Utilising transactional insurance as a financial solution for your next deal
April 2014 | SPECIAL REPORT: MANAGING RISK
Financier Worldwide Magazine
Merger & acquisition activity is on the rise given several factors including: economic recovery/stability, inexpensive financing, robust cash reserves on corporate balance sheets and active private equity markets. Following the 2008 global financial crisis, which stifled global M&A markets, deal participants have become more risk sensitive and increasingly concerned with deal execution. As such, transactional insurance (often called M&A insurance) is increasingly becoming an important deal tool; a financial solution that can be used to transfer risks or other indemnity hurdles to a third party insurance company allowing the parties to move toward deal completion.
Undoubtedly, deal activity in Europe for 2013 was low, primarily due to prevailing macroeconomic uncertainty, and there was also a slowdown in activity in the Asia-Pacific region. Encouragingly, general sentiment is that M&A expectations are higher for 2014, and the sectors which are expected to perform well are infrastructure, technology, media and telecommunications (TMT) and energy.
Over the past five years, use of transactional insurance for North American transactions has climbed sharply and the trend appears to be a sustained one as private equity principals, law firms, corporate deal staff and other deal advisers become more familiar with the significant benefits and variety of functions for these insurance policies.
Historically, transactional insurance had been used infrequently in North America having been perceived as unduly expensive, with limited actual insurance coverage benefit and intrusive underwriting (or diligence) on the part of the insurance companies. That has changed as flexible underwriters with expertise in this niche area are now active in the space. Deal underwriters can be inserted early as a strategic solution or late in reaction to a deal hurdle. Either way, the transactional insurance products can provide significant value and help streamline a difficult negotiation.
Awareness of transactional insurance products is increasing in Europe, the Middle East, Africa (EMEA) and Asia-Pacific, with the United Kingdom being the most established market. There is a growing trend for transactional insurance to be used on complex cross-border transactions where buyers often have a reduced appetite for taking on risk. One example in the UK is on real estate transactions where a seller is unable to assume any post-closing liability as a result of the corporate wrapper or trust structure that is in place.
In Australia, warranty & indemnity insurance (W&I)is seen as an important M&A transactional tool and is used by both private equity houses to deliver a ‘clean exit’ and by corporations who are seeking to address deal specific issues such as the inability to recover proceeds from a seller in the future. The most important development in Australia in 2014 will surround cover for ‘new breaches’ between signing and completion. In certain circumstances, coverage might be achievable depending on the risk profile of the business and the period of time between signing and completion.
Understand the type of coverage
A comprehensive suite of transactional insurance products encompasses the following.
Warranty & indemnity insurance, also known as representation & warranty insurance (R&W), provides coverage for losses arising from an unforeseen breach of representations and warranties within the context of an M&A transaction. Often, during M&A negotiations, a gap exists between the level of warranties (quantum or duration) that will be offered by a seller and the level of warranties that a buyer will accept. A W&I insurance policy can bridge that negotiation gap by transferring certain breach risks to a third party insurance carrier. Either a buyer or seller can procure this specialised coverage.
In terms of strategic use and benefit to deal teams, buyers are increasingly using W&I insurance to differentiate their bid in an auction. Rather than require a steep escrow from the seller for the seller warranties and indemnities, buyers will procure their own insurance policy. Sellers are likewise seeing benefit in this insurance as it allows them to close a deal with less escrow duration and dollars. For private equity sellers specifically, it allows them to exit a position cleanly and quickly, providing significant utility for the final investment in a closing fund.
Tax opinion liability insuranceis a valuable tool for managing significant known tax risks arising out of complex merger or acquisition transactions. Like W&I insurance, if a buyer and seller are at a standstill regarding a tax position, they can move that specific risk away from the deal using a specialty insurance product.
Contingent risk insurancefocuses on other known issues, allowing both the seller and the buyer to focus on their broader commercial objectives by transferring an identified contingent risk (like pending litigation) to a customised insurance policy.
Deal specific transactional insurance, like environmental/pollution legal liability transactional coverage, may be used by either party to move targeted risks away from the deal, helping to overcome an execution stumbling block.
Getting the most from your coverage
A good example of transaction insurance in action is for a deal with environmental concern. The seller holds that no real or material exposure exists while the buyer does not want to worry about an unknown or latent environmental issue creating significant future liability. In the past, W&I coverage would be limited, perhaps only covering the permitting risks. Now coverage is more fulsome and can be crafted using a transactional pollution legal liability policy in concert with an environmental representation & warranty policy to cover pre-existing environmental conditions that may arise after closing. This innovative and integrated solution is often considered to bridge a negotiation gap between buyer and seller.
M&A insurance is complex and as a true partner in the process, skilled underwriters engaged in the deal should be specialists in the field, be ready to work with deal urgency and understand the complexities involved for all deal parties. Importantly, there is no boilerplate or template coverage for M&A insurance. While each policy starts with a base form, each policy is crafted specifically for the deal at hand and should reflect the unique terms of the respective deal, customised to fit the distinctive needs of all parties involved in the negotiation.
For 2014, you should expect the use of transaction insurance to rise globally as deal parties see the product in use, become accustomed to the streamlined underwriting process and transactional insurance claims are paid.
Jeff Anderson is a senior vice president and Andrew Graham is a vice president at Allied World. Mr Anderson can be contacted on +1 (678) 704 8445or by email: firstname.lastname@example.org. Mr Graham can be contacted on +44 (0)207 220 0600 or by email: email@example.com.
© Financier Worldwide
Jeff Anderson and Andrew Graham