Claims hit one in five insured M&A deals, with large transactions more exposed: AIG

Transaction risks in merger and acquisition deals remain high, with a claim on one in every five (19%) warranty and indemnity (W&I) policies covered by AIG, the insurer said on publishing its third annual market study.

The research shows that risks increase for larger M&A deals. AIG saw a claim on 24% of its policies for transactions greater than $1bn. This is pretty much level with the 23% recorded last year. For deals worth between $500m and $1bn, claims have risen to 21% from 18% in 2017.

“Even the most thorough due diligence process can fail to uncover potential sources of dispute and litigation,” AIG said.

Its UK M&A manager, Angus Marshall, said it is almost impossible to cover every base for deal sizes that exceed $500m. “For those larger deals, diligence is far more complicated, costly and more difficult for dealmakers to assimilate – these very practical issues do have a material impact on transaction risks,” he said.

Claims worth more than $10m made up 8% of AIG’s W&I total. The average claim on payouts in excess of $10m stood at $19m. Nearly half (46%) of AIG’s W&I claims from 2011 to 2016 paid out between $1m and $10m, with an average settlement of $4m.

AIG said buyers are under pressure from potential competitors and investors to complete deals, adding that cross-border transactions involving several jurisdictions are particularly complex.

“There’s a lot of pressure to get the deal done and sometimes issues are not being identified until post-merger,” said Dr Dennis Froneberg, north Europe M&A manager at AIG.

AIG policies covered 2,000 M&A deals between 2011 and 2016, with a total value of more than $700bn. AIG recorded claims on 400 of the policies in force. For the first time, its research has drilled down into industry sectors.

Mary Duffy, global head of M&A insurance at AIG, said: “Our aspiration is that over time – as we build and refine this claims data – it can be used to help clients and their counsel to negotiate better deals. By better understanding where deals get tripped up, they may be able to refine the way they carry out their due diligence.”

Globally, the most common type of claim on M&A insurance policies, accounting for 18%, is financial statement breaches, followed by tax at 16%, according to AIG. In Europe, the Middle East and Africa, tax tops the list of breaches and accounts for 24% of claims, it added.

“It’s no surprise that a large portion of claims in EMEA are related to tax, given how difficult it is to carry out meaningful due diligence in all those different jurisdictions you’re operating in across Europe, with no unified tax system,” said Dr Froneberg.

Germany is a hotspot for tax-related breaches. “There are countries such as Germany where the respective tax authorities are conducting frequent tax audits on corporates, in which case it is very likely that we receive at least one claim notice related to taxes in such countries,” said Dr Froneberg.

Claim types by industry also show significant variations, which AIG said will help clients see where the major risks sit in M&A deals.

Manufacturing reveals a broad spread of risks, but the most common are financial statements (17%) and material contracts (16%). In health and pharmaceuticals, 31% of claims relate to compliance with laws, followed by tax at 20%. In technology, again the top breach is tax at 25%, followed by intellectual property at 19%. Claims from financial services M&As are dominated by financial statements at 25% and material contracts at 23%. Tax breaches are particularly low in financial services deals, causing just 4% of claims.

“This additional industry data helps take M&A insurance out of the abstract and into the real world,” said Ms Duffy. “It shows us that many of the issues that sit at the heart of your business – financial statements, compliance, taxation – are the things that will affect your deal in the most material way,” she said.