The Curious Contradiction of M&A Risk Transfer
This article first appeared in Commercial Risk.
Mary Duffy, global head of M&A insurance, explains why it pays for risk managers to be front and centre during an acquisition or divestiture.
Risk and insurance managers are central to placing international programmes, managing relationships with insurance and broking partners and coordinating the claims process. But it is a curious contradiction that the same is often not the case when it comes to managing and transferring risk during mergers and acquisitions (M&A). Here, the warranty and indemnity insurance (W&I, also known as R&W in the US) purchase may be driven more by outside counsel, not taking into account existing insurance relationships, which can be helpful in negotiating terms of the coverage.
At AIG, we see too many examples where risk managers are brought into the deal process too late in the day, with the result that risks inherent in the deal are not managed in a way that is consistent with the company’s overall risk strategy. When this happens, there is naturally a concern that claims could be tougher to navigate and the policy may not respond as expected.
This can be an extremely costly mistake. AIG’s fourth M&A Claims Intelligence Report reflects the potential for both claims frequency and severity losses, showing that one in five deals insured by AIG result in a notification. Notably, the 2019 report shows that the most material claims over $10m have nearly doubled year on year, with an average claims payout of $19m. Meanwhile, claims frequency remains highest for the largest, most complex deals (at 26% for deals between $500m to $1bn), with an overall frequency close to 20%.
With the use of W&I continuing to grow, it is clear that this insurance plays an important role in facilitating transactions and reducing some of the complications that are inherent in buying or selling. Whereas W&I insurance was once seen primarily as a private equity tool, an increasing number of large corporations are using the cover repeatedly on their deals, particularly the more complex cross-border transactions.
All M&A deals are fraught with complexity, but this is particularly the case for transactions that occur outside a familiar jurisdiction. At a time when macroeconomic uncertainty is increasing and emerging, high-growth markets present many of the opportunities, it is clear the risks inherent in cross-border M&A must be managed carefully, with a permanent seat at the deal table for the corporate risk manager.
Uncertainty surrounding Brexit, increasing protectionism and political intervention have added a new dimension to cross-border transactions, with the number of such M&A deals falling by 6.6% to 6,405 in 2018, according to Mergermarket. Overall, the number of global deals fell for the first time since 2010. “Intensifying trade tensions, political instability and increased regulatory scrutiny,” are taking their toll, according to the report.
While companies may feel relatively comfortable handling the risks associated with deals within their home country and determine to self-insure for domestic M&A, less familiar territories can present challenges where the presence of risk partners is highly desirable. Organisations setting a course on strategic global growth cannot eliminate all risk, even with a thorough due diligence and risk assessment process.
It may also be the case that buyers are very comfortable with the terms their M&A team and lawyers have been able to negotiate, however they may be less certain about their ability to enforce those contract terms. If there is a dispute when buying in a different jurisdiction or selling a subsidiary to a foreign buyer, it may involve accessing the courts in an overseas territory as well as dealing with less-familiar tax and regulatory regimes. This is where enforcement risk comes into play and it becomes a question of whether the insured is able to execute upon what has been negotiated.
Taxing times in Europe
Tax is the main driver of W&I notifications in Europe, according to AIG’s claims data, which in itself reflects the complexity of cross-border transactions. In part, it is driven by the challenge of dealing with multiple different tax and audit regimes across the EU and the increasing scrutiny of certain tax authorities. Even with a thorough due diligence process, the wide variety of tax notifications received by AIG during the past 12 months shows this remains an area that is fundamental to the success of any cross-border transaction.
With so much at stake, it is clear the involvement of the risk manager from the start can lead to a better outcome. This is also an opportunity for risk managers to open up a dialogue with senior management and ensure their role remains relevant. The best strategy is one where the risk manager proactively educates management, general counsel and the CFO on the importance of W&I insurance outside the context of a live deal, so that when the next deal comes up, management knows to call upon the risk manager early on in the process.
This way, the risk and insurance manager will be well placed to manage the placement and underwriting process in line with the group’s overall insurance-buying strategy and leveraging those all-important relationships with insurers and brokers. As W&I has become more mainstream, we find corporate buyers are becoming more sophisticated and getting their risk managers involved much earlier in the process, to the benefit of all parties.