M&A insurance outside of Asia has grown exponentially in the past decade. In Asia, M&A insurance has also been gaining increasing recognition in recent years, but the growth in usage has not kept up with the pace of M&A activity in the region. In this article, BMS’ Aris Wong and Martijn de Lange, members of our Private Equity, M&A and Tax practice, explain why.
M&A insurances more commonly comprise of and are known as R&W insurance (in North America) or W&I insurance (rest of the world) in the industry. The acronyms R, W and I each referring to representations, warranties and indemnities –legal terminology which does not aid understanding of these products.
The products were first developed by former legal M&A practitioners more than a couple of decades ago in the United Kingdom, who were seeking to deal with the pain points of the deal-making process. In particular, they sought to extract statements such as warranties about the historical affairs of the target company to be acquired, and for the seller to be held accountable for them post-acquisition.
The divergence in expectations between sellers and buyers on these matters often rendered negotiations on such warranties excruciating and even when agreed to, buyers often encountered difficulty enforcing the agreed obligations should the seller decide to wind up (voluntarily or involuntarily) post-acquisition.
While such insurances could be taken up by either the seller or the buyer, nine out of 10 policies placed are buyer-insured. By shifting the seller’s liability to insurers and putting a price tag to this future contingent risk, sellers benefit from having a clean exit with little or no tail end liabilities, while buyers have certainty of recourse should they discover a breach of warranties post-acquisition. When used strategically, it helps bidders secure their targets in auctions and allows sellers to maximise their sale price.
These products were a game changer when first introduced in regions outside of their birthplace. The ability to categorise unknown risks associated with M&A transactions, and to transfer them to an insurer, created a safe harbour for buyers.
Increasingly, transactions in Europe and the Pacific are stapled with M&A insurance, while North American dealmakers have developed a significant appetite for M&A insurance on buyouts and minority deals alike.
Growth in M&A insurance
From 2008 and 2018, the total number of M&A insurance policies bound annually in North America grew more than 3,000% and the total insurance capacity purchased rose from a mere $540m to more than $38bn.
While we have not witnessed the same enthusiastic uptick in Asia, the picture is far from homogenous. M&A insurance is still in its infancy in a number of countries such as China and India, two of the largest markets in Asia, due to unfamiliarity with such risk transfer solutions. This is in stark contrast to Asian financial hubs such as Singapore, Hong Kong, Seoul and Tokyo, where we have witnessed an increasing level of regularity and sophistication in the usage of M&A insurance.
Although the use of insurance is rising in popularity in these markets, there remains a group of M&A professionals who remain hesitant and are more likely to self-insure and simply insist on warranty protection alone rather than incurring the premium costs which, while not insignificant (consisting of a one-time payment for a seven-year policy), are often a rounding figure compared to the deal size at hand.
This begs the question, when does M&A insurance move from one end of the spectrum of opinion, from being seen as an unnecessary cost, to the point where it is recognised as changing the dynamics of the transaction and adding real value to both seller and buyer?
The answer is simple: By conducting a risk-benefit analysis, weighing up the cost of insurance against the unknown risks undertaken by the insurer to determine if the insurance adds value to the transaction. The practical application of this analysis, however, is much more complicated.
First, each M&A transaction is unique. There are no two companies or assets that are alike in all aspects. As such, there are no acquisitions that would share exactly the same risk profile.
Second, due to the confidential nature of the industry, there is limited public information identifying deals in which insurances have been taken out, much less the commercial terms and scope of coverage.
Third, the risks undertaken by the insurer are unknown. The unknown factor renders the cost-benefit analysis imperfect. We have seen M&A deal makers fill this gap by drawing from their past deal experience and applying the analysis to the one on hand on the basis that historical transactions have rarely thrown up risks and therefore the current ones are unlikely to either.
Adapting to the market
While this approach appears to be logical, such M&A players should bear in mind that the cost and coverage of M&A insurance are in constant flux as the industry continues to adapt and innovate in our part of the world.
A fresh cost-benefit analysis should be undertaken for each transaction, bearing in mind unknown factors and the differences in coverage for each of the transactions. More importantly, dealmakers should consider how such insurance coverage could be expanded to affect the overall calculation.
A common complaint is the number of items excluded by the W&I insurers. However, such risks are either not undertaken by the seller at the outset, such as disclosed matters discovered during diligence, or such risks are not commensurate with the risk profile of premiums charged by the insurers.
While each transaction is unique and there are grey areas as to whether certain items should be excluded, an experienced M&A insurance broker should guide the deal team in paring down exclusions and obtaining optimal coverage from the W&I insurer.
In most instances, after conducting the cost-benefit analysis to the best of their ability, we note that increasing numbers of Asian M&A practitioners are beginning to recognise the value of W&I insurance.
In particular, more end-users are adopting it as a matter of good corporate governance, should a risk of such a breach materialise and cause their balance sheet to take a hit.
A very useful tool
Further, once M&A practitioners are familiar with the way insurers view and analyse M&A risks, there are many other uses of M&A insurance to take advantage of. It could be used to create harmonious relationships between joint venture partners, avoid sinking dead money into escrow, sharpen one’s terms in a competitive auction process or even to mitigate buyers’ concerns with respect to specific known risks such as lurking tax liabilities.
And the premiums flows tell their own story. The value of W&I insurance is reflected in the adoption rates globally and, increasingly, in the Asia region. This solution is not meant to apply to every single M&A transaction. However, in order to first analyse whether it does/should apply, one must be familiar with the uses and advantages of W&I insurance as a tool in the M&A deal kit to make an informed decision.
Further, as we step into a more uncertain world due to events such as the pandemic, offerings in the M&A insurance space continue to expand. Solutions dealing with known issues like tax liability insurance are being made available.
With Asian economies widely projected to emerge soonest and strongest from the COVID-inspired global slowdown, and M&A activity expected to bounce back first here too, it is highly likely that the interest in M&A insurance in Asia is set to soar. Having relevant M&A coverage in place would allow the buyers to focus on what truly matters; running the target company well post-acquisition.
Ms Aris Wong and Mr Martijn de Lange are managing directors with BMS Asia’s private equity, mergers and acquisitions and tax practice.