Insurance for mergers and acquisitions risks (namely Warranty & Indemnity, Tax, Legal and other related contingencies) has come a long way since the early 2000’s. Back then there were limited insurers with a fairly restricted appetite, resulting in coverage that was slow to place, expensive and largely restrictive. Now W&I insurance is seen as an accepted tool in the M&A process and is used on around 24% of European private M&A deals.
Whilst claims activity in this highly confidential sector of the insurance industry is largely opaque, [please see Lockton claims paper] claims are generally considered to be relatively benign when compared with other classes of insurance. Consequently a number of insurers have seen this class of business as an attractive investment opportunity.
Today Lockton can approach more than 16 insurers offering coverage for Warranty and Indemnity insurance (although fewer have real appetite for contingent risks). This additional capital and increased insurer appetite has resulted in more competition for business leading to lower premiums and continued downward pressure on policy retentions.
This must surely be good news for buyers of insurance? The answer is both yes and no.
A transaction is not a static risk, but rather an evolving risk that changes alongside commercial negotiations and the findings in the buyers DD. Insurers in many instances provide, and are selected on, their initial non-binding indications which are based on limited information and assumptions. They also expressly exclude cover for any known and identified risks.
Once selected, an Insurer’s final coverage position is reserved until the final stages of a transaction, but the insurer selection has likely happened in the early stages of the deal.
Whilst the early insurers selection is well intentioned, i.e. intended to ensure the insurance runs in tandem with the transaction timeline, we see an increasing degree of execution risk arising in transactions.
Why? The soft market cycle has created an environment where insurers aggressively price risk, which is good for buyers. Hand in hand with this, as deal flow has increased, insurers are competing for market share. Unlike other lines of business in the insurance sector, this is not an annuity business, so winning business is key. This has led to aggressive positions being taken in regard to pricing and retention levels. When difficult issues arise later on in a transaction, insurers can be unwilling to take commercial decisions which can slow down the deal. We have heard of a number of incidents of insurers stalling a deal through their inability to get comfortable with a risk thrown out by DD. The wrong insurer selection can cause huge distress to a deal and pull all the commercial parties back to the table to negotiate fundamental points.
What’s the answer to choosing the insurer?
Here at Lockton, we place huge emphasis on execution risk and making sure we are selecting the right insurer for the right risk. Of course, pricing and retention level positions have an impact in decision making but our good faith and confidence in the ability of the insurer to provide the best coverage within the deal timetable and close the deal remains our critical focus.
The process has to change, and for us at Lockton we have a new approach. For a different perspective on insurer selection and managing execution risk, call us for a fresh insight.