Transactional insurance is taking off in the US, along with a so-called sellers’ market in M&A.
One reason is the coverage saves companies that are being bought–and which may be fielding rival bids–the need to set aside funds for potential “unknown” liabilities.
“Companies being bought can ask buyers to go out and get R&W instead of having to put up escrow,” said Navine Aggarwal, vice president of mergers and acquisitions at Allied World, referring to representations and warranties, the most popular type of transactional insurance.
“And the seller can be more competitive by offering to buy it in the process, instead of asking the seller to put up an escrow account,” Aggarwal told Advisen in an interview.
The insurance, sales of which have doubled or tripled in each of the past few years, according to Allied World, is a topic at Advisen’s Transactional Insurance Insights Forum, to be held on April 15 in New York. Panelists will address the M&A environment, due diligence and related insurance products including R&W, and tax and contingent liability insurance.
The discussion comes amid a resurgence of M&A un the US. The insurance industry alone saw eight $1 billion-plus deals in 2014, as many as had been announced in the past several years combined, figures from Deloitte show.
An R&W policy can protect a buyer or seller from liabilities arising from exceptions to representations and warranties made in the acquisition agreement, including those related to tax, environmental, compliance, benefits and labor issues.
The policies have long been popular outside the US, especially in cross-border deals where the buyer may be unfamiliar with the environment of the target company, and is known as warranty and indemnity insurance in Europe.
“R&W is the real bread and butter of the transactional insurance industry,” Aggarwal said. “Contingent and tax indemnity policies aren’t always a known liability, but they are a known exposure–meaning an uncertain tax position or uncertain litigation outcome.”
Rates for R&W coverage are relatively cheap, ranging from 2.5 to 4 percent of liability limits, Aggarwal said. These can run to $400 or $500 million per M&A transaction, with customers buying layers of coverage.
But while the insurance can help protect companies from the “unknown” in the acquisitions process and eliminate tensions around recovering funds in the event of liability, it cannot replace due diligence, risk managers and M&A professionals said.
“You have to be a detective,” when it comes to M&A, said Audrey Rampinelli, vice president of risk management at conglomerate Loews Corp. She was speaking on a panel at Advisen’s Casualty Insights conference last month.
“The benefits side should be part of due diligence,” she said. “What fiduciary issues might there be out there?”
Susan Reinhard, co-panelist and senior director of claims and risk management at EMCOR Group, said “The history of a company will dictate what faces us in the future.”
If there isn’t adequate information on casualty claims and legacy exposures at an acquisition target, she said, “I take that as seriously as if it were in the present day.”
Christopher Tutoki, a partner in M&A transaction services at Deloitte, will be addressing tax due diligence at Advisen’s Transactional Insurance forum.
“While tangibles can be insured, there are a few aspects that are more nebulous” he told Advisen in an interview.
An example is situations involving the liabilities of other member companies in the consolidated tax-return group of a target acquisition.
“When buying or selling an entity, you want it to be free from tax liability, but it’s liable for the tax exposures of other entities for the years in which it was a member of the group,” he said, citing Treasury regulation section 1.1502-6.
Since the other entities are not part of the sale, a seller may be unwilling to disclose information about them to the prospective buyer.
In general, when information is not available, clients sometimes get the insurance and go through with a deal, he said. The less due diligence is done, though, the more someone may “have to pay to replace it.”
Knowledge is power, and vetting a company’s liabilities can give executives more confidence when negotiating a sale.
“Many of my clients don’t yet purchase transactional insurance and retain me or others to perform the diligence,” Tutoki said.
Even with the dramatic increase in sales of R&W, penetration of the US market is at 8 to 10 percent, Allied World said. Should the sellers’ market subside, the global insurer and reinsurer expects adoption to continue here.
“We see penetration going to 20, 30, 40 percent, like in the rest of the world,” Aggarwal told Advisen. “We are continuing to see competition in this space, with more brokers entering the market, which broadens it. You see R&W for sale in small cities and regions now, not jut the big ones.”