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Transactional risk insurance buys on the rise as M&A pace heats up

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Transactional risk insurance buys on the rise as M&A pace heats up

A growing number of corporate investors and private equity firms are employing transactional risk insurance in merger and acquisition agreements to help accelerate M&A deals, experts say.

Janet Oliver, San Diego-based counsel with MoginRubin L.L.P., said transactional risk insurance, and specifically representative and warranty insurance, is “the cost of admission in doing these deals.”

“One interesting trend I’ve noticed is that private equity picked up on this trend a little earlier, but now we’re seeing more corporate buyers using these policies as well,” she said. “There does seem to be a drastic increase in the use of these policies in the last two years even though they have been around for maybe a decade or more.”

The increase could partially be due to fact “that we’ve also seen a lot of increased competition with a number of insurers who are writing these policies,” Ms. Oliver said.

A report by Marsh L.L.C. released last week said it placed 28% more transactional risk insurance policies globally in 2017 compared with 2016. Average limits placed also increased, rising 38% last year, driven by the size and number of transactions in which insurance is being used.

Marsh said that 2017 was the third consecutive year with transaction volumes in excess of $3 trillion. Corporate buyers continue to increase their use of transactional risk insurance and now represent 50% of the policy purchasers, which Marsh said was once almost exclusively the domain of private equity firms.

“In the last four to five years there’s been an explosion in usage,” said Richard Warren, Richmond, Virginia-based partner with Hunton Andrews Kurth L.L.P. “It’s almost become ubiquitous in the private equity market and its gaining a strong foothold in the strategic market.”

Worldwide M&A activity totaled $3.6 trillion during 2017, on par with 2016 levels and the fourth consecutive year to surpass $3 trillion, according to a Thomson Reuters Corp. analysis.

Worldwide M&A activity totaled $1.2 trillion during the first quarter of 2018, up 60% from the first quarter of 2017 and the strongest first quarter for global M&A since records began in 1980, according to the company.

“It’s a competitive M&A market, and it was once seen as something that would set aside a buyer, and now it’s something that’s expected of a buyer in this market,” Ms. Oliver said.

The insurance “also enables everyone to close quickly, which is also what businesspeople are looking for,” she said.

Transactional risk insurance “makes the negotiations easier between the buyer and the seller because the buyer does due diligence, the seller gives the buyer full access to due diligence, and they come up with a customary set of representations and warranties in the agreement for the transaction,” said Brian Hamilton, New York-based partner with Sullivan & Cromwell L.L.P.

“As for the cost of the insurance policy, buyers will take that into account as part of the deal price or sometimes the buyers and sellers will simply split the cost of the policy fifty-fifty,” he said. “In a deal that’s hundreds of millions of dollars, the price of a policy can be relatively small compared with the deal amount and it makes it easier to get a deal done by just going out and getting the policy because there’s one less thing to negotiate.”

Sellers like to make sure they are getting all the purchase price at the closing, Mr. Hamilton added. Indemnities were often backed by escrow, keeping a portion of the purchase price in escrow, which “could sit there a year or longer and this is a way to allow the seller to get all its money up front,” he said.

There is “definitely a sweet spot” for transactional risk insurance, describing it as primarily a middle market product for deals roughly between $50 million and $1 billion, Mr. Warren said.

“So, where you’re a financial investor or PE fund or pension fund and you’re acquiring a company, you’re more likely to use risk and warranty or any other type of transactional insurance than if you’re a large corporation making acquisitions,” he said.

There will always be certain transactions where transactional insurance is not an appropriate solution and “that’s not going to change,” Mr. Warren said. This would include target companies that have existing liabilities or real high-risk issues “that insurers cannot or just would never be willing to cover,” he said.

“But there’s plenty of room for growth,” Mr. Warren said. “More participating carriers and brokers, increasingly sophisticated users and more tailored products will lead to a really competitive market place with lower premiums, lower deductibles, and more expansive coverage. I see it growing.”

 

 

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