Mergers and acquisitions appear to be in global decline, but insurance policies and coverage limits for M&A are on the upswing. What’s the deal?
A study by Deloitte, Corporate Development 2012: Leveraging the Power of Relationships in M&A, finds that fiscal and political uncertainty in Europe and a stream of new regulations and laws in the United States appear to be depressing enthusiasm for M&A. Indeed, in the first half of this year, the value of global M&A totaled of $929.4 billion, marking a decline of 21.6% on the first half of 2011, according to mergermarket. That first-half figure is also the third-lowest first-half total since 2004.
“M&A is definitely down,” says Craig Schioppo, a managing director in the financial professional practice at Marsh, a big insurance broker. Faced with the tougher climate, though, intermediaries are looking for any help they can get in nailing down a deal. And Schioppo contends that improvements in coverage for M&A, including the ability to put policies in place quickly, as well as cheaper pricing, have spurred deal makers, particularly lawyers, to buy coverage to facilitate deals: sometimes in the middle of negotiations.
Schioppo observes that attorneys use insurance as a tool to facilitate negotiations and remove hurdles. Policies can be bought once negotiations begin — when there is a buyer and a seller — but not after the deal is closed, he explains. Once a deal is under way, parties may decide to use insurance to remove a negotiating obstacle, he says.
“Transactional insurance is for the event that something the buyer was told turns out to be untrue and the buyer suffers financial loss. The policy covers that financial loss,” says Schioppo.
Marsh says it observed increased policy-buying activity over the first half of 2012. Total policy limits for transactional risk insurance purchased by the broker’s corporate clients increased by 35%, to $2.3 billion, in the past 12 months to June of this year, according to Marsh Insights: Transactional Risk Update.
Schioppo points out that only one party can be covered in the transaction, either the buyer or the seller. These solutions also work best for middle market to upper-middle market, often private-company deals that have a purchase price of $50 million to $1.5 billion, he adds.
The coverage pays off if seller representations turn out to be false and the buyer finds this out after closing, Schioppo says. On a $100 million deal, the buyer is typically protected by an indemnity arrangement in which the seller might be “on the hook for two years, [during which] the buyer is allowed to come back if something turns out to be false for up to $10 million — called a 10% indemnity cap.”
The buyer in a merger can also buy transactional risk insurance that protects it from a loss of that $10 million up to $50 million. For their part, sellers can buy insurance that covers what they might have to pay buyers they’ve misinformed.
One example of a covered exposure occurs if the seller says its “20 major customers were in good standing, but one of them was really in bad standing — [and] a month after closing they were no longer doing business with the company,” says Schioppo.
Another example might be one in which the seller claims there is no litigation against the company, but it turns out that there is indeed a lawsuit. Or there could be a mistake in a financial statement — a $1 million error in inventory, say.
“That million dollars could come from the seller or the insurance policy, depending on how the buyer has protected itself,” explains Schioppo.