Claims, Capacity and COVID: Welcome to M&A Insurance in 2020

The mergers & acquisitions market is challenging for insurers due to an increase in claims activity and an oversupply in capacity. Throw a pandemic into the mix, and you get emerging risks, squeamish deal participants and plenty of uncertainty — yet deals are getting signed at a record pace.

Welcome to M&A in 2020.

To help explain the current climate, Liberty Global Transaction Solutions examined the company’s past 10 years of claims notifications. The final few months are perhaps the most interesting, as COVID-19 changed everything.

The pandemic halted many deals in Q2 due to travel restrictions and work shutdowns. Economic uncertainty led private equity firms to step back from buying new assets. Then the floodgates opened, leading to the largest quarter ever for Liberty GTS in number of deals and premium volume, said Rowan Bamford, president of Liberty GTS.

“All the deals put on hold in April and May have come back online,” said Bamford. “It’s a more pro-buyer environment, because pricing had been adjusted downwards as a result of COVID and other financial turmoil, so they were able to get deals done quickly without having to haggle so much on price. Our brokers are telling us to prepare for Q4 to be just as large as Q3.”

Still, COVID has not led to an uptick in claims but is making due diligence tougher to execute.

“The diligence process has changed with people working virtually, so it’s more difficult to get on site and kick the tires of the target business,” said Bamford. “A lot of these businesses, particularly in the manufacturing sector, have been basically mothballed for the past five months, and when a new buyer turns the machine on, they’re seeing creaking issues and that the machine is not working properly.”

The pandemic has also led to buyer’s remorse — where an entity uses the virus as an excuse to opt out of a deal.

Rowan Bamford, president, Liberty GTS

“If someone is unhappy with the deal they’ve made, they’ll look at every which way to try to recoup some of that value,” said Bamford.

Jennifer Drake, senior vice president of M&A and transaction solutions at Aon, said that despite the pandemic, claims have continued at a robust pace that’s on par with previous years. That said, she hasn’t found any correlation between COVID-19 and new claims.

“We’ve been watching this closely to see if there is anything we can tie to COVID, but to date, we haven’t seen any specific identifiable claim trends,” said Drake. “We’re not really seeing claims alleging loss arising directly from COVID and we have not seen an uptick in any particular type of claim.”

Small Deals, Big Problems

Liberty GTS researchers also found that 19% of policies now receive a notification, a “noticeable uptick” over the last few years. Still, no more than 25% of these notifications result in actual claims, the survey found.

Smaller deals are leading to more notifications.

Deals with an estimated value of $250 million or less are more likely to result in notifications and account for the largest paid claims, compared to deals valued at more than $1 billion. Smaller deals have also resulted in the most payouts of policy limits. The reason is simple — smaller businesses tend to have less sophisticated processes in place and may not have record-keeping and compliance issues buttoned up.

“Many are founder-owned companies being sold for the first time, and they may have been doing things the same way for 50 years,” said Bamford. “The buyer often comes to realize that the business isn’t totally compliant with current regulations and that record keeping etc. isn’t quite tip-top.”

Most claims notifications come in industries that experience the most regulatory scrutiny — like industrials and healthcare. The most common breach type (19%) is tax-related. Still, those notifications are typically precautionary in nature, related to the receipt of a notice of a mandatory tax audit that has yet to be conducted. Only a small percentage evolve into substantive claims. The next most common breach types were material contracts (16%), accounting and financial (15%), employee-related (14%), compliance (13%), and litigation (13%).

An Aon study of M&A claims activity jived with the Liberty GTS findings. It also found an increase in the percentage of policies notifications (rising from 18.6% in 2014 to 25.3% in 2016.) It also found that claim size had been trending upwards in 2019, with an average claim payment of $10.7 million. That’s largely due to the larger deal sizes and insurance policies in Aon’s portfolio from 2017 and 2018, said Drake.

In the Aon study, financial statements breaches led to the most claims notifications — meaning an acquired company fell short of projections or had errors in its financial statements.

“After a buyer strikes a deal, they may realize that there were misrepresentations with respect to the company’s financials,” said Drake. “Some recent examples I’ve seen are companies with lax accounting controls or an under-staffed accounting department, leading to poor accounting procedures and accounting errors that are discovered after the close of the transaction.” &