If you thought M&A activity would slow in 2022 after the record year in 2021…think again.
Market watchers see current levels continuing through at least the first half of next year. As you know, an increase in M&A activity equals more demand for R&W insurance.
And that means you should expect to see many of the same trends driving the use of Representations & Warranty (R&W) and other M&A-related coverage continue as well—if not become even more widespread.
Here’s a breakdown of what you should be looking out for in the coming year:
1. The “extra” frees being charged on smaller deals are creeping into all
For a while now, many insurance brokers have been quietly adding fees onto what are considered small deals (under $50M TV). They typically add fees when they don’t charge commission. Now they are trying to do so on all the deals they cover.
Premium ranges that used to be standard at 2.5% to 3% of the amount of the policy, so $250,000 to $300,000 for a $10M policy, are now at or above 5%.
There could be some pushback on this from policyholders as premiums go up. However, many brokers will still be able to “sneak in” fees like this because the overall cost of an M&A transaction is expensive and those fees can get lost in the shuffle, so to speak.
This is fair warning to keep an eye out.
2. Increased scarcity for a home for sub-$50M TV deals.
As I wrote in my article, “Limited Bandwidth for R&W Insurance in 2021”, there are fewer and fewer Underwriters who want to work on deals under $50M in Transaction Value. Simply because there are so many deals above $500M+ out there. With limited time and resources, insurers, of course, will focus on those deals generating higher revenues..
As Woodruff Sawyer put it in their Private Equity and M&A Looking Ahead to 2022 report:
“We expect RWI options for deals less than $50 million in enterprise value to be scarce leading into the end of the year. As bandwidth reaches capacity, underwriters will pick and choose only deals they deem highly profitable to pursue. We believe there will be limited to no capacity for small deals or deals with financial issues or a lack of underwriting.”
But if you don’t hit that desirable threshold, all hope is not lost.
What you need is a clean deal and solid due diligence. With a simple package like this that Underwriters could process quickly, there could be a receptive audience. You should also find a smaller, boutique firm that specializes in smaller deals and will give you their full attention.
With an approach like this coverage is scarce but not impossible.
Why would Underwriters turn away business from smaller deals?
If the due diligence is lacking, that leads to unanswered questions. As a result, Underwriters have to put exclusions in the policy or limit the coverage. And they don’t like to do that because it makes them look like the “bad guys”—they get the blame when policyholders get upset.
This type of situation often happens because the insurance broker did not adequately manage expectations.
Sometimes, Underwriters just need clarification in these types of cases where they might otherwise decline to cover a deal.
For example, in the case of one company that was buying a film and TV library. The Buyer had not done extensive diligence on who owned all that content, which made the Underwriters very nervous. They were expecting thorough legal diligence on the intellectual property.
Then the Buyer made several good points. Since they were simply distributors, they were not subject to intellectual property infringement laws —those who produced and planned the use of the content would be on the hook. And not only were they not exposed in that way, but all their contracts had indemnification language, so they were further insulated from IP complaints. On top of that, they had insurance to respond to IP related issues.
That was shared with the Underwriters and the rest of the underwriting process went smoothly, was completed ahead of schedule and with no limitation on IP.
It’s the perfect illustration of how packaging makes all the difference.
3. Rates will continue to be high well into Q1 2022…and beyond
Premium rates went up from 2020 to 2021…and I see them continuing to rise into 2022, at least into the first half of the year. Demand for R&W insurance is just too high to compel a decrease. And, as I said at the beginning M&A activity is on a tear and will continue.
4. Watch out for the impact of the shake-up at R&W insurers.
R&W insurance companies have an Underwriter problem. First, new insurers are entering this lucrative market and poaching whole teams of Underwriters from established carriers. This interruption in talent and staff could slow down processing.
Also, in some cases one of the larger national brokers is losing experienced brokers, and executives in the wake of a failed merger which would have made them redundant. They’ve seen the writing on the wall and decided to leave and start their own firms, including some Underwriters who want to get in on the brokerage side.
They have the contacts. They have repeat clients they can bring over. It’s the perfect opportunity.
5. Expect increased scrutiny from Underwriters with regard to insurance that the target is carrying and cybersecurity.
R&W insurers and Underwriters are looking to pull other policies in to recover losses to be paid in the event of a breach. The thinking being those losses are actually insured by a company’s traditional commercial insurance policies.
There is also a focus on cybersecurity. Underwriters want to see that companies have adequate IT and cybersecurity measure in place to protect data.
As Woodruff Sawyer puts it on their report: “If a deal team does not perform diligence in these key areas, they should expect additional questions and/or exclusionary language related to things like Management Liability, Cyber Liability, and Professional/E&O Liability.”
6. Claims are steady.
More R&W insurance claims are being paid these days. But it stands to reason as more claims are being reported…because there are more policies out there. No big concern here. “Roughly 20% of policies result in claims, and about 25% of submitted claims result in a limit loss,” as they mention in the Woodruff Sawyer report, and that is a similar rate to 2020.
The rate of claims being paid has not changed.
7. Expect more deals with no indemnity.
There is an interesting phenomenon that has been occurring.
The accepted wisdom in M&A Insurance circles for a long time was that R&W policies with no Seller indemnity would be more risky and have more claims. As a result, Underwriters used to favor deals where the Seller indemnity clause was present, and deductible was shared by the parties. They wanted to see both sides have “skin in the game.”
However, in practice this has not been the case. There is no discernible difference between the two types of deals. So, expect to see more deals be covered with no indemnity needed.
Here’s how it used to be:
In the Purchase and Sale Agreement there would be an indemnification clause that the Seller must pay the Buyer’s loss if there was a breach. If there was a R&W policy in place, the policy stepped into the Seller’s shoes to take care of that and pay the loss. Although the Seller would still be on the hook for at least a share of the deductible.
Today, however, now Sellers want no indemnity and negotiate that the reps and warranties do not survive past closing. They want to sell “as is” – kind of like a used car. To be clear, in these types of “as is/non-indemnity agreement”, the Seller is liable to the Buyer for nothing…ever…nothing is held back. However, the risk is hedged for the Buyer because they have R&W insurance in place.
8. Concern about COVID is waning.
As the pandemic winds down, insurers are less concerned about pandemic-related claims. Although they will continue to ask about COVID in their diligence process.
9. Prices for targets are not going down.
From attendees of a recent McGuire Woods Independent Sponsor Conference, the word is that prices for targets are not going down any time soon—despite any pandemic effects. Many vulnerable companies pulled themselves off the market. And they are strengthening. The multiples and competition for these targets is going up, not down. So, if you’re waiting for a dip in evaluations…it’s not happening.
It’s clear that it’s going to be an interesting year in 2022. And I’m happy to help with your M&A insurance needs.
You can contact me Patrick Stroth, at firstname.lastname@example.org.