Despite M&A activity being on the wane thanks to the recession, a new player is emerging in the form of W&I insurance
One of the great certainties in business is that dealmakers will pursue every available avenue before walking away from a potentially profitable transaction. A process as old as capitalism itself, the decision of course rests on an acceptance and trust from each side to deliver goods or assets in exchange for adequate compensation.
Unfortunately, in the corporate mergers and acquisitions world, the global financial crisis introduced uncertainty into the mix to an extent that confidence has suffered and deals have – for the most part – stagnated.
In Europe this has certainly proved the case, with deals dropping by 3% in value from 2012 to 2013. But for those that have reached the finish line, a new trend is emerging – revealing how insurance is playing an increasingly significant part in the successful completion of such deals.
W&I on the rise
A study from CMS Cameron McKenna carried out in March revealed that warranty and indemnity insurance is becoming an increasing feature of M&A activity across the Continent. The annual CMS European M&A Survey found that while overall transaction volumes have fallen across Europe, the number involving W&I insurance has risen to 9%.
W&I insurance has been available for many years, but has only broken through as a real solution in recent times. It provides a solution for the ‘warranty gap' – where sellers are not prepared, or in some cases are unable, to give warranties and indemnities in the sale process.
The product is particularly attractive to financial sellers such as private equity in controlled auction processes, because they can provide a package to prospective buyers that will enable them to make warranty claims against the insurer rather than the seller.
W&I can be offered both for the seller and the buyer, but is more usually taken out by the buyer (76 % of relevant deals between 2011 and 2013). The premium is typically between 1% and 2% of the cover purchased, often being borne by the seller.
Our research was significant in revealing that over the two-year period between 2011 and 2012, W&I insurance was either taken out or actively contemplated in 8% of transactions, rising to 9 % in 2013.
Given that many transactions – such as those providing a perfectly acceptable corporate covenant – will not give rise to material concern about the ‘warranty gap', this is a significant statistic that suggests W&I insurance is very much part of the landscape for European M&A transactions.
Indeed, many brokers have echoed our findings in the demand for their services, with corporate M&A teams providing an increasing amount of ‘transactional liability' cover – of which W&I makes up the lion's share.
Ultimately, insurance products are only ever as good as their claims history dictates, but the signs are that W&I has found a niche among corporate dealmakers that is helping to oil the wheels of capitalism.
Increase in claims history
Among the drivers in the W&I marketplace is the fact that a more detailed claims history is now forming, enabling underwriters and customers to have greater confidence in the product. Buyers have typically been sceptical of the ability of insurers to satisfy claims, but a growing claims history allays some of these fears.
The key for buyers is the product's ability to offer back-to-back cover for a full set of well-negotiated warranties that have benefited from due diligence.
There have been some signs of a recovery in European corporate finance activity during the first quarter of 2014. The fact that initial public offerings are also on the rise – there were eight IPOs on the London exchanges in Q1 – points to a little more confidence from investors.
Nevertheless, recent experience suggests dealmakers have come to rely on innovative transactional liability products as an extra layer of protection. Given the fragile confidence we have today, this is a trend that should continue.
By Aaron Fairhurst, partner at CMS Cameron McKenna
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