Page 5 - M&A

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Mergers & Acquisitions | MONDAY, OctOber 26, 2015 | S5
or the seller will pay the policy premium is routinely negotiated as part of broader dis- cussions around price and other economic terms of the transaction.
Recent Trends in the Use of R&W Insurance
only a few years ago, most middle-market M&A deal professionals had either never heard of or would not consider using R&w insurance. Times have changed. one lead- ing insurance broker estimates that over $1.5 billion of R&w insurance limits were placed in North America in 2014, which was more than double demand from the prior year. Through the first three quarters of 2015, demand for R&w insurance has continued to grow. A majority of these policies have been purchased by financial sponsors, who have been quicker than corporate buyers to embrace the product. however, corporate buyers as a group are becoming more com- fortable with the product and beginning to purchase R&w insurance on a regular basis, which is a trend that is expected to continue.
Key Drivers Behind the Growth
The middle-market acquisition market remains very active. There is significant competition among M&A buyers for quality companies, especially among financial spon- sors who are eager to put their investors’
money to work. As a result, auctions are robust and competitive, with sellers often demanding favorable terms of sale, includ- ing limited or no post-closing recourse for breaches of representations and warranties. Sellers are motivated to exit the investment without any risk of post-closing liability—and to eliminate or reduce the size of escrow or holdback amounts—which enables financial sponsors to maximize receipt of sales pro- ceeds and distributions to limited partners. An R&w insurance policy enables the buyer to enhance its bid by offering an indemnifica- tion package that provides for limited or no post-closing recourse against the seller for breaches of representations and warranties, while still providing the buyer with protec- tion against breaches. Currently, many seller auction drafts of acquisition agreements con- template that the buyer will purchase an R&w insurance policy, especially where there are numerous selling parties, and buyers must be willing to accept this structure in order to remain competitive in the auction process.
Market acceptance of R&w insurance among buyers, sellers and their advisors has also been a key factor in growth. As the use of R&w insurance policies continues to expand, middle-market M&A deal profession- als are becoming increasingly more familiar and comfortable with the product. Market acceptance has also helped to facilitate increased competition among insurance
carriers, a more streamlined and efficient underwriting process and positive claims payment experience for the insured. In the past couple of years, several insurance car- riers have entered the market, which has led to declines in policy premiums and policy terms to become more favorable for the insured. Coverage has expanded and exclu- sions have been narrowed. It is less common to see broad-based subject matter exclusions in R&w insurance policies unless compel- ling underwriting concerns exist. In addition, while there is limited publicly-available data on claims history, it is understood across the industry that insurance carriers have made payments and are continuing to make pay- ments in respect of legitimate claims arising under R&w insurance policies.
Cost of Premium and Policy Retention
R&w insurance policies are priced as a per- centage of the limits of coverage purchased. Increased competition among insurance carriers and broader claims experience has led to a significant reduction in pricing over the years. Currently, most buyer-side R&w insurance policies are being priced between 3.5-4.0 percent of the insured amount (down from between 8.0-10.0 percent of the insured amount 15 years ago). The amount of the premium in a given transaction can depend on several factors, such as the insurance car-
rier’s assessment of the risks relating to the target company’s business and industry and the amount of the insurance being sought. For example, premiums tend to be higher (closer to 4.0 percent of the insured amount) for smaller policies where the insured amount is less than $7.5 million. In addition, premiums are often higher in “public style” transactions where the seller does not retain any post- closing indemnification liability to compen- sate the insurance carrier for the additional perceived risk of the seller having limited exposure in the deal and less incentive to negotiate and disclose exceptions against the agreement’s representations and warranties.
Like other insurance products, R&w insurance policies contain a deductible, often referred to as the policy “retention.” Insurance carriers determine the policy reten- tion as a percentage of the transaction value (as opposed to a percentage of the insured amount). Currently, the standard retention is typically at least 1.5 percent of the transaction value, though the retention is often higher (closer to 2 percent of the transaction value) in “public style” transactions.
Underwriting Process
while insurance carriers have developed underwriting processes to match the pace and intensity of M&A transactions, prospec-
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