Given the reduced amount of merger and acquisition (M&A) activity as a result of the financial crisis, it’s not surprising that the deals, which do go through, engender greater risks. An article from Lloyd’s points out that “in such an environment, insurance is increasingly being used as a strategic tool by companies.”
According to Adam Codrington, a partner at JLT Specialty Ltd, M&A insurance can help bring parties together to enable deals to go ahead. “It can improve the position the seller gets, it can help the buyer negotiate better terms or it can help a buyer offer a more attractive bid if there’s an auction situation,” he explained. “This type of insurance is used to take the risk out of the sale and purchase agreement for either the buyer or the seller.”
Lloyd’s said: “While the level of activity in the global M&A environment may be down, demand for M&A insurance has increased dramatically in the last 2 to 3 years. Such a tool is a boon in the current environment where market valuations are low and volatility is reducing. Boards are reluctant to dive into M&A transactions – even when they appear to make sound financial sense – fearing further financial shocks, particularly in Europe where the sovereign debt crisis looks to be far from over.
“Even where deals are going ahead, they are proceeding slowly. The completion of one of this year’s biggest deals – the proposed merger between Swiss commodities trader Glencore and mining group Xstrata to form a $90 billion company – has been delayed by a month to January 2013.”
With a lot more caution in the current environment, insurance is seen by risk managers as a significant way to de-risk the transaction. Coddington noted: “The primary function of these covers is strategic, i.e. helping people get from A to B to get over a bump or to help the negotiations in the purchase or sale of a business. It can alter the tone of the whole negotiation.”
Lower pricing, broader coverage and growing capacity have resulted in an altogether better experience for the buyer. “The ease with which these products can be put in place has increased considerably,” Codrington continued. “The advisory community – the lawyers, investment bankers and corporate finance houses – are much happier to use these policies to help get over any hurdles between buyers and sellers in terms of the negotiation process.”
He explained that formerly “it might take six to eight weeks to do a deal and the insurer might cover some but not all of the warranties and they’d want a rate of 3 to 4 percent of the limit purchased. Nowadays you can get a deal done in a week, the underwriters will go back-to-back with the sale and purchase agreement and the price is more like between 1 and 2 percent, so the advisors and lawyers in particular have got a lot more confidence in the process.”
The coverage has developed with the times. Lloyd’s indicated that “a decade ago M&A insurance, otherwise known as warranty and indemnity insurance, was not that common. Today, an increasing number of insurers are offering the product, including Lloyd’s insurers Beazley and Pembroke amongst others. However, it remains highly specialist and the barriers to entry are high because it can be difficult to find sufficiently qualified/experienced underwriters.”
Many M&A underwriters are former corporate lawyers who understand the transactions, Codrington explained. “What they look for are commercially balanced, well-negotiated sale and purchase agreements. Secondly, they will look at the due diligence reports, tax positions and specific documentation around the deal as well as who is advising on the transaction and the companies involved. You can usually get a pretty good flavor for a deal that looks like it makes sense from one that doesn’t.”
Source: Lloyd’s of London
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