the U.S. Department of Justice, before selling its remaining stake in Ranbaxy to Sun Pharmaceuticals for $3.2 billion in 2014.

“They lost a lot of money over a short period of time because they neglected some of the risks that due diligence could have addressed,” Moscho said.


Gordon Zellers, Colorado practice leader, Woodruff-Sawyer & Co

Gordon Zellers, Colorado practice leader at Woodruff-Sawyer & Co., said that joining the two companies’ cultures together is often one of the biggest stumbling blocks in the M&A process.

“You can almost always get the insurance-related parts of the deal right like the carrier relationship, program structure and collateral — it’s really the big picture issues that you need to look at when doing your due diligence, such as the company’s culture,” he said.

Jim Walters, a managing director with Aon, added that among the biggest risks that need to be recognized when buying a company were the potential effects that cost synergies will have on the new company in the future, including layoffs and plant closures.

Risk Management Involvement


Zellers said that the main problem with due diligence is in many cases risk managers don’t get involved until the transaction has been completed, because management is so keen to push the deal through.

He said that it is vital to assemble an experienced team including financial, legal, tax and risk experts that can sort out the key details of the deal in advance such as dispute resolution mechanisms, performance goals and monitoring.

“Often the finance and legal departments aren’t aware of the types of insurance solutions available to cover them against unforeseen risks.”

John Connolly, North American practice leader, life science and pharmaceuticals, Willis Towers Watson

John Connolly, North American practice leader, life science and pharmaceuticals, Willis Towers Watson

John Connolly, North American practice leader, life science and pharmaceuticals at Willis Towers Watson, said that it is essential to put a valuation on any potential net exposure that your company may incur as a result of the acquisition, as well as looking at settlement opportunities.

He added that it is also important to ensure that the target’s insurance programs are fully compliant with the law from day one, in addition to reviewing and understanding its risk management procedures, reporting guidelines and communications, and loss control.

“Look to create protocols that embrace the best of both approaches but, above all, ensure that the new operations and people are able to meet your existing standards at minimum,” he said.

Alex Wright is a U.K.-based business journalist, who previously was deputy business editor at The Royal Gazette in Bermuda. You can reach him at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Risk Focus: Cyber

Expanding Cyber BI

Cyber business interruption insurance is a thriving market, but growth carries the threat of a mega-loss. 
By: | March 5, 2018 • 7 min read

Lingering hopes that large-scale cyber attack might be a once-in-a-lifetime event were dashed last year. The four-day WannaCry ransomware strike in May across 150 countries targeted more than 300,000 computers running Microsoft Windows. A month later, NotPetya hit multinationals ranging from Danish shipping firm Maersk to pharmaceutical giant Merck.


Maersk’s chairman, Jim Hagemann Snabe, revealed at this year’s Davos summit that NotPetya shut down most of the group’s network. While it was replacing 45,000 PCs and 4,000 servers, freight transactions had to be completed manually. The combined cost of business interruption and rebuilding the system was up to $300 million.

Merck’s CFO Robert Davis told investors that its NotPetya bill included $135 million in lost sales plus $175 million in additional costs. Fellow victims FedEx and French construction group Saint Gobain reported similar financial hits from lost business and clean-up costs.

The fast-expanding world of cryptocurrencies is also increasingly targeted. Echoes of the 2014 hack that triggered the collapse of Bitcoin exchange Mt. Gox emerged this January when Japanese cryptocurrency exchange Coincheck pledged to repay customers $500 million stolen by hackers in a cyber heist.

The size and scope of last summer’s attacks accelerated discussions on both sides of the Atlantic, between risk managers and brokers seeking more comprehensive cyber business interruption insurance products.

It also recently persuaded Pool Re, the UK’s terrorism reinsurance pool set up 25 years ago after bomb attacks in London’s financial quarter, to announce that from April its cover will extend to include material damage and direct BI resulting from acts of terrorism using a cyber trigger.

“The threat from a cyber attack is evident, and businesses have become increasingly concerned about the extensive repercussions these types of attacks could have on them,” said Pool Re’s chief, Julian Enoizi. “This was a clear gap in our coverage which left businesses potentially exposed.”

Shifting Focus

Development of cyber BI insurance to date reveals something of a transatlantic divide, said Hans Allnutt, head of cyber and data risk at international law firm DAC Beachcroft. The first U.S. mainstream cyber insurance products were a response to California’s data security and breach notification legislation in 2003.

Jimaan Sané, technology underwriter, Beazley

Of more recent vintage, Europe’s first cyber policies’ wordings initially reflected U.S. wordings, with the focus on data breaches. “So underwriters had to innovate and push hard on other areas of cyber cover, particularly BI and cyber crimes such as ransomware demands and distributed denial of service attacks,” said Allnut.

“Europe now has regulation coming up this May in the form of the General Data Protection Regulation across the EU, so the focus has essentially come full circle.”

Cyber insurance policies also provide a degree of cover for BI resulting from one of three main triggers, said Jimaan Sané, technology underwriter for specialist insurer Beazley. “First is the malicious-type trigger, where the system goes down or an outage results directly from a hack.

“Second is any incident involving negligence — the so-called ‘fat finger’ — where human or operational error causes a loss or there has been failure to upgrade or maintain the system. Third is any broader unplanned outage that hits either the company or anyone on which it relies, such as a service provider.”

The importance of cyber BI covering negligent acts in addition to phishing and social engineering attacks was underlined by last May’s IT meltdown suffered by airline BA.

This was triggered by a technician who switched off and then reconnected the power supply to BA’s data center, physically damaging servers and distribution panels.

Compensating delayed passengers cost the company around $80 million, although the bill fell short of the $461 million operational error loss suffered by Knight Capital in 2012, which pushed it close to bankruptcy and decimated its share price.

Mistaken Assumption

Awareness of potentially huge BI losses resulting from cyber attack was heightened by well-publicized hacks suffered by retailers such as Target and Home Depot in late 2013 and 2014, said Matt Kletzli, SVP and head of management liability at Victor O. Schinnerer & Company.


However, the incidents didn’t initially alarm smaller, less high-profile businesses, which assumed they wouldn’t be similarly targeted.

“But perpetrators employing bots and ransomware set out to expose any firms with weaknesses in their system,” he added.

“Suddenly, smaller firms found that even when they weren’t themselves targeted, many of those around them had fallen victim to attacks. Awareness started to lift, as the focus moved from large, headline-grabbing attacks to more everyday incidents.”

Publications such as the Director’s Handbook of Cyber-Risk Oversight, issued by the National Association of Corporate Directors and the Internet Security Alliance fixed the issue firmly on boardroom agendas.

“What’s possibly of greater concern is the sheer number of different businesses that can be affected by a single cyber attack and the cost of getting them up and running again quickly.” — Jimaan Sané, technology underwriter, Beazley

Reformed ex-hackers were recruited to offer board members their insights into the most vulnerable points across the company’s systems — in much the same way as forger-turned-security-expert Frank Abagnale Jr., subject of the Spielberg biopic “Catch Me If You Can.”

There also has been an increasing focus on systemic risk related to cyber attacks. Allnutt cites “Business Blackout,” a July 2015 study by Lloyd’s of London and the Cambridge University’s Centre for Risk Studies.

This detailed analysis of what could result from a major cyber attack on America’s power grid predicted a cost to the U.S. economy of hundreds of billions and claims to the insurance industry totalling upwards of $21.4 billion.

Lloyd’s described the scenario as both “technologically possible” and “improbable.” Three years on, however, it appears less fanciful.

In January, the head of the UK’s National Cyber Security Centre, Ciaran Martin, said the UK had been fortunate in so far averting a ‘category one’ attack. A C1 would shut down the financial services sector on which the country relies heavily and other vital infrastructure. It was a case of “when, not if” such an assault would be launched, he warned.

AI: Friend or Foe?

Despite daunting potential financial losses, pioneers of cyber BI insurance such as Beazley, Zurich, AIG and Chubb now see new competitors in the market. Capacity is growing steadily, said Allnutt.

“Not only is cyber insurance a new product, it also offers a new source of premium revenue so there is considerable appetite for taking it on,” he added. “However, whilst most insurers are comfortable with the liability aspects of cyber risk; not all insurers are covering loss of income.”

Matt Kletzli, SVP and head of management liability, Victor O. Schinnerer & Company

Kletzli added that available products include several well-written, broad cyber coverages that take into account all types of potential cyber attack and don’t attempt to limit cover by applying a narrow definition of BI loss.

“It’s a rapidly-evolving coverage — and needs to be — in order to keep up with changing circumstances,” he said.

The good news, according to a Fitch report, is that the cyber loss ratio has been reduced to 45 percent as more companies buy cover and the market continues to expand, bringing down the size of the average loss.

“The bad news is that at cyber events, talk is regularly turning to ‘what will be the Hurricane Katrina-type event’ for the cyber market?” said Kletzli.

“What’s worse is that with hurricane losses, underwriters know which regions are most at risk, whereas cyber is a global risk and insurers potentially face huge aggregation.”


Nor is the advent of robotics and artificial intelligence (AI) necessarily cause for optimism. As Allnutt noted, while AI can potentially be used to decode malware, by the same token sophisticated criminals can employ it to develop new malware and escalate the ‘computer versus computer’ battle.

“The trend towards greater automation of business means that we can expect more incidents involving loss of income,” said Sané. “What’s possibly of greater concern is the sheer number of different businesses that can be affected by a single cyber attack and the cost of getting them up and running again quickly.

“We’re likely to see a growing number of attacks where the aim is to cause disruption, rather than demand a ransom.

“The paradox of cyber BI is that the more sophisticated your organization and the more it embraces automation, the bigger the potential impact when an outage does occur. Those old-fashioned businesses still reliant on traditional processes generally aren’t affected as much and incur smaller losses.” &

Graham Buck is editor of He can be reached at