A record rebound in merger & acquisitions (M&A) activity in the second half of 2020 is likely to continue this year in the wake of the pandemic. Insurers are targeting this segment with an expanded portfolio of solutions to reduce the financial risk of transactions.
Rising M&A activity
Driven by the pandemic, M&A activity accelerated by between 17% and 20% worldwide during the second half of 2020 compared to the first half of the year, according to PWC’s Global M&A Industry Trends report (opens a new window).
There are many reasons to believe that 2021 will continue to be busy. Companies anticipating economic fallout from the global coronavirus pandemic have an accumulated war chest of more than $7.6 trillion in cash and marketable securities—and interest rates remain at record lows, according to PWC. For companies facing imminent distress, consolidation or capital injection may be inevitable. Others might see M&A as an opportunity to reposition themselves in the market or to expand.
The risk of transactions
As ever, the valuation of assets remains a major challenge to M&A success. Target companies may misrepresent their accounts to achieve a higher sales price and a deal may result in potential disputes with lengthy and costly litigation. Companies often need to set money aside for such disagreements that can result in costly and lengthy litigation.
It’s not uncommon to see buyers and sellers engaging in disputes over contractual provisions of sale and purchase agreements (SPAs), which may centre on:
Purchase price adjustments
Warranties due to complexities of the deal
Different opinions on accounting principles
Lack of specific wording around the financial provisions in SPAs
Inadequate pre-deal due diligence leading to unforeseen obligations or exposures
M&A insurance premium is currently estimated (opens a new window) to total $2 billion worldwide. In Europe, the most common M&A protection is warranty and indemnity (W&I) insurance, which covers the warranties and indemnities provided in a deal’s SPA. The use of W&I insurance policies increased from 10 percent in 2010 to 19 percent (opens a new window) of all M&A transactions in 2019. This trend is likely to have continued during the pandemic. Companies normally insure around 10-30% of the value (opens a new window) of a deal while the premium is usually set at around 1% of the sum insured.
The demand is highest for ‘buy-side policies’ which offers protection directly to the buyer in case of damages from warranty breaches or indemnity claims. A buyer can take out insurance against any company information included in the warranties such as the accuracy of financial statements, for example. Such policies also benefit the seller since it transfers the risk of a breach of contract to the insurer. The seller can therefore immediately use the proceeds from the transaction since the policy may make the need for an escrow obsolete.
Although less common, a seller may also decide to purchase insurance protection to avoid holding money in an escrow account.
Need for innovation
Investors are looking at the end of furlough schemes across Europe as leading to a rise in distressed M&A where companies will be bought out of insolvency or liquidation. Here it is likely that the seller will be unable to give any warranties at all. A potential alternative in such situations may be a Synthetic Warranty and Tax Deeds. These sit outside of the SPA and would typically be presented as a solution to the purchaser if the vendor is in administration or receivership.
A Synthetic Warranty Deed, so-called because they are provided by the insurer and not the vendor, is available from a select number of insurers with whom Lockton has negotiated a bespoke product to be utilised in the aforementioned situations.
The W&I insurance landscape has changed dramatically in the last five years. With now more than 26 underwriters offering M&A insurance solutions, the scope for innovative products such as synthetic packages has increased. Underwriters willing to look into synthetic packages for distressed transactions will want to gain comfort on:
The viability of the business going forward
The plan for the turnaround
The experience and reasons for purchase of the Buyer
Such solutions are likely to become increasingly popular as the number of distressed sales rises. Alternatively, the product could also be used more widely outside of distressed sales, where sellers regain the leverage they had pre Covid-19 and buyers are looking to steal a march on other bidders in competitive auction processes. For further information, please contact:
Harry Blakelock, Partner Transactional Risks E: Harry.Blakelock@uk.lockton.com (opens a new window) T: +44 (0)20 7933 2024