Dealmakers are increasingly turning to transactional insurance products as risk mitigation tools in mergers and acquisitions. In the first six months of 2012, the total policy limits for transactional insurance policies purchased increased by 35 percent over the same period in 2011.
While successful private equity buyers have been using representations and warranties insurance to distinguish their bids in auctions for many years, a growing percentage of policies placed worldwide in 2012 were for corporate buyers. Corporate acquirers are typically more cautious on the amount of warranty protection they require in a transaction than their private equity counterparts and often lose out on a deal because of this aversion to risk. Through the use of transaction insurance, corporate buyers are having more success in winning sought after assets, especially overseas targets, while at the same time satisfying their board’s requirements for risk mitigation in the deal.
The surge in popularity is also being fueled by Sellers who are increasingly building representations and warranties insurance into the M&A process from the beginning in order to minimize their post-closing exposure, while at the same time maximizing purchase price.
Strategic private equity sponsors are using insurance policies to maximize the efficiency of capital structures and insuring off the remaining tail liabilities for all of the portfolio companies in a particular fund, enabling an earlier distribution or redeployment of fund proceeds.
Several other factors are contributing to the growth in demand for transaction insurance. In general, deal makers are more risk averse today than they were prior to the global financial crisis. In addition, the terms of the insurance products themselves have improved significantly since they were first introduced to the market. The coverage has improved, there are fewer standard exclusions, the pricing has come down and the underwriting process has been expedited. Technology and a higher level of sophistication are enabling the insurers to complete their underwriting and be in a position to issue a policy within the time frame of the overall deal negotiations. This process is commonly completed in two to three weeks. Finally, a history of successful claims under these policies has eliminated the early skepticism expressed by some parties.
While representations and warranties insurance is the most commonly used transactional insurance product, contingent liability insurance, tax liability insurance and litigation buyout insurance are increasingly being used to overcome specific deal obstacles the parties are unable to resolve through traditional contractual indemnification.