Reps & Warranties

Reducing Friction for M&As

The reps and warranties market is growing rapidly, but some newer players may have taken on more risk than they realize.
By: | February 20, 2018 • 6 min read

Strong demand and booming capacity are driving the market of representation and warranty insurance, which is used by companies to transfer to underwriters risks of future liabilities originated from the acquisition of another firm.

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In the past few years, the number of carriers who offer this coverage has increased from half a dozen to more than four times as many. As a result, terms and conditions have become much more favorable to insurance buyers, while premium rates have gone down consistently.

Even so, they remain significantly higher in the United States than in Europe or the UK.

More importantly, however, in the current market, it is possible for companies to buy coverage for virtually any kind of liabilities arising from an M&A deal. This includes tax liabilities and risks that, not long ago, markets were leery of, such as intellectual property infringements, Medicare and Medicaid billing, product recall, product liability and even environmental risks.

On the other hand, the explosive pace of growth in this market also means higher loss ratios and raises concerns that some new arrivals in the segment may not be fully prepared to face the challenges of the product.

“There are more underwriters who want to get involved in this segment than there are people with the skills required to underwrite the risk,” said Emily Maier, group leader of Transaction Solutions, Woodruff Sawyer & Company.

Emily Maier, group leader of Transaction Solutions, Woodruff Sawyer & Company

For a couple of decades, R&W coverages were mostly a tool deployed by private equity investors to unblock M&A deals by taking off the table the risk that liabilities unknown at the time of the transaction would cause significant losses to the buyer in the future.

It has gradually replaced, in a growing number of transactions, a demand that sellers deposit a share of the price paid into an escrow account — for several years — to show their confidence in the veracity of the R&W included in the sales and purchase agreement (SPA).

The insurance coverage makes the deposit unnecessary, liberating sellers to fully dispose of the capital raised immediately as they see fit.

As a result, in a competitive M&A market, investors have increasingly purchased the coverage to make their bids more attractive to sellers of coveted assets. It also helps to reduce the risk of friction between the new owners and the talent acquired along with the physical assets.

Jonathan Gilbert, senior managing director, Crystal & Company, estimates that, while not long ago one out of every 20 transactions was covered by R&W insurance, today the ratio reaches between 75 percent and 80 percent of the total.

A large majority of policies are purchased by buyers, who can have additional forward coverage, which is not the case with sellers.

Buyers can also insure any amount they want, while sellers can only insure up to the limit of liability. But Maier has spotted a growing number of sellers purchasing the coverage as well, as its scope of use expands.

“I have seen sell-side policies where the seller is much smaller than the buyer, and so it does not necessarily have as much bargaining power,” she said. “There are also situations where international buyers come from a jurisdiction where the market is not as familiar with this product and do not feel comfortable with it.”

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Demand has attracted a growing number of insurers and MGAs to the markets, and prices have fallen accordingly.

Brian Benjamin, global head of M&A Insurance, XL Catlin, estimates that rates dropped 10 percent in 2017, reaching between 2.8 percent to 3.5 percent of the primary limit in the American market, which is one of the most expensive in the world. Not long ago, rates between 4 percent and 5 percent of the purchased limit were standard in the market, he said.

Rates are higher in America due to factors such as the higher risk of litigation, lower disclosure of data requirements imposed on sellers and more expensive claims than in other markets.

Policies offer a mix of first-party and third-party liability coverages, and third-party liability risk tends to be higher in the U.S., Benjamin remarked. On the other hand, he noted U.S.-based coverages tend to be broader in scope, with narrower and less frequent exclusions than in other markets.

Maier has noticed that the market is taking almost all kinds of liability risks, as carriers compete to offer more attractive terms and conditions.

“I have not seen a lot of requests from clients that have not been met from carriers,” she pointed out.

Soft conditions are also bringing retention levels down, Gilbert added. “Previously, insurers would often require a retention equal to 1.5 percent to 2 percent of deal value. Now it has fallen to 1 percent, especially for larger deals,” he said.

“There are more underwriters who want to get involved in this segment than there are people with the skills required to underwrite the risk.” — Emily Maier, group leader of Transaction Solutions, Woodruff Sawyer & Company

Some exclusions can be added to the coverage, and among the most common are forward-looking warranties. Carriers do not like to cover purchase price adjustments and any known issues such as pending litigations or product recalls that are already expected.

Other thorny issues include the underfunding of pension plans, wage and hour disputes and union activity. On cross-border deals, transfer pricing liabilities also tend to be excluded.

A key element to the underwriting process is the due diligence that buyers are supposed to perform on their targets before closing a deal, as carriers base the wording of the policy on the analysis their clients have done on the risks represented by the transaction.

Insurers may refuse to provide the coverage if the due diligence is poorly done, or they can come up with a high number of exclusions if they see material gaps in the information provided.

“We would rather write good deals at a more competitive price rather than increase price and write bad deals. We believe that the market has under-priced certain metrics,” said Bryce Guingrich, managing director of R&W, Vale Insurance Partners.

Maier, however, notes that some underwriters are less demanding regarding the due diligence of deals in a quest to attract customers.

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Studies by AIG and UK brokers Paragon reveal that the frequency of claims in R&W policies is firmly on the rise. Rob Brown, the global practice leader of M&A insurance at Lloyd’s insurers Neon, believes some of the new entrants into the market have underestimated the level of losses that carriers can suffer in this line.

Another development is that capacity is increasingly being offered in new jurisdictions. Buyers must also keep in mind considerations such as the local expertise that they want the underwriter to offer them and the jurisdiction where the insurance premium will be taxed.

The insurance contract is likely to stay open until the negotiation is concluded. That can mean an eleventh-hour rush to finalize the coverage, requiring an intense time commitment from brokers and underwriters.

“Timescales are very tight, and they require people who can understand the transactions and respond to situations very quickly,” Brown said. &

Rodrigo Amaral is a freelance writer specializing in Latin American and European risk management and insurance markets. He can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Insurtech

Kiss Your Annual Renewal Goodbye; On-Demand Insurance Challenges the Traditional Policy

Gig workers' unique insurance needs drive delivery of on-demand coverage.
By: | September 14, 2018 • 6 min read

The gig economy is growing. Nearly six million Americans, or 3.8 percent of the U.S. workforce, now have “contingent” work arrangements, with a further 10.6 million in categories such as independent contractors, on-call workers or temporary help agency staff and for-contract firms, often with well-known names such as Uber, Lyft and Airbnb.

Scott Walchek, founding chairman and CEO, Trōv

The number of Americans owning a drone is also increasing — one recent survey suggested as much as one in 12 of the population — sparking vigorous debate on how regulation should apply to where and when the devices operate.

Add to this other 21st century societal changes, such as consumers’ appetite for other electronic gadgets and the advent of autonomous vehicles. It’s clear that the cover offered by the annually renewable traditional insurance policy is often not fit for purpose. Helped by the sophistication of insurance technology, the response has been an expanding range of ‘on-demand’ covers.

The term ‘on-demand’ is open to various interpretations. For Scott Walchek, founding chairman and CEO of pioneering on-demand insurance platform Trōv, it’s about “giving people agency over the items they own and enabling them to turn on insurance cover whenever they want for whatever they want — often for just a single item.”

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“On-demand represents a whole new behavior and attitude towards insurance, which for years has very much been a case of ‘get it and forget it,’ ” said Walchek.

Trōv’s mobile app enables users to insure just a single item, such as a laptop, whenever they wish and to also select the period of cover required. When ready to buy insurance, they then snap a picture of the sales receipt or product code of the item they want covered.

Welcoming Trōv: A New On-Demand Arrival

While Walchek, who set up Trōv in 2012, stressed it’s a technology company and not an insurance company, it has attracted industry giants such as AXA and Munich Re as partners. Trōv began the U.S. roll-out of its on-demand personal property products this summer by launching in Arizona, having already established itself in Australia and the United Kingdom.

“Australia and the UK were great testing grounds, thanks to their single regulatory authorities,” said Walchek. “Trōv is already approved in 45 states, and we expect to complete the process in all by November.

“On-demand products have a particular appeal to millennials who love the idea of having control via their smart devices and have embraced the concept of an unbundling of experiences: 75 percent of our users are in the 18 to 35 age group.” – Scott Walchek, founding chairman and CEO, Trōv

“On-demand products have a particular appeal to millennials who love the idea of having control via their smart devices and have embraced the concept of an unbundling of experiences: 75 percent of our users are in the 18 to 35 age group,” he added.

“But a mass of tectonic societal shifts is also impacting older generations — on-demand cover fits the new ways in which they work, particularly the ‘untethered’ who aren’t always in the same workplace or using the same device. So we see on-demand going into societal lifestyle changes.”

Wooing Baby Boomers

In addition to its backing for Trōv, across the Atlantic, AXA has partnered with Insurtech start-up By Miles, launching a pay-as-you-go car insurance policy in the UK. The product is promoted as low-cost car insurance for drivers who travel no more than 140 miles per week, or 7,000 miles annually.

“Due to the growing need for these products, companies such as Marmalade — cover for learner drivers — and Cuvva — cover for part-time drivers — have also increased in popularity, and we expect to see more enter the market in the near future,” said AXA UK’s head of telematics, Katy Simpson.

Simpson confirmed that the new products’ initial appeal is to younger motorists, who are more regular users of new technology, while older drivers are warier about sharing too much personal information. However, she expects this to change as on-demand products become more prevalent.

“Looking at mileage-based insurance, such as By Miles specifically, it’s actually older generations who are most likely to save money, as the use of their vehicles tends to decline. Our job is therefore to not only create more customer-centric products but also highlight their benefits to everyone.”

Another Insurtech ready to partner with long-established names is New York-based Slice Labs, which in the UK is working with Legal & General to enter the homeshare insurance market, recently announcing that XL Catlin will use its insurance cloud services platform to create the world’s first on-demand cyber insurance solution.

“For our cyber product, we were looking for a partner on the fintech side, which dovetailed perfectly with what Slice was trying to do,” said John Coletti, head of XL Catlin’s cyber insurance team.

“The premise of selling cyber insurance to small businesses needs a platform such as that provided by Slice — we can get to customers in a discrete, seamless manner, and the partnership offers potential to open up other products.”

Slice Labs’ CEO Tim Attia added: “You can roll up on-demand cover in many different areas, ranging from contract workers to vacation rentals.

“The next leap forward will be provided by the new economy, which will create a range of new risks for on-demand insurance to respond to. McKinsey forecasts that by 2025, ecosystems will account for 30 percent of global premium revenue.

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“When you’re a start-up, you can innovate and question long-held assumptions, but you don’t have the scale that an insurer can provide,” said Attia. “Our platform works well in getting new products out to the market and is scalable.”

Slice Labs is now reviewing the emerging markets, which aren’t hampered by “old, outdated infrastructures,” and plans to test the water via a hackathon in southeast Asia.

Collaboration Vs Competition

Insurtech-insurer collaborations suggest that the industry noted the banking sector’s experience, which names the tech disruptors before deciding partnerships, made greater sense commercially.

“It’s an interesting correlation,” said Slice’s managing director for marketing, Emily Kosick.

“I believe the trend worth calling out is that the window for insurers to innovate is much shorter, thanks to the banking sector’s efforts to offer omni-channel banking, incorporating mobile devices and, more recently, intelligent assistants like Alexa for personal banking.

“Banks have bought into the value of these technology partnerships but had the benefit of consumer expectations changing slowly with them. This compares to insurers who are in an ever-increasing on-demand world where the risk is high for laggards to be left behind.”

As with fintechs in banking, Insurtechs initially focused on the retail segment, with 75 percent of business in personal lines and the remainder in the commercial segment.

“Banks have bought into the value of these technology partnerships but had the benefit of consumer expectations changing slowly with them. This compares to insurers who are in an ever-increasing on-demand world where the risk is high for laggards to be left behind.” — Emily Kosick, managing director, marketing, Slice

Those proportions may be set to change, with innovations such as digital commercial insurance brokerage Embroker’s recent launch of the first digital D&O liability insurance policy, designed for venture capital-backed tech start-ups and reinsured by Munich Re.

Embroker said coverage that formerly took weeks to obtain is now available instantly.

“We focus on three main issues in developing new digital business — what is the customer’s pain point, what is the expense ratio and does it lend itself to algorithmic underwriting?” said CEO Matt Miller. “Workers’ compensation is another obvious class of insurance that can benefit from this approach.”

Jason Griswold, co-founder and chief operating officer of Insurtech REIN, highlighted further opportunities: “I’d add a third category to personal and business lines and that’s business-to-business-to-consumer. It’s there we see the biggest opportunities for partnering with major ecosystems generating large numbers of insureds and also big volumes of data.”

For now, insurers are accommodating Insurtech disruption. Will that change?

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“Insurtechs have focused on products that regulators can understand easily and for which there is clear existing legislation, with consumer protection and insurer solvency the two issues of paramount importance,” noted Shawn Hanson, litigation partner at law firm Akin Gump.

“In time, we could see the disruptors partner with reinsurers rather than primary carriers. Another possibility is the likes of Amazon, Alphabet, Facebook and Apple, with their massive balance sheets, deciding to link up with a reinsurer,” he said.

“You can imagine one of them finding a good Insurtech and buying it, much as Amazon’s purchase of Whole Foods gave it entry into the retail sector.” &

Graham Buck is a UK-based writer and has contributed to Risk & Insurance® since 1998. He can be reached at riskletters.com.