1. Global Trend Snapshot
Transactional risk insurance (TRI) which includes policies that cover risks related to M&A, such as representations and warranties insurance for the US market, the corresponding warranty and indemnity (W&I) insurance for the EU market, tax insurance, and contingent liability insurance, has faced a growing demand over the last years. In its latest “Transactional Risk Report 2019: Year in Review” Marsh reports that TRI limits placed globally by Marsh JLT Specialty (Marsh) increased in 2019 by 51% to USD 50.9 billion. These limits spread over 1,241 transactions, which is an increase of 26% in comparison to the prior year.
TRI insurer capacity continued to expand in 2019 with more than 30 insurers offering primary terms for coverage globally. Overall capacity now supports insurance limits in excess of USD 1 billion for a single transaction.
2. EU Market Trends
2.1 General Market Parameter
While the number of M&A deals and the total value of transactions in the EU declined in 2019, Marsh saw a 23.6% increase in insured deals compared to the prior year. In total, Marsh placed insurance for 589 transactions in 2019. For these transactions, Marsh placed 623 TRI policies in total, which is an increase of approximately 38.4% compared to 2018 (450 policies). The numbers show that on many transactions, not only W&I insurance was purchased, but also contingent risk policies to mitigate identified risks (e.g. tax) (Fig. 1).
Fig. 1: Number of Policies
Source: Marsh JLT Speciality
A total number of 553 W&I policies were placed in 2019. 54% of these policies were placed for private equity investors while 46% of the policies were bought by strategic corporate buyers. The vast majority of placed W&I insurance policies were taken out by the buyer (almost 97%) while only 3% were placed on the sell-side.
The total insurance limit placed in 2019 increased, compared to the prior year, by about 56% to USD 24.73 billion. There are two main reasons for this growth: First, the number of large insured transactions (enterprise value of more than USD 1 billion) increased compared to 2018. Second, the “seller-friendly” M&A market observed in many EU countries motivated a growing number of sellers to refuse any residual liability for warranty breaches (even for title and capacity warranties). This development forced buyers to turn to the insurance market for protection and to purchase also cover for title and capacity issues. The purchase insurance limit for title and capacity issues is often equivalent to the full transaction value (Fig. 2).
Fig. 2: Limits places (USD bn)
Source: Marsh JLT Speciality
The average limit of liability of TRI policies placed in 2019 amounted to USD 36.4 million, compared to USD 29.9 million in 2018 which at first glance is surprising as the average enterprise value of insured transactions increased slightly from USD 197.8 million in 2018 to USD 217.5 million in 2019. Looking at the individual deal, this means that insureds tended to purchase proportionally higher limits compared to prior years. The reasons for this trend are laid out in the preceding paragraph (Fig. 3, & Fig. 4).
Fig. 3: Limits places as a percentage of enterprise value
Source: Marsh JLT Speciality
Fig. 4 • Average enterprise value (USD mn)
Source: Marsh JLT Speciality
Despite the moderate growth in the average enterprise value of insured deals, the data shows that the median enterprise value of insured deals in 2019 actually decreased. This deviation is a result of multiple, very large insured transactions coupled with a growing number of small insured deals involving SME targets. The increase of insured SME deals paired with intensifying competition between specialized insurers focusing on SMEs show that the TRI is economically viable and also efficient in the lower size range of deals. The numbers further show that W&I insurance is still used to facilitate large cap transactions with a stable insurer appetite to participate in larger and more complex transactions.
As to premia, we see a slightly increased rate-on-line (i.e. premium expressed as a percentage of the limit of liability) of 1.33% in 2019 compared to 1.19% in 2018. The main reason for this increase is that insureds tend to purchase more coverage enhancements (such as synthetic coverage of indirect losses and lost profits) which often results in premium increases. Looking down the road, premia are expected to be stable despite the high level of competition between M&A insurers. The experience shows that such competition has led and will lead to further broadened insurance coverage. This is in line with the demand by insureds, which focus primarily on broad coverage while pricing is still important but not the central pivoting point.
With respect to the seller’s liability for warranty breaches in case of insured deals, a cap of such seller’s liability at EUR 1 (i.e. no economic liability) appears to be the norm across the EU. This structure has been common in the UK, the Nordic countries, and Central Europe for a number of years now representing roughly 75% of Marsh’s placements.
Taken this aforementioned nil seller recourse structure into account, it is not surprising that 167 placed buy-side W&I policies were initiated by sellers. Those controlled stapled W&I insurance processes are very common in controlled auction processes so that a small number of bidders cannot conflict the insurance markets at an early stage of the transaction.
2.2 Contingent Risk Insurance
The data shows a growing demand for coverage for identified risks through contingent risk insurance – both for tax and non-tax risks. Marsh recorded an increase in contingent risk policies and placed more than 70 policies in total in 2019, which is c. 20% of all TRI policies placed in that year. With c. 80%, W&I insurance policies still represents the majority of TRI policies placed in 2019. The majority of such placed contingent risk policies are cover tax and title risks. We also noted numerous insurance policies covering environmental and other contingent risks.
Marsh expects that the demand for contingent risk insurance products especially in the area of identified tax and legal risks will grow significantly in the coming years in both M&A and non-M&A contexts (such as restructurings). This is reflected by a sharp rise of enquiries for contingent risk insurance since the beginning of 2019 and rising popularity in the EU. Moreover, insurers continue to deploy significant capital and expand their specialist underwriting teams in this sector.
2.3 Claims
Marsh completed a comprehensive review of its W&I claims ‘book’ across EMEA spanning a 10-year timeframe to explore key trends and topics around TRI claims. The study revealed that since 2011 there was a continuous rise of claim notifications under W&I policies. In 2016 there was a sharp rise of such numbers. The portion of policies placed with a claim notification also increased over the last years as shown in Fig. 5.
Fig. 5: Limits notifications as a proportion of all policies placed increased between 2016 and 2018
Source: Marsh JLT Speciality
Having reviewed all notifications across EU jurisdictions, the UK, Germany, France, the Netherlands, and the Nordics were the five countries with the most notifications (Fig. 6).
Fig. 6: Country notifications as a proportion of total policies placed
Source: Marsh JLT Speciality
As to the timing of notifications, between 2013 and 2016 the highest portion of notifications was made in the second year of the policy (typically towards the end of the non-tax policy period). For recent placements (2017 onwards), initial data shows a higher proportion of earlier notifications although the notification periods are likely to balance out somewhat when these policies mature.
The data further shows that the majority of launched claims were paid. Between 2009 and 2019 84% of claims with the insured investigating the loss and presenting the claim to insurers formally under the policy for payment were actually paid. If an insurer denied a claim, 89% of such denials were due to a triggered policy exclusion while 11% of the claims were rejected due to a lack of loss. The average time between first notification to the insurer and the insurer´s payment of the claim has dropped significantly and is now below 6 months.
The most common warranty breach notified in Germany is related to financial statement warranties accounting for 54% of all breach types notified between 2009 and 2019, followed by breaches related to tax and material contract matters (Fig. 7).
Fig. 7: Germany: Breaches of financial statements account for more than half of notifications
Source: Marsh JLT Speciality
For France for the same period, the most common warranty breach notified related to tax and operation matters (Fig. 8).
Fig. 8: France: Tax and operations-based breaches each account for more than a third of notifications
Source: Marsh JLT Speciality
In respect of the United Kingdom, the majority of notifications contained claims relating to tax issues (51% of all notifications) followed by breaches of warranties on financial statements (18%) and material contracts (5%) (Fig. 9).
Fig. 9: United Kingdom: Tax breaches accounted for more than 50% of all notifications (between 2009 and 2019).
Source: Marsh JLT Speciality
2.4 Innovations
W&I insurance is nowadays an established M&A deal tool. The product continued to evolve over the last years in particular with respect to so-called coverage enhancements to purchase broader coverage. Such enhancement can be a broader definition of loss going beyond the acquisition agreement’s definition of loss, the removal of knowledge qualifiers stated in the warranties through a so-called knowledge scrape or the removal materiality qualifiers by way of a materiality scrape. Moreover, insurers are willing to expand their coverage by a deemed non-disclosure of the data room and due diligence reports for policy purposes.
For real estate and infrastructure related transactions, we have recently seen W&I insurance coverage without the requirement to link the coverage to existing warranties granted by a warrantor. In contrast, the policies foresaw a warranty-style coverage on a synthetic basis.
2.5 Distressed M&A
In the glance of Covid-19, W&I insurers have expanded their risk appetite and became more flexible to look at distressed M&A transactions. In distressed scenarios, there are two insurance options. In case of existing warranties granted by a warrantor, buyers can take out W&I insurance. The insurance coverage kicks in if warranty breaches occur (even if the warrantor’s liability for warranty breaches is capped at EUR 1). If the seller or insolvency administrator does not wish to provide warranties (and therefore W&I insurance does not work) insurers offer Distressed M&A (DMA) insurance. This is a stand-alone coverage concept without the requirement of or link to existing warranties (i.e. a synthetic cover). In terms of coverage, DMA insurance is similar to W&I insurance: The coverage is warranty-like covering risks remaining unknown after an appropriate disclosure exercise by the seller and a corresponding due diligence by the buyer. The coverage comprises fundamental matters (e.g. ownership of assets or real estate) but extends to operational matters (such as IP, material agreements etc.). It is to expect that DMA insurance will allow access to distressed M&A transactions to more buyers that were unable to invest in distressed assets in the past due to a lack of warranty protection. For the seller, this increased buyer demand means increased bidder competition.
Risks identified in the course of the transaction are insurable through contingent risk insurance, which can be used in a variety of ways in distressed scenarios. For example, it can provide protection in case of unclear ownership structures, ongoing legal disputes or the potential claw-back of state-aid. Risks relating to taxes or the legal transfer of employees in an asset deal may also be covered.
Insurance solutions are also available for transactions involving non-performing loans (NPL). The insurance concept mirrors W&I insurance and covers buyer’s loss due to breaches of seller’s warranties. As an important requirement, insurers request the buyer to perform a market-standard due diligence but are willing to accept sampling approaches.
2.6 Conclusion
The TRI market shows steady growth when looking at insured M&A transactions. W&I insurance appears nowadays to be almost a standard tool in mid and large cap transactions with growing popularity also in small cap and venture deals. Contingent risk solutions are still less common and popular but certainly the most innovative area of the TRI world alongside new risk transfer solutions for distressed M&A transactions. Looking at the current European and global unstable market environment, these developments go into the right direction to face new risks of a changing world.
