It was the Competition and Markets Authority that recently put paid to Sainsbury’s and Asda’s marriage plans, but there are plenty of other risks that also regularly threaten the success of mergers and acquistions – ranging from the uncovering of material issues like customer disputes or major tax investigations to difficulties with integrating technology
UK merger and acquisition contracts are based on the principle of ‘caveat emptor,’ there are many steps that acquiring parties must take to ensure they don’t end up crying over spilt milk. Use of risk management and insurance should figure prominently among these.
Risk managers need to feature both in initial due diligence and in the subsequent arrangement of appropriate insurance. But feedback from the M&A community on the extent of their actual involvement is mixed.
Alex Hartley, corporate finance partner for KPMG UK, says: “In the mid-market we do not typically see risk managers on deals. Risk management is usually the responsibility of the deal executive leading the acquisition, be that the investment director from a private equity fund or the corporate development director or M&A director from a corporate.”
But the M&A practice at Marsh is regularly working with risk managers, although it points out that this happens more on the corporate side than with private equity, infrastructure and real estate funds. Furthermore, even with corporates there is clearly still room for improvement.
Andrew Hunt, UK practice leader for PE and M&A practice at Marsh, says: “We have clients that have come to us after the event when they haven’t done any or sufficient due diligence and there has been a lack of understanding of the assets being bought. But it happens less than it used to.”
The due diligence process
Opinions also vary on whether those risk managers who are involved start early enough. With due diligence they should ideally be in the loop as soon as the letter of intent has been signed and the flow of information begins.
Forum of Insurance Lawyers spokesperson Jeremy Irving, who is financial services partner at law firm Browne Jacobson, says: “It will vary from company to company. In principle, one might reasonably expect a chief risk officer to be involved from the outset, and a risk manager reporting to them might similarly be involved at an early stage.
“Companies without such governance functionality might, of course, not involve the risk manager early, and it could also be that the risk manager could be personally affected adversely by the project.”
The insurance due diligence report should consider any legacy issues, including warranties and other liabilities – which will often be influenced by the sectors concerned. It should also cover risk financing, including the insurance programmes and claims record of both the current entities.
Domestic M&A the highest for 10 years
Merger and acquisition activity during 2019 could be affected by uncertainty surrounding Brexit, global trade arguments and fears of recession, but figures released by the Office for National Statistics certainly don’t suggest a lack of momentum going into the year.
The total value for domestic M&A (UK companies acquiring other UK companies) was £26.5bn during 2018, the highest value recorded since 2008 (£36.5bn).
Domestic M&A was valued at £5bn in Q4 2018 – similar to the £5.2bn reported in the same quarter of the previous year.
The value of outward M&A (UK companies acquiring foreign companies abroad) was £9.9bn in Q4 2018, a sizeable increase on the value recorded in the previous quarter £4.3bn.
In Q4 2018, the total value of inward M&A was £33.3bn, the highest value since Q4 2016 £85.2bn.
Chris Halliday, M&A partner at Eversheds Sutherland, says: “The claims history gives you important insights into how a business has been run. An unusually high level of claims for a certain type of business may be a potential cause of concern for the buyer. For example, high product liability claims for any type of manufacturing concern or high professional negligence or liability claims for an advisory business.”
The importance of the seller’s risk management function should also not be underestimated, as it must understand how any risk exposures are protected so that the business knows what it is selling. Its input will also shed important light on the compatibility of the two parties.
Julia Graham, technical director and deputy CEO, the Association of Insurance and Risk Managers, says: “It’s important to consider country and regional, and business and cultural differences at an early stage, as these can impact on the attitude of both parties and the associated insurance programmes.”
Once risks have been identified, risk managers can be heavily involved in mitigating them via suitable use of insurance solutions. These can range from cyber insurance, to protect against historic data breaches and viruses, to ensuring that valuations for conventional property and casualty insurance are correct.
Transactional liability products are also now increasingly being used to enhance the position of the buyer or seller, or to overcome potential issues within the deal negotiations. For sellers, they can be used to boost the exit value and, for buyers they can provide additional financial comfort or a method for them to remove a deal issue from the table.
The process of actually arranging insurance cover should ideally begin when the first draft of the share purchase agreement is made and, once again, the penny gradually seems to be dropping.
Because it is currently a highly seller-driven market, sellers have the ability to impose specialist insurance products on the buyer from outset. They are, therefore, becoming a prerequisite for a lot of transactions.
The most popular of the transactional liability covers is warranty and indemnity insurance, which aims to provide cover for unknown breach of ‘warranties’ – contractual promises given by the seller.
2018 another record year for specialist M&A insurance market
According to Paragon’s 2018 M&A and Tax Insurance Global Review, compiled from data from questionnaires sent to two dozen insurers globally:
2018 was another record year, with 4355 transactions using M&A insurance – compared to 3096 in 2017 and only 1315 in 2014.
870 of these 4355 transactions occurred in the UK, the second biggest market behind North America (2396).
The last three years have seen a significant rise in the number of specific tax liability insurance policies, with over 250 issued in 2018.
There are now over a dozen dedicated markets underwriting standalone tax risks.
Broker Paragon reports that demand for W&I insurance has grown by around 20% a year for the past five years, which is primarily the result of M&A activity globally rising at a similar rate. It also highlights that a lot of bidders are now embracing the solution to gain a competitive edge.
George Minoprio, executive director of Gallagher’s M&A practice, says: “W&I is increasingly being used in transactions to facilitate a clean exit, and the risk manager needs to be aware of the product and its ability to help de-risk a transaction. The market has changed positively over the last few years, which has led to wider cover and lower costs.
“The process takes place during the heat of the deal, and having the risk manager there to assist in this work stream can be beneficial.”
Wherever possible, all parties should be given adequate time, as insurers will expect a certain level of information. But insurers have been adapting their processes to suit.
Tan Pawar, senior vice-president, M&A practice at Paragon, says: “The market has become much more nimble and flexible during the last decade and it can take anything from between a few days and a few weeks to prepare a policy. Insurers are effectively working in real time to suit an M&A timetable.”
For identified risks there are also growing appetites for tax liability insurance and contingency liability insurance, and many of the generalisations about risk manager involvement with W&I insurance also apply to these.
Don’t forget the technology
Although having a good risk manager can be crucial in the mergers and acquisition process, they are severely restricted unless the board invests in the technology necessary to centralise all the data so that it can be readily analysed.
Ben Potts, managing director of Novidea, the insurance distribution platform, says: “Data is one of the most important assets for the new organisation but is often the forgotten element in an acquisition and can be regarded merely as a plumbing problem for the technology team to fix. Getting it all into one place is key.”
“In many brokers, employees will tell you that it’s difficult, if not impossible, to pull any kind of useful data from their systems, let alone interpret it. Data management is difficult enough in most organisations but is exacerbated when you bring two businesses together that have different technology, legacy platforms and data management approaches, and that hold data in silos in different formats and locations.”
“Putting all the data in one place enables the risk manager to benchmark and to see where information is missing” continues Potts. “It also helps the board itself to see the pros and cons of the proposed merger or acquisition.”
Halliday says: “If it is seen by the buyer as a transactional activity, the risk manager may not have as much of a direct role, so there’s a need for joined-up thinking. For example, if the buyer’s house broker isn’t the best option to obtain W&I cover, it may be well advised to instruct a more specialist broker.
“In my view a well-coordinated buy-side advisory team, drawing on the skills and experience of a participating risk manager, is likely to generate a lower-risk transaction. I have seen situations when advising W&I insurers where there hasn’t been good alignment among a buyer’s internal teams.”
The fast-growing nature of the specialist M&A insurance market, that now has over 20 serious providers compared to a mere handful five years ago, also means that risk managers must familiarise themselves with a range of Lloyd’s syndicates and managing general agents as well as with the large liability insurers. All have a part to play in the M&A eco system, with capabilities and appetites varying for certain types of deals.
Sellers often stipulate the products should be used in a particular way, so risk managers need to ask whether they provide sufficient recourse and broad enough cover – a task made more difficult now that many more permutations are being requested.
Simon Price, head of international M&A at Axa XL, says: “Increased competition in recent years has resulted in a softening market. As a result, insurance buyers are requesting reduced premium rates, reduced retention levels, more policy enhancements and broader coverage.”
Risk managers will also have an increasing role to play on the claims side. Some insurers report a claims notification for every one in seven policies, others for every one in 20. But what’s not in dispute is that claims levels will continue to increase as the market continues to grow.
Jane Childs, partner in the insurance and reinsurance practice at international law firm Mayer Brown, says: “The risk manager’s knowledge of the deal can really come to the fore at the claims stage, but they need to appreciate that the matter will be a complex one. A great level of detail is required to demonstrate what has gone wrong and how the seller’s warranties have been breached, and for assessing the policy wording against that landscape.”
Increasing future role
The consensus view is that risk manager involvement with M&A activity is only likely to gain momentum, and this is not just because of claims increases. There simply remains so much untapped potential for the specialist covers outside the PE front.
Allen & Overy’s recent Global Trends in Private M&A report finds that W&I insurance was used on some 70% of PE exits the firm advised on globally in 2018. When it came to deals with non-PE sellers, however, it was used by only 16%.
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