As mergers and acquisitions activity continue to heat up, the insurance industry is seeing greater demand for transactional insurance products.
Transactional insurance can include products that assist in the transaction itself, or a new coverage that can offer protection for the seller's known or unknown liabilities. They are products can bridge a gap between the buyer and the seller in a merger and acquisition transaction, or put them at ease about unknown liabilities, said Kevin Maloy, senior managing director at Crystal & Co.'s mergers and acquisitions special practices.
"We saw a dramatic uptick in demand for 2012, and are at a pace in 2013 that will outperform that," Maloy said.
The years 2006 or 2007 were the pinnacle of merger activity in the past decade, but the financial crisis and economy dampened the number of transactions in the next few years. "We've seen an uptick in both the size of the deals as well as the numbers. Private equity firms have a lot of powder right now," said Seth Gillston, senior vice president of the Ace Group's mergers and acquisitions industry practice.
About 42% of U.S. chief executive officers surveyed by PricewaterhouseCoopers said they're planning to complete a domestic deal this year, and 30% said they completed a domestic deal in 2012.
The market penetration for transactional insurance products in the United States is still relatively low, but growing as companies build greater awareness, Maloy said. He estimated about a 5% market penetration of representations and warranties coverage in the United States, although it's greater in Europe and London.
"The potential is definitely there to grow," Maloy said. "It should become a prudent part of most transactions, but may take some time to get there."
Representations and warranties insurance protects the parties in a transaction in the event the seller's representations prove inaccurate. For instance, a seller may promise a certain amount of inventory, but ends up falling short.
As part of the transaction, a seller is often asked to put up money into an escrow account to cover such contingencies. In a case where the buyer is asking the seller to put up 10% of the purchase price in escrow, but the seller only wants to set aside 5%, rep and warranties insurance can close the gap, Maloy said.
Three factors are driving the growth of rep and warranties insurance, he said: The cost of the product has come down in recent years, brokers are more aware of the product, and buyers are having to put up larger amounts of equity, so there's more pressure to protect the rate of return.
Reps and warranties insurance premiums are based on the nature of the transaction and can range from 1.5% to 4% of the limit. On a recent $100 million policy, the rate was 2.6%, Maloy said. But the average limit is $5 million to $25 million, he said.
Other insurance products that can help a merger or acquisition transaction close include directors and officers insurance, environmental insurance, loss portfolio transfers, umbrella and excess liability, and legacy liability insurance, said Gillston.
"We spend a lot of time educating the buyer and seller on different products that are out there. Some are traditional and some are one-off," Gillston said.
Through insurance, the acquiring company can close the door on the seller's old liabilities, and move forward with a clean slate.
For instance, if a large company is spinning off a division, purchasing additional insurance coverage "puts more certainty around their liabilities," Gillston said.
A loss portfolio transfer can be used to put more certainty around existing liabilities from a workers' compensation program or a casualty program, or to help close a captive down, he said.
"There isn't a one-size-fits-all product for buyers and sellers," Gillston said. "It's important for insurers to not only get the right products for a deal, but to understand the global relationship between the buyer and seller."