M&A insurance: Are you covered?

Buying or selling a business comes with great rewards, but those involved know that making an acquisition also comes with great risks. Due diligence is the key to mitigating these risks, but is it ever possible to spot everything before a deal goes through?

To combat this, an increasing number of dealmakers have decided not to take the risk of being caught out after the deal is completed. These business buyers and sellers are taking out Representation and Warranties (R&W) insurance policies to protect themselves with an additional layer of cover for both during and after the sale takes place.

R&W policies, regardless of whether they are for the seller or buyer, aim to indemnify the insured party for any loss as a result of warranty or tax/contract violation in a Sale and Purchase Agreement. In taking out these policies, buyers can safeguard themselves by ensuring that their warranties retain real value even if sellers cannot pay the claim in the future, whilst sellers can protect their sale proceeds from being lost in escrow accounts.

A recent in-depth study, published by American International Group (AIG), researched the claims made on its M&A policies and found that a notable proportion of mergers and acquisitions resulted in either side breaching agreements and violating the terms and conditions upon closing the deal. More specifically, 14 percent of all M&A policies underwritten by AIG between 2011 and 2014 across the globe ended in a claim.

Interestingly, while individuals on the buy-side are more likely to take out a policy, actual claims were more likely to come from sellers. Three-quarters of policies were taken out by buyers, but only 13 percent of claims came from buyers, and sellers had a notably higher claim rate of 19 percent.

AIG’s global head of M&A insurance, Mary Duffy, noted that in some instances claims were brought in well after a deal had finished, saying that at times “a deal can come back to haunt”. The study found that although 74 percent of all claims were filed within 18 months of a deal completion, it still meant that 26 percent of the claims were only processed well after the timeframe.

“Transactions pose risks to a significant number of companies, despite the best efforts during due diligence. Even the most sophisticated and largest companies can and do miss critical issues during the deal process,” added Duffy.

It is therefore unsurprising that, when claims are made, the focus lies on the financials. The insurance company reported that of all the claims they monitored, 28 percent were a result of financial statement misrepresentations, which was by far the most prominent reason. A further 13 percent was put down to errors or misrepresentations in matters relating to tax, whilst 11 percent of the claims were due to inconsistencies in the companies’ contracts that materialised only after the deal had been done and dusted.

Although it is a relatively niche section of the whole insurance industry, the R&W division has always performed well. However now, due to the increasing awareness and rising levels of interest, business buyers across the UK have reportedly demonstrated a strong demand for more of such policies to cover the acquisition process and market.

It is important to remember that the motivation that forms the premise for the desire to take out R&W policies is not focused on self-preservation. It is rather built on the need to ensure that buyers are protecting their negotiating abilities and to secure themselves a stronger bargaining position. By no means do these policies negate the need for due diligence; taking out a policy allows buyers to offer more attractive deals and most importantly, facilitate a cleaner exchange – something that is incredibly appealing to sellers.

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