In the Anglo Saxon legal world, the idea of insuring against warranties and indemnities in an acquisition or divestiture is not new, although its frequent use as an integral part of deal structuring has only become common in recent years.
Thanks to high premiums and few insurance providers, even in the UK and USA, M&A insurance was, for many years, reserved for the bigger deals. It is, however, now moving into the mid-market, as more products become available and premiums fall.
Executives involved in acquisitions are learning to appreciate its usefulness in offering certainty on both the buy-side and sell-side of a transaction, providing a safety net for risks that due diligence may have failed to identify and even for known risks where outcomes cannot be quantified.
The insurance can take many forms, from tax liability insurance designed to cover potential, but uncertain, claim from a tax authority to litigation buyout insurance that ring-fences contingent liabilities.
By far the most common form of M&A insurance, though, is Representations and Warranties (R&W) insurance, or Warranty and Indemnity (W&I) insurance, as it is also known. This insurance is designed to cover breaches in representations and warranties that are provided by sellers in a transaction and can be taken out by either buyer or seller for a variety of reasons.
It can be leveraged by sellers (e.g. private equity firms) to allow a clean exit from a sale enabling the PE firm to distribute the proceeds to its members, rather than retaining a portion to meet contingent liabilities down the line. It can also be offered as part of the sale package to provide greater certainty, expand the pool of potential buyers and boost the sale price.
Buyers will often opt for W&I insurance if they are uncomfortable with the quality of the financial backing behind the warranties and indemnities provided by the seller.
Figures from American International Group, Inc., (AIG) show that the global market for M&A insurance tripled between 2013 and 2017, with the number of insurers offering cover increasing from 11 to 33 and the number of policies issued rising from 1,000 in 2013 to 3,100 in 2017.
The UK is one of the most mature markets for M&A insurance where, according to Paragon Insurance Brokers, 28 per cent of M&A deals done in 2017, employed W&I insurance. For North America, that figure was 13.6 per cent and in Europe only 12.6 per cent. Given the vast size of the North American M&A market, the smaller percentage nevertheless represents nearly half of all policies issued globally. Even in North America, W&I insurance is yet to have a significant impact on the mid-market, where the potential for growth in the sale of W&I policies is therefore enormous.
Testimony from IR Global’s US and German advisors, in the piece you are about to read, suggests that AIG and Paragon’s numbers are already outdated. Michael Roberts in Chicago reports that seven of the last 10 deals he did carried R&W insurance, while Urs Breitsprecher in Dusseldorf reports that one fifth (20 per cent) of all German deals now carry R&W insurance.
Our Italian member Lorenzo Bacciardi tells us that 7 per cent of acquisitions valued below 25 million used M&A insurance in 2017, doubling from a year earlier. Our Belgian member Steven De Schrijver says that, while growing, the figure in Belgium is a bit lower still, with between 3 and 5 per cent of transactions using M&A insurance.
Our panel of experts from across Europe and the USA have identified a clear trend for the increased use of M&A insurance in smaller transactions, linked to increasing availability of products, lower premiums and the growing complexity of mid-market deals, many of which have complicating factors such as cross-border elements or technological applications.
R&W insurance offers a way of mitigating the risks associated with indemnification against complex areas such as tax, compliance, intellectual property and environmental risk.
Provided the claims record remains benign, the number of providers high and premium rates low, we expect to see mid-market executives in a variety of different industries make the decision that the cost of M&A insurance premiums is well worth it to ensure a smoother transaction process.