Insights

Limited Bandwidth for R&W Insurance in 2021
POSTED 9.7.21 M&A

We’re well into the second half of 2021 now…and Representations and Warranty insurance is more popular than ever. Given the protection it provides both Buyers and Sellers in an M&A deal that should be a good thing.

However, that popularity, based on the trust both sides of the table have placed on this coverage, has also brought about an unintended consequence that has resulted in PE firms and Strategic Buyers scrambling to get their deals covered.

Here’s the deal: insurance companies are declining to cover otherwise great risks due to bandwidth. In other words, they don’t have the teams of Underwriters they need to research and understand the deals and then determine coverage and terms for all those parties wanting coverage.

As a result, if your deal is under $400M in transaction value (TV), you can’t go to one of the major nationwide insurance brokers. They’re just stretched thin and are concentrating on the deals that will bring in the most substantial fees. They’re no longer looking at $100M or even $200M deals.

So, at this point, if you come under that threshold and are interested in R&W insurance, you must find a boutique firm to secure your coverage.

Why is this happening… and why now?

There are a few factors:

  • Everybody wants R&W insurance now – overall volume is increasing. People understand its benefits, that claims are paid promptly, and that it can speed up a deal to closing and smooth out negotiations. So many users of RW are so satisfied with the coverage that they are using it on all their deals – and telling the others how effective it is. As a result it is on the verge of becoming ubiquitous.
  • M&A activity overall is ramping up. In fact, it increased by 48% in Q1 2021 compared to the same period in 2020, according to a report from GlobalData, which also noted that momentum from the last half of 2020 continued into this year. The cause: low interest rates, Buyers with cash to spend, surging stock market, and flood of deals postponed by the pandemic now moving forward. And with valuations only going up for target companies, there is an urgency to get through a merger or acquisition quickly. The attitude is to get it done now.

More M&A activity = more demand for R&W insurance.

  • The number of “mega deals,” those $1B+, in particular is going up – and they get priority from insurers because they’ll make more money in fees than on smaller deals.
  • Companies can’t add Underwriters fast enough to meet demand. This is partly due to COVID but it’s also because upstart new insurance companies are poaching entire underwriting teams from established companies—further hamstringing their work. In fact. One leading R&W insurer recently had a very significant number of their Underwriters recruited away by a competitor, who wanted an experienced workforce right away.

Who Is Behind This Trend?

M&A activity is at record levels right now, across the board. Driving demand are:

  • PE firms that are sitting on a ton of dry powder.
  • Strategic Buyers that have sat on the sidelines and are now getting back in the game.
  • SPACs – There are 400 out there actively looking for targets. These special purpose acquisition companies are created solely to acquire an existing private company in a process that is a much easier, quicker, and cheaper way to go public than a traditional IPO. SPACs must make an acquisition within two years of being formed…and the deadline for many of them is looming.

3 Steps to Take Now in Light of This Trend

Despite these trends, all hope is not lost to secure R&W coverage this year, even if you’re deal is under $400M in TV. But you do have act quickly and put in some extra effort to make an insured deal happen. (And you should still prepare yourself for waiting until 2022.)

Here’s what you should do now:

1.  Line up all your diligence experts right now, e.g. lawyers and accountants.

R&W policies right now are being placed on $400M TV deals and up. If your deal is smaller than that, look for boutique broker. Go to solid, experienced regional boutique firms in law, accounting, and insurance to get response you need. If you need a Quality of Earnings report, the big 5 nationwide accounting firms won’t touch you at this point.

Contact these smaller firms and get on their calendar now.

2.  Engage with an experienced, boutique regional R&W insurance broker now. The sooner you get your engagement lined up, the better, even if you are at the Letter of Intent stage.

In both cases you want to avoid the backlog at bigger, national/international players.

3.  Expect and plan for increases in diligence costs, insurance costs, and R&W premiums. The sooner you act, the better as costs continue to rise. It’s simple supply and demand.

To give you an idea, the total cost for a $5M Limit R&W policy was under $200,000, now it’s running $225,000 to $240,000.

But also remember that the protection and peace of mind these policies offer is well worth even the increased costs… and all things considered this coverage is cheap.

As you can see, there is real urgency here.

If you’ve got a deal in the pipeline and are thinking of using R&W insurance to cover it, we should talk now so I can help guide you through the process.

You can contact me Patrick Stroth, at pstroth@rubiconins.com.