M&A insurance comes of age

AIG claims statistics show that M&A insurance buyers are getting their money’s worth, particularly on the largest, most complex cross-border M&A deals. In AIG’s latest claims intelligence report, claims trends from some of the largest programme M&A transactions are considered.

The report captures the growing maturity and credibility of the M&A insurance market, analysing warranty and indemnity (W&I) policies issued by AIG (also known as ‘representations and warranties insurance’). Risk and insurance managers are developing a better understanding of the breadth of coverage and the nature of losses that can be claimed under it. In our experience, where breaches occur and notifications are made, these are varied and well structured, demonstrating that insureds are becoming more sophisticated in their use of the product.

W&I insurance offers buyers and sellers of companies a strategic tool to mitigate transaction risks and facilitate transactions. Underwriters, brokers, insureds and their advisers work closely during the due diligence process to put in a place a policy aimed at providing wide liability coverage, enabling sellers to exit investments cleanly, while giving warranty protection to buyers.

Large corporates and conglomerates are now using W&I insurance more than ever before, giving comfort to boards and investment committees that hidden or unknown liabilities are mitigated and that, should there be any issues with the transaction, there is a policy in place that can be called upon. This is especially the case for large transactions where AIG’s claims intelligence statistics show that nearly one in four M&A deals worth more than $1bn make a claim, and for which AIG paid out millions of dollars to insureds for claims during the period 2011 to 2015. This reflects the inherent risk in larger, cross-border transactions between multinational organisations, exacerbated by pressure to complete transactions within a short space of time.

The report analyses incidents by breach type and these range from financial statements, compliance with laws and material contracts to tax, intellectual property and employee-related breaches. Twenty-seven percent of claims are made during the first six months from policy inception, suggesting (perhaps unsurprisingly) that the first year of ownership is the riskiest for any acquirer but that despite even the most rigorous due diligence process, unexpected liabilities can and do arise shortly after completion of the transaction. Again, this is particularly true for the largest, most complex deals.

This shows the importance to M&A acquirers of considering how W&I insurance will fit into the M&A process at the earliest possible stage. The breadth of cover provided by W&I insurance is, to a certain degree, led by the contract negotiations and the scope of the due diligence.

As such, if the underwriter is able not only to respond to the final legal and due diligence work product but also input into its development and progression, the more aligned the processes become and (more often than not) the wider the scope of insurance cover. This underlines the real value of involving the buyers’ risk managers early in the process, who are uniquely placed to balance the needs of the transaction process and the key requirements of the insurance protection.

Awaiting the megadeals
Total global mergers and acquisitions in 2016 amounted to $3.9trn, according to statistics from JP Morgan, Dealogic and the IMF. And 2017 looks to be another active year as consolidators around the globe seek to complement organic growth with M&A, enabling organisations to enter new markets and gain new capabilities.

However, uncertainty surrounding China’s ability to sustain its economic growth and the perception that many large targets are overpriced has so far stifled megadeals (those in excess of $10bn). Two of the largest transactions in the first half involved UK-based acquirers – the $49.4bn merger of British American Tobacco and Reynolds American, and Reckitt Benckiser’s $17.88bn acquisition of Mead Johnson Nutrition – suggesting deals are going ahead despite Brexit.

This deal activity is encouraging for the M&A market in the context of significant geopolitical pressures, however W&I insurance remains a less common feature of deals with values from $2bn to $3bn. It will be interesting to monitor how this develops if megadeal activity grows, especially given the particular relevance of W&I insurance to high value deals, highlighted by AIG’s W&I claims intelligence.

An issue of integration
M&A activity can impact an organisation’s multinational insurance programme in a number of ways that need to be considered by risk and insurance managers. Normally, an acquisition takes place to achieve a certain goal, such as to enter a new market (whether geographically or by sector), to capitalise on market synergies or with a view to a short-term (three to five year) return on investment (private equity), and this has implications for the risk profile and insurance needs of the acquired entity as it is integrated into the new corporate structure.

Logistical complications can arise in particular in the context of mergers between two large multinationals (more common in the US than in Europe); there is the doubling up of global programmes, brokers, carriers and risk and insurance teams. This can result in flexing of muscles as competing teams vie to maintain the relationship and the business. One can imagine this tension was a feature following Shell’s $53bn buyout of BG Group, which completed last year. Here, there was also the considerable challenge of incorporating more than one captive and risk management strategy into a consolidated programme to achieve the desired synergies and savings that should result from any M&A.

For the acquirer, a relatively straightforward change to an existing insurance arrangement as new assets are incorporated is possible, albeit requiring mid-term adjustments. Typically, the target company’s multinational insurance arrangements are rolled up into the programme of the acquiring company. Differences in culture and risk appetite tend to be resolved fairly quickly, with the acquirer exerting its dominant influence.

However, it may not be possible or cost effective to cancel existing policies and put them into a new programme. A project-managed approach is essential, particularly when two large organisations are coming together, to ensure multinational programmes are fully integrated with policies responding as expected. Again, this highlights the importance of risk managers being brought into the M&A process early on, so that an organisation’s legal team fully understands the risk and insurance repercussions of a transaction.

Contributed by Angus Marshall, AIG, head of M&A, UK and London Market; and Salil Bhalla, AIG, head of complex multinational accounts – UK