Competition for deals fuels rapid adoption of transactional risk insurance: Marsh

Firms are increasingly using transactional risk insurance in the global deal community to resolve risk issues that arise in their most complex transactions, while buyer-side purchases in the United States and Canada during the first half of 2014 were markedly higher than in the same period of 2013, notes a new report from Marsh.

Figures released last week by the global insurance broking and risk management company indicate the limits of transactional risk insurance placed by Marsh globally in the first half of 2014 have increased by 59% on the same period in 2013 to US$3.5 billion.

The figure is included in the report, Transactional Risk Solutions: Global Review, based on research conducted by the company’s Private Equity and Mergers & Acquisitions Services Practice.

“Growth in the global transactional risk insurance market is currently underpinned by a sharp rise in demand in emerging territories, amid continued development in mature markets such as the United States and Europe,” notes a statement from Marsh.

In the U.S. and Canada, however, the company reports the amount of buyer-side representations and warranties (R&W) insurance, “which is used by clients to protect themselves against breaches of representations and warranties in acquisition agreements, has increased by 225% on the same period in 2013.”

The U.S. and Canada showed the greatest growth in the purchase of R&W insurance, states the report, adding that the rise was “driven, in part, by an increase in deal value and the limits of insurance purchased.”

The report notes the motivations for using R&W insurance differ depending on whether a company is on the sell or buy side. “On the sell side, key motivations include the reluctance to retain proceeds in escrow and the ability to achieve a ‘clean exit. On the buy side, creating strategic value during an auction process, concerns about the strength of a seller’s financial covenant, and mitigating jurisdictional specific risk on cross-border transactions are all primary concerns.”

In an attempt to achieve a cleaner exit, Marsh explains in its statement that private equity sellers have been driving bidders in auctions to accept buyer-side R&W insurance in lieu of a traditional escrow.

In addition, Marsh reports an increase in the use of R&W insurance in the U.S. on transactions greater than US$500 million, “signalling growing awareness and confidence in the product among the private equity and legal communities,” the company statement adds.

“Increasingly, buyers in the U.S. are using representations and warranties insurance strategically to differentiate their bids,” explains Craig Schioppo, managing director in Marsh’s U.S. Private Equity and M&A Services Practice, and leader of the transactional risk team.

“Seller-initiated buyer-side representations and warranties policies, which have traditionally flourished in Europe, are also increasingly being used in the U.S. to enable sellers to free up capital for new acquisitions,” Schioppo says.

Looking specifically at the U.S. and Canada, a chart in the report indicates the following:

• limits of insurance placed (US$ millions) – 1,245;
• number of transactional risk policies placed – 53;
• private equity policies placed (as percentage of policies placed) – 74%
• corporate policies (as percentage of policies placed) – 26%
• seller-side W&I (warranty and indemnity) policies (as percentage of W&I policies placed) – 24%
• buyer-side W&I policies (as percentage of W&I policies placed) – 76%

The chart also includes figures for Europe, the Middle East and Africa (EMEA) and Asia-Pacific.

Marsh reports that claims notifications under R&W insurance policies are increasing in line with market growth. The report states the increase in claim notifications under R&W insurance policies are resulting in significant settlement payments being made by insurers.

“The claims that Marsh currently manages, as well as those that are currently in the R&W insurance market, range from amounts that would be unlikely to exceed the aggregate claims limit (or retention under the policy) to amounts as high as the full transaction value,” the report notes.

“Although, in the past, the occurrence of warranty claim breaches was low, an increase in claim notifications and paid insurance claims for breaches of warranties in private market mergers and acquisitions is inevitable as the number of policies written continues to grow.”

“An increase in claim notifications and paid insurance claims for breaches of representations and warranties in private market mergers and acquisitions are byproducts of the significant growth in the market since 2010,” Schioppo adds.