M&A Insurance
Heats Up Despite
Lower Deal Volumes
Recent trends in the M&A marketplace and maturing products fuel growth
By Jay Rittberg
Sales of insurance policies for buyers and sellers involved in mergers and acquisitions have risen to historically high levels in 2012, even as deal volumes decline.
Innovations in policy terms and underwriting procedures, along with improved distribution over the last 15 years, have allowed for the continued growth of M&A insurance.
According to Thomson Reuters, global middle-market M&A activity decreased during the first half of 2012 compared to 2011, as measured by the number of deals (down 16 percent) and total dollar value of deals (down 12 percent). Further, M&A activity is significantly below the record pace observed in 2006 and 2007. Still, according to M&A insurance industry statistics, there has been nearly a 40 percent increase in submission volumes in 2012 as compared to 2011, representing record levels of premium volumes and numbers of policies issued. Discussion with M&A industry insiders, as well as the entry of new insurers into the market, confirms that there is more interest in these products than ever before.
Buyers and sellers are now more frequently thinking about M&A insurance products as strategic tools, and using insurance to win bids for companies and accomplish financial and relationship-related goals. From the carrier perspective, this book of business has become more predictable and repeatable and can create valuable relationships with new business partners. These dynamics have created an excellent
From the carrier
perspective, this
book of business
has become more
predictable and
repeatable and
can create valuable
relationships with
new business
partners.
environment for both buyers and sellers of M&A insurance products and help explain why M&A insurance is on the rise, despite the soft M&A market.
M&A Insurance Evolves to Address Fundamental
Market Concern
M&A insurance has been available in the United States for more that 15 years. As a general matter, M&A insurance products shift risks of transactions from the principal participants in those transactions (buyers and sellers) to the insurance markets. The most widely utilized M&A insurance product is representations & warranties insur ance (RWI), which addresses losses that arise from a transaction in the event that the representa tions and warranties made by a seller in the acquisition agreement entered into in connection with an M&A deal were inaccurate.
Typically, the representations made by a seller are quite comprehensive, including statements about the accuracy of financial statements, compliance with laws, the payment of taxes and ownership of intellectual property, among other warranties related to the operation of the target business. These representations are relied on by the buyer for purposes of determining the purchase price paid in the transaction. If, after the consummation of a transaction, the buyer discovers that any of these representations were inaccurate, the seller may have to indemnify the buyer for the financial consequences of that inaccuracy, often for up to 20 percent of the proceeds received by the seller in the transaction. In a typical M&A transaction, sellers have to put a portion of their proceeds into an escrow account for up to two years after the completion of a transaction to allow the buyer to have a source of funds for this indemnification in the event that they discover an inaccuracy.
RWI policies are customized policies that act to step into the shoes of a seller to pay indemnification claims made by the buyer for inaccuracies of the representations and warranties. These policies often allow sellers to walk away with more cash and certainty of returns at the closing of the transaction by eliminating or reducing the amounts they would otherwise be required to place into escrow, while providing buyers with certainty of recourse in the event of a loss. (In this situation, policies can be issued to either a buyer or seller, but as a general matter policies issued with the buyer as insured are best for accomplishing the goals of all parties to a transaction.) In the early days of M&A insurance, carriers and brokers had to overcome some of the usual challenges with new products—long underwriting processes, uncertainty with pricing given limited claims history and overcoming skeptical clients. Some of the most common questions faced by insurers were: “Will the insurance underwriting process slow down our M&A deal?” “How will the claims process work?” and “Why is
it so expensive?”
Over time, markets were able to respond to these items and further refine the products. Insurers demonstrated to clients how seeking recourse against the insurance markets in the event of a loss could add significant value in the context of an M&A transaction. The underwriting process went from a month-long inquisition to a streamlined review that could take just a couple of days. Claims were paid, and the price of the insurance came down. This was an important stage for the development of these products, but the utility of these products was not fully appreciated until the credit crisis of 2008.
2008 Credit Crisis: Regret & Opportunity
In 2008, M&A activity fell off a cliff. This decline made buyers of companies more cautious about their investments than ever before. Many realized that if they had purchased M&A insurance, then they could have protected their returns or limited the extent of their losses.
When seeking to recover losses from sellers after deals gone bad, buyers found that, as a consequence of the economic downturn, sellers were either out of business or financially unable to make good on their obligations. Others realized that the era of easy returns was over, and that any tool that might help retain an edge in a competitive environment should be considered.
• A private equity fund was bidding for an acquisition target against a number of other private equity funds and strategic acquirers.
The private equity fund structured its bid so that a RWI policy would be used in the place of the typical seller indemnifi-cation obligation, winning the deal and allowing the seller to exit with $15 million more cash on the date of closing.
• The founder of a business planned to retire and was negotiating to sell his business.
The founder wanted to take the proceeds from the sale and enjoy his retirement without having to be concerned about any indemnification claims from the buyer. The founder convinced the buyer to accept a RWI policy in lieu of his tradi-tional indemnification obligation.
• A venture capital-backed technology company was being sold to a much larger strategic acquirer, which was offering a very high purchase price, but requiring very onerous representations and warranties and very stringent indemnification obligations from the venture capital fund shareholders.
The venture capital shareholders acquired a RWI insurance policy to backstop their obligations to the acquirer and were able to distribute the proceeds of the sale to their investors immediately after the closing of the transaction. n
M&A Insurance At Work
M&A insurance
markets estimate
that 40 percent
of their books of
business come from
repeat buyers.
M&A insurance
gives buyers of
businesses the
opportunity to
seek recovery
of loss from an
insurer in a familiar
jurisdiction, such as
the insured’s state
of domicile, rather
than chasing down
sellers around the
world.
These concerns can each be addressed by M&A insurance, and thus a major opportunity was created for M&A insurers to respond to market sentiments.
The Current Fertile Landscape for M&A Insurance
As noted in recent Advisen articles, private equity-driven M&A is trending away from the mega-billion dollar deals seen in 2004-2007 and towards transactions in the $25 million to $500 million range. M&A insurance has been targeting those middle market-sized deals since its inception because M&A insurance policy limits of liability can have a more meaningful impact on deals of that size. Larger deals in the billion-dollar-plus range may not be affected by the amounts of limits currently available. (Typically limits are available up to $50 million, but the market has more capacity available than ever before and insurance towers in excess of $100 million are becoming more common.)
With more participants focusing on the middle market, one way to succeed in an auction without having to overpay for a business is to require a less onerous indemnification package in the acquisition agreement as a key distinguishing factor in a bid. The ability to exit an investment and to avoid paying indemnity claims can make a bid that uses RWI very attractive to a seller.
Other publications have noted two key trends in the M&A market that have also led to increased demand for transactional insurance: (1) many private equity funds and strategic corporate acquirers are flush with cash; and (2) a significant number of private equity funds are reaching the end of their expected lives and seeking to have a clean exit from investments.
With so much cash that M&A players are eagerly awaiting the opportunity to use, highly competitive auctions are being conducted by sellers, particularly for companies with a proven ability to generate EBITDA (earnings before interest, taxes, depreciation, and amortization). Buyers who are able to offer sellers the chance to walk away from a transaction with all of their consideration on day one without any strings attached may have an advantage over other bidders that may require more onerous indemnification terms from sellers.
In addition, private equity shops understandably want to move on to the next fund without concern of large claims against the last fund. Having to request a return of funds from investors after an indemnification claim can have severe consequences for a private equity shop’s reputation, and M&A insurance can help avoid this situation. (In this scenario, the PE buyer of a business purchases the M&A insurance to allow the seller to have reduced indemnification obligations. See related textbox, “M&A Insurance At Work.”)
What might once
have been viewed
as a business with
a few one-off
trans-actions, can now
be viewed as a
steady stream of
income.
Should You Buy M&A Insurance?
If you are buying or selling a business, there has never been a better time to use M&A insurance. With pricing generally at 2-4 percent of the limits of liability being purchased for RWI in the United States, it is cheaper than ever before (the price was 8 percent or higher in the early days). Policy terms are more insured-friendly than in the past, as insurers are now able to match up more closely with the underlying terms of the M&A transaction. There are now claims examples with millions of dollars having been paid to insureds, demonstrating that the insurance does respond as expected.
M&A insurance can also address concerns with cross-border deals, which are on the rise. For example, M&A insurance gives buyers of businesses the opportunity to seek recovery of loss from an insurer in a familiar jurisdiction, such as the insured’s state of domicile, rather than chasing down sellers around the world. M&A insurance also provides broad enough coverage to protect against some key threats on cross-border deals including risks arising from the enforcement of the Foreign Corrupt Practices Act and actions by the Office of Foreign Assets Control.
Why Are More Insurers Selling M&A Insurance Now?
As recent press releases demonstrate, more insurers are entering the M&A insurance market. This is not surprising. As the market has matured, insurers can now view this business more like an annually renewable business, since established M&A insurance markets estimate that 40 percent of their books of business come from repeat buyers. What might once have been viewed as a business with a few one-off transactions, can now be viewed as a steady stream of income. In addition to the growth of repeat buyers, there are more channels for distribution than ever before. The larger insurance brokerages have seasoned M&A veterans that have been in the market for years, and since 2008, more brokers around the United States have been introduced to the products and have become savvy in advising clients on how to use the products strategically.
One last reason why insurance companies like these products is that they can bring in new business and provide cross-sell opportunities, as there is a large suite of insurance products that are often placed upon the closing of most M&A transactions.n
