Transactional insurance gains traction in US as dealmaking picks up pace

As seen on Advisen Insurance Intelligence: 

By Cate Chapman on April 8, 2015

Transactional insurance is taking off in the US, along with a so-called sellers’ market in M&A.

One reason is the insurance saves a company that is being sold, which may be fielding rival bids, the need to set aside funds to cover potential “unknown” liabilities.

“Companies being bought can ask buyers to go out and get R&W instead of having to put up escrow,” said Navine Aggarwal, vice president of mergers and acquisitions at Allied World, referring to the most popular type of transactional insurance, representations and warranties.

“And the seller can be more competitive by offering to buy it in the process, instead of asking the seller to put up an escrow account,” Aggarwal told Advisen in an interview.

The insurance, sales of which have doubled or tripled in each of the past few years, according to Allied, is a topic at Advisen’s Transactional Insurance Insights Forum, to be held on April 15 in New York. Panelists will address the M&A environment, due diligence and related insurance products including R&W, and tax and contingent liability insurance.

The discussion comes as M&A makes a comeback in the US. The insurance industry alone boasted eight $1 billion-plus deals in 2014, as many as had been announced in the past several years combined, figures from Deloitte show.

“R&W is the real bread and butter of the transactional insurance industry,” Aggarwal said. “Contingent and tax indemnity policies aren’t always a known liability, but they are a known exposure–meaning an uncertain tax position or uncertain litigation outcome.”

R&W protects buyers and sellers from liabilities that may arise from exceptions to the representations and warranties made in an acquisition agreement, including those related to tax, environmental, compliance, benefits and labor issues.

Known as warranty and indemnity insurance in Europe, R&W has long been used outside the US, especially in cross-border deals where the buyer may be unfamiliar with the environment of the target company.

Rates for the coverage are relatively cheap, ranging from 2.5-4 percent of liability limits, Aggarwal said. These can run to $400 or $500 million per M&A transaction, with customers buying layers of coverage.

But the insurance doesn’t replace due diligence, risk managers and M&A professionals said, because information is what is most needed in any transaction.

“The history of a company will dictate what faces us in the future,” said Susan Reinhard, senior director of claims and risk management at EMCOR Group.

If there isn’t adequate information on claims and legacy exposures,“I take that as seriously as if it were in the present day,” she said at Advisen’s Casualty Insights conference last month.

Audrey Rampinelli, vice president of risk management at conglomerate Loews Corp., also speaking at the forum, said “you have to be a detective in M&A. The benefits side should be part of due diligence. What fiduciary issues might there be out there?”

Another issue that falls outside the purview of transactional insurance is culture. How compatible are the respective characteristics of two companies, from risk appetite to insurance programs?

Christopher Tutoki, a partner in M&A transaction services at Deloitte, will speak to tax due diligence at the Transactional Insurance forum. He told Advisen in an interview that while “tangibles can be insured, there are a few aspects that are more nebulous.”

An example is situations involving the liabilities of other member companies in the consolidated tax-return group of a target.

“When buying or selling an entity, you want it to be free from tax liability, but it’s liable for the tax exposures of other entities for the years in which it was a member of the group,” he said, citing Treasury regulation section 1.1502-6.

Since the other entities are not part of the sale, a seller may not be willing to disclose information about them.

In general, when information is not available, clients sometimes get the insurance and go through with a deal, he said. But the less due diligence there is, the more someone may “have to pay to replace it.”

Knowledge is power, and having a company’s liabilities vetted can give its executives more confidence when negotiating a sale.

“Many of my clients don’t yet purchase transactional insurance and retain me or others to perform the diligence,” or discovery of existing and potential liabilities, Tutoki said.

Even with the dramatic sales increase in the US, market penetration is still at 8-10 percent, Aggarwal said. Should the sellers’ market subside, he expects adoption to continue here.

“We see penetration going to 20, 30, 40 percent, like in the rest of the world,” he told Advisen. “We are continuing to see competition in this space, with more brokers entering the market, which broadens it. You see R&W for sale in small cities and regions now, not jut the big ones.”