July 2024 Market Update – Transaction (M&A) and Contingent Risks

The M&A market remains optimistic while wading against continued economic uncertainty, growing inflation, higher interest rates, geopolitical conflict, and various elections in multiple jurisdictions.

As we weather the vagaries of the economy, Warranty and Indemnity (W&I) insurance continues to be an effective risk mitigation tool and policy uptake remains strong. W&I insurance is an important and necessary risk transfer option for private equity, corporates and financial sponsors on all transactions.

Transactional (M&A) risk insurances more broadly include:

With the increasing dominance of corporates in M&A, W&I insurance has naturally gained popularity amongst corporate sellers and buyers. Prudent directors consider the application of W&I and contingent legal risk insurance as part of their risk management obligations. However, there is a greater need to socialise the utility of these risk transfer options amongst corporate stakeholders. It benefits corporate clients (whether a buyer or seller) to engage early with the W&I risk advisor, investment/deal teams and the insurance managers to understand and facilitate a smooth W&I process and its seamless interaction with the deal timetable.

W&I insurance and contingent legal risk insurance are critical to a transaction and ease negotiations. Their benefits include:

The M&A insurer pool in the Pacific has expanded significantly, stirring up competition that has been compounded by a decline in M&A in 2023. The market offers ample risk capital, has strong underwriting appetite, and is supported by capable underwriting teams.

Rates: While we were expecting high premium rates (premium as a percentage of the policy limit) to recalibrate post 2021-22 and set a new baseline, competition has now driven rates lower than expected. Bearing in mind the cyclical nature of the insurance market, these rates may not be sustainable in the long term and are not necessarily reflective of the risk assumed by insurers. We remain vigilant and engaged with insurers over rates as claims payouts impact insurers’ loss ratios and consequently pricing and sustainability of the W&I insurance market.

For mid-size ($300M to $500M) share sale transactions presenting a favourable risk profile, with market standard Asia Pacific qualifications, limitations and diligence, rates can be in the vicinity of 0.70 to 0.74 per cent (of $150M) for a $150M limit, and 0.80 to 0.84 per cent (of $100M) for a $100M limit.

Thresholds: Lower aggregate retentions/aggregate claims thresholds (0.25 per cent of the enterprise value and 0.25 per cent tipping to nil) have become more common on deals. We are also seeing lower per claims thresholds (0.05 per cent of the enterprise value) offered more consistently, in addition to the more standard 0.1 per cent of the enterprise value.

Underwriting approach: Insurers are willing to scrutinise and underwrite risks which they may have previously declined or excluded, where satisfactory due diligence has been undertaken. Market capacity is strong and includes established insurers, Lloyds syndicates and underwriting agencies, and provides a healthy blend in underwriting approaches that break away from a former rigidity.

Process: M&A insurance markets have eased the burden of the W&I underwriting process. To achieve timing and process efficiencies, markets streamline the underwriting Q&A, limit the requirement for underwriting calls and carry out their underwriting review within condensed timeframes.

Approach: An in-depth review of the target’s risk profile extends to understanding the broader risk landscape and the target’s insurance programmes. We have seen a marked improvement in underwriting quality, with markets displaying a more technical understanding of the target business and its risk profile. This allows them to take less of a one size fits all approach to coverage.

With greater collaboration amongst underwriting teams across product lines (e.g. environmental liability, intellectual property etc.), M&A insurers look to offer alternate risk transfer options where available. A holistic risk review is a foundational principle of our practice, and the M&A insurance market is aligned with our approach to M&A risk advisory.

Balance sheet exposure v insurance: M&A advisors and deal parties are increasingly aware that known risks such as tax risks, environmental liability risks, regulatory risks, intellectual property and litigation risks may be insurable. Risk capital is available outside the transaction perimeter and can help protect the target’s balance sheet when transferred to the insurance market, independent of a transaction.

Equally, deal parties are seeing the value in transferring known risks that might ordinarily sit within the remit of a specific indemnity in the sale agreement, to an insurance policy.

While eagerly awaiting an uptick in M&A activity, markets have recognised the need to pivot and explore the untapped potential of contingent risk transfer options in unlocking value for customers outside a transaction.

With large volumes of available risk capital, the market is keen to innovate. Our discussions with M&A advisors and deal parties confirm that we need more proactive and robust engagement amongst M&A advisors, deal parties and the M&A insurance market to identify alternate transaction solutions. The market is continuing to explore ways in which it can improve sector specific offerings or hone their underwriting approach. While W&I insurance is typically sector agnostic, the M&A insurance market has organically evolved in its approach to underwriting certain industry sectors and transaction structures as discussed below.

Real estate transactions: 2024 budget announcements, regulatory changes, and the implementation of incentives (e.g. build-to-rent and housing sector) have churned up investment in the real estate sector. Property developers, investors, construction companies, real estate investment trusts and funds, utilise W&I on a cross-section of complex real estate transactions. The market has a healthy appetite for these transactions which may also present a favourable risk profile. Transactions with reduced operational risks attract materially lower premiums, retentions (aggregate claims thresholds) and a truncated underwriting timeline. These transactions present unknown risks such as regulatory/compliance risks, tax risks, risks under the relevant leases etc., which the W&I policy covers. In addition to the more standard W&I policy, real estate specific insurance products are available in the market that cover both known and unknown real estate risks such as title to real estate, ownership and use of land, and restrictive covenants.

Renewables transactions: We expect the ongoing energy transition, government incentives (e.g. the Capacity Investment Scheme), private capital and transformational M&A likely to continue driving activity in the renewables sector. A consistent flow of renewable transactions has spurred insurers to refine their underwriting approach when considering these risks on a deal-by-deal basis. These transactions commonly involve a combination of operating assets, greenfield projects and projects in-development, with a varying risk profile.

The targets are typically solar farms, wind farms and battery energy storage systems (BESS). This calls for an in depth understanding of the target business to provide meaningful coverage. Underwriters recognise the assessment of historic operational risks extends beyond more superficial factors such as the target’s jurisdiction, size of transaction and the stages of development of these projects. They are sensitive to the extent of operational risk retained by the target with due consideration as to whether the construction, operations and maintenance is run in-house or by third parties, as well as the nature and extent of the workforce (employment risk). While appetite for ongoing construction risk remains muted among W&I insurers (noting there are specific insurances to manage these risks), W&I insurers look to underwrite to historic development risks around permits, authorisations, and approvals, on these deals. A reduction in historic operational risks (e.g. greenfield projects) translates to materially lower premiums and enhanced (lower thresholds) retention structures when compared to transactions with a more comprehensive operational risk profile.

Insuring public M&A: With strong public M&A activity reported through 2023 and well into 2024, it is important to note that these transactions may be W&I insured when facilitated via a scheme of arrangement. When targets are looking to attract PE buyers, structuring a W&I insurance solution bolsters the transaction offering. While W&I insurance has previously been utilised on notable public M&A transactions, there is still a gap to bridge in educating parties on the insurability of these transactions and the benefits to both the buyer and target shareholders.

Boards need to satisfy shareholders of having secured the best value for the target, and risk capital available to a buyer under a W&I policy helps enhance the purchase price. Buyers (that typically have no meaningful recourse to the shareholders), benefit from recourse to the insurance proceeds under a full suite of fundamental and operational warranties appended to the sale documentation, that would otherwise be unavailable.

To ensure inclusion of these warranties in the sale documentation and to socialise the strategy around the W&I process, early stakeholder engagement is recommended. The W&I underwriting process, information requirements and pricing is comparable to a private transaction. Adequate seller disclosures help facilitate the buy-side due diligence required to support the W&I underwriting process. The buyer can also run a W&I process post signing of the Scheme Implementation Deed (SID), provided that the seller is willing to adequately disclose against the warranties to facilitate the buy-side diligence and the W&I process. In these circumstances, markets might be willing to append a suite of warranties to the SID if these are verified by the buyer in diligence.

As a testament to the agility of the product, markets are also open to considering the insurability of distressed transactions and minority sales. Although, this remains a case-by-case proposition sometimes met with a tepid response from markets. Nonetheless, we expect some terms in support of insuring these deals in the current market.

As the market encounters evolving transaction structures and deal dynamics, it is critical that we capitalise on the market conditions to test the reach of transactional risk capital. Identifying effective risk management tools that address transaction hurdles or assist deal parties at an impasse, involves consulting and working in collaboration with M&A advisors. We invite advisors and clients to reach out to our practice when managing these risks, even where it involves breaking the traditional mould of W&I insurance.

To discuss your transaction and contingent risk requirements, please contact Bellrock Practice Leader, Sahalya Uthappa.

For more in depth market updates by product class, profession and industry, please see our individual reports below: