Is a extremely aggressive M&A market driving up insurance coverage claims?

Strain to shut offers amid a extremely aggressive mergers and acquisitions (M&A) atmosphere may have led to the next variety of representations and warranties (R&W) insurance coverage claims this 12 months, regardless of dealmaking slowing over the previous 12 months.

That’s the evaluation of specialists at Liberty International Transaction Options (Liberty GTS), the M&A insurance coverage arm of Liberty Mutual Insurance coverage.

Liberty GTS’ newest annual claims briefing confirmed a “predicted uptick” in R&W claims primarily based on the heightened M&A exercise of 2021 and early 2022.

“We now have seen, notably throughout that pandemic interval, that we have been in a really frothy M&A atmosphere, which was very a lot a vendor’s market,” mentioned Rowan Bamford (pictured proper), president of Liberty GTS.

“Our claims expertise now suggests what all of us in all probability knew, [and that’s] offers are being carried out extra shortly and diligence has been carried out maybe much less rigorously.

“This isn’t essentially intentional, however I believe that the character of the expertise of timelines and stress in a aggressive M&A atmosphere meant that individuals maybe weren’t spending fairly as lengthy with due diligence as they could in any other case have carried out.”

R&W insurance coverage, often known as guarantee and indemnity (W&I) insurance coverage, gives protection for all representations and warranties of a goal firm or vendor in an M&A purchase order settlement. It’s designed to guard events from monetary loss arising from breaches in the course of the sale.

R&W claims tendencies – accounting, monetary points driving giant payouts

Liberty GTS has facilitated over 1,500 M&A offers a 12 months on common and operates in 14 jurisdictions throughout the Americas, Asia Pacific (APAC), and Europe, the Center East, and Africa (EMEA).

In its 2023 claims briefing, it pinpointed a number of R&W insurance coverage tendencies, drawing insights from almost 500 notifications it has acquired since 2019.

The info exhibits that accounting and monetary points have been liable for over 1 / 4 (28%) of claims of over $1 million within the final 18 months.

Simon Radcliffe (pictured left), head of claims at Liberty GTS, mentioned there was a broad vary of claims associated to monetary and accounting points.

“When it comes to frequent themes, points with administration accounts are one thing we’re seeing quite a lot of and is driving a few of our bigger claims,” mentioned Radcliffe.

“Stock-related points are additionally a standard supply of claims. Income recognition points additionally appear pretty frequent, typically leading to giant claims as a result of income is a key driver for EBIDTA, which is a key driver for valuation.”

Liberty GTS has additionally seen a number of claims regarding the accuracy of (unaudited) carve-out accounts and, particularly, points with how bills have been allotted between the enterprise being bought and the corporate being retained.

Claims involving mental property points have gotten more and more frequent and expensive.

The notifications contain commerce secret theft and IP infringement claims, making up 9% of the notifications that Liberty GTS acquired in 2022 (up from 6% in 2021). A lot of these claims are commonest within the IT, pharma, and client merchandise sectors, in accordance with the claims report.

Patrons’ regret, inflation influencing R&W insurance coverage claims?

In keeping with Bamford, offers usually tend to have claims on them when the market is most buoyant as a result of valuations are at their highest, and thus, consumers are most certainly to have regret on their purchases and file for R&W claims to get some worth again.

“If you’re in a down cycle, which maybe we are actually, as valuations dropped considerably, not solely do consumers have a extra practical concept of what they’re shopping for, they’re paying much less for it. So, the claims we get needs to be for a decrease worth than the comparable deal written three years in the past,” Bamford mentioned.

“You’d additionally hope that as a result of there isn’t the stress on timings, any purchaser can have had much more time to elevate the hood and verify the tires of the enterprise, so they need to have a extra correct and practical view of the enterprise than they maybe would do in a really frothy, overheated market.”

Moreover, rising operational prices on account of inflation have had a major downstream affect on R&W claims.

“When folks or companies are beneath stress, it goes with out saying that they try to reduce prices the place they’ll,” Bamford mentioned.

“That is perhaps across the upkeep of property. You may spend much less in the course of the annual service, or your well being and security division could shrink as a result of it’s not essential for the enterprise.

“All these cost-cutting measures, in flip, result in issues down the road as a result of machines fail or anyone hasn’t noticed that one thing’s leaking into the water system, which results in reps and warranties claims surrounding the adequacy of property.”

Insurance coverage ‘not a substitute’ for M&A due diligence

Then again, Radcliffe mentioned the slowdown in M&A exercise on account of larger rates of interest and different financial components has additionally been mirrored within the claims notifications for 2023.  

“We’re seeing a little bit of a slowdown by way of notifications that we’re receiving, and that’s a byproduct of the truth that the final 18 months have been comparatively quiet from a dealmaking perspective, actually in comparison with 2020 and 2021,” mentioned Radcliffe.

“However we nonetheless have quite a lot of lively claims on our e-book, and people are translating into some vital funds.”

With international M&A forecast to select again up in 2024, Bamford harassed the significance of insureds conducting thorough due diligence.

“We’d argue that M&A insurance coverage is all the time meant to not be an alternative choice to due diligence however to take a seat on prime of it,” mentioned Bamford.

“[During M&A], you are supposed to act as an insured such as you would for those who aren’t insured.”

What are your ideas on the R&W insurance coverage claims tendencies highlighted by Liberty GTS? Please share them within the feedback.