Transactional risk insurance in Asia Pacific
November 2019 | TALKINGPOINT | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
November 2019 Issue
FW moderates a discussion between Darren Savage and Ami Kalmath at AIG and Terence Montgomery at Willis Towers Watson on transactional risk insurance in Asia Pacific.
FW: Could you provide an overview of M&A insurance in the Asia Pacific region?
Savage: We have seen a huge increase in the use of M&A insurance in recent years globally. In Australasia, a mature warranty & indemnity (W&I) insurance market, the product has been used for over 15 years and transaction advisers are very sophisticated in terms of their understanding and use of the product, with anywhere between 40 and 70 percent of private equity (PE) deals baking W&I insurance into the deal process. In Asia, the product has gained significant traction in the last three or four years, particularly in Hong Kong, China, Singapore, Korea and Japan, with its use spreading to other jurisdictions, such as Taiwan, Malaysia, Vietnam and Indonesia. This pattern is reflected in the increase in the number of specialist M&A brokers and underwriters employed in the region.
Montgomery: M&A insurance has developed widely across the region. Asia has seen significant recent growth across a range of jurisdictions, sectors and deal sizes. Australasia, an earlier mover and more mature, sees strong continued use. W&I and representation and warranty (R&W) insurance use has followed the recent dynamic of the Asia Pacific M&A market, which has been highly seller-driven, but with a diverse buyer universe, including a mix of PE, corporates, state-owned enterprises, sovereign wealth funds and ultra-high-net-worth individuals being required to take W&I/R&W insurance, many as first time users. Also significant is the number of Asian buyers using W&I/R&W insurance on outbound deals into the Americas and Europe, the Middle East and Africa. Tax insurance has grown across several geographies and risks in Asia Pacific. On the M&A insurer side, there is a deeper yet growing pool of underwriting expertise and capital. On the client side, M&A dealmakers and advisers are increasingly experienced and confident in the product, coverage, execution and claims.
“Globally, not just in Asia Pacific, M&A insurance pricing and coverage has become increasingly user-friendly.”
FW: What options are available to buyers and sellers to help them mitigate potential transactional risks? To what extent are you seeing M&A insurance appearing more regularly in Asia Pacific deals?
Montgomery: Used effectively, W&I/R&W insurance can be used to support M&A valuation, execution, certainty and risk, to the benefit of both buyers and sellers. In Asia Pacific, W&I/R&W insurance is often seller-driven with first draft sale and purchase agreements (SPAs), providing fulsome warranties and indemnities, but with nil or limited recourse provisions requiring the buyer to take W&I/R&W insurance as a de facto signing condition. The seller gets a clean exit without escrow or retention. The buyer gets comfort from recourse against an insurer. Valuations are supported by that comfort. SPA negotiations are smoother and expedited. So, it is deal enabling, not just risk transfer. Even when not seller-driven, a buyer will use W&I/R&W insurance to avoid claims against a seller, partner or management, or when seeking a more fulsome recourse package. Tax and contingent risk insurance can be used to ringfence and provide certainty over specific known matters. M&A insurance is appearing more regularly, with year-on-year double digit growth, across the region.
Savage: Buyers and sellers are exposed to significant transactional liabilities when acquiring or divesting businesses, whether or not deals are structured as asset or share sales. Under traditional transaction structures, a buyer’s main recourse for a breach of warranty or indemnity by a seller would be against the seller, with the use of escrow accounts as a common form of security blanket. With M&A insurance, however, buyers are increasingly turning to W&I insurance as the preferred form of security and we are seeing this in the number of policies being written, which has increased significantly year-on-year in the Asia Pacific region. Buyers see W&I insurance as an effective tool to supplement their contractual recourse options with insurance and by so doing, protect ongoing relationships with sellers who in some circumstances may become the buyers’ key employees or commercial business partners after the transaction closes.
FW: Could you provide an overview of the functions and benefits of representations and warranties/warranty and indemnity insurance and tax insurance for example?
Savage: W&I insurance provides a remedy for unknown transactional liabilities or, in the case of a tax policy, a specific identified tax risk. One of the key benefits of purchasing a buy-side W&I policy is that, in the event of a breach of warranty or indemnity, the buyer can make a claim directly under the policy without having to seek recourse against the seller. Under normal circumstances, recovery against a seller might be impracticable and is usually overly time-consuming and expensive, especially if the commercial relationship between the parties has broken down resulting in formal legal proceedings. The seller may have wound up or found itself in financial difficulty rendering the possibility of recovery remote. A W&I policy takes these sorts of factors off the table and provides an efficient form of recourse directly against the insurer under the policy, negating the need to go directly against the seller.
Montgomery: W&I/R&W insurance is widely available to cover a suite of title and capacity, financial, tax and operational matters which occur, but were not known, before signing or close. More than 90 percent of policies are buy-side, giving the buyer significant comfort of recourse for breaches directly against the insurer. This is particularly important in the context of a nil/limited recourse deal or when there are other claims concerns such as creditworthiness of the seller or dealing with a joint venture partner, founder or management. Tax insurance is available, albeit more selectively than W&I/R&W, to deal with specific known tax risks which tend to relate to issues flagged in diligence or advice as potential problems for the seller, buyer or target, based on the interpretation or application of tax law or practice. Tax insurance can be used to ringfence and provide certainty over the issue and enable the parties to agree and close deals.
“The assessment of loss can be complicated, and it is normal practice to see experts employed to assist with analysis of the financial data and loss calculation. ”
FW: How can M&A insurance be used strategically to improve a bid, allow sellers to achieve a clean exit, or simply remove a roadblock?
Montgomery: In Asia Pacific, a key growth driver and strategic use of W&I/R&W insurance has been sellers structuring it into auctions from the outset and requiring buyers to take W&I/R&W insurance to effect a clean exit for the seller, while giving the buyer comfort of recourse against an insurer. Outside of this, other main strategic uses, which are often more buyer driven, are, firstly, bid differentiation, when a bidder offers a seller a nil or limited recourse exit and execution certainty. Some deals are fully underwritten at final bid. Second, dealing with joint venture partners, founders or management to maintain important go-forward relationships. Third, when a buyer seeks comfort around coverage or if the seller is reluctant to provide fulsome warranties. Fourth, when a buyer has concerns over recourse and claims. Fifth, if a buyer seeks additional comfort investing cross-border. Finally, the product can also be used in special situations such as take privates and dealing with distressed sellers or targets.
Savage: We have seen a proliferation in the use of auction processes in the current market conditions, with sellers often mandating the use of W&I insurance, meaning that potential suitors are having to incorporate W&I insurance as part of their bid proposals. Even absent any mandated requirement by a seller, we are frequently seeing buyers use W&I insurance in order to differentiate themselves in a competitive auction and gain a commercial advantage over other bidders that do not opt for W&I insurance. Through use of W&I insurance, buyers can supplement protection for breaches of warranties, both in terms of value and certainty of payment, and may even extend the duration of coverage, affording buyers additional time to detect and report problems that may exist with the acquired business. For the seller, careful planning and the integration of W&I insurance into the auction process can result in less liability and take escrow accounts out of the equation, thus allowing sellers to exit a business cleanly and distribute all or most of the sale proceeds to investors or use proceeds to pay down existing debt.
FW: What considerations should parties in Asia Pacific take into account when determining whether an M&A insurance policy is right for their particular situation, and evaluating the pricing, terms and coverage on offer?
Montgomery: M&A insurance is suitable for a wide range of share and asset deals, and is being considered earlier in deal timetables, often at the preparatory stage. Globally, not just in Asia Pacific, M&A insurance pricing and coverage has become increasingly user-friendly. While the strategic uses noted in the question above are key, the product is a low cost, practical and often more certain alternative to traditional escrow or seller indemnification structures. Coverage has improved with narrower exclusions and better back-to-back, and often enhanced, cover for SPA warranty regimes. Dealmakers in Asia Pacific, particularly first time users, should give early consideration to adequate due diligence to enable a smooth W&I process and fulsome coverage, and also to any deal-specific exclusions if facing a nil recourse structure.
FW: In the event of an actual or alleged breach that may trigger a claim, what do parties need to know about the claims process for M&A insurance, and how it is handled?
Kalmath: In the event of a breach, parties are encouraged to notify the issues and engage with their W&I insurer at an early stage. The insurer will work closely with the insured to gather the necessary information in order to facilitate the determination of indemnity. The assessment of loss can be complicated, and it is normal practice to see experts employed to assist with analysis of the financial data and loss calculation. Over recent years, as the product is more widely used, the market has become more sophisticated and familiar with the requirements of insurers. We have seen that clients provide more detailed claim notices which helps to improve conversations with clients and speeds up the insurance process.
Montgomery: Policies include claims management provisions. These relate to how and when the insurer is notified, what information is required, how the claim proceeds and the respective obligations of the insured and the insurer. Many insurers have dedicated M&A claims teams formed with a view to efficient processing of M&A related claims. Claims involve two key parts, firstly confirming indemnity, and subsequently agreeing quantum of loss and indemnification. The most efficient claims processes see early notifications with a clear presentation of the facts, matters and circumstances giving rise to the breach, backed with relevant supporting information on the fact pattern, dates and quantums.
“In Asia, while we have seen a sharp rise in the use of W&I insurance in recent years, the product is still in its relative infancy.”
FW: What trends are you seeing in M&A insurance in Asia Pacific? What is driving these trends?
Montgomery: On the client, counsel and adviser side, the key trend is increased use, driven by increased confidence and experience in execution, coverage and claims. On the insurer side, there are a number of trends. There is more available capacity, lower pricing, lower retentions, more readily available cover enhancements and more jurisdictions open for use – driven mainly by increased global competition, but also increased familiarity with emerging jurisdictions, sectors and local dealmaking dynamics. Examples include the first W&I/R&W, tax and title insurance policies in a number of jurisdictions, and also US-style cover enhancements being secured on a number of other deals, recently across Asia. We also see larger and more experienced underwriting teams, with the ability to execute complex deals with speed and accuracy. Finally, claims activity is increasing, driven by the increased use of the product and better understanding of the claims process.
Savage: The pricing pressure we have seen globally, largely driven by increased competition, is now being reflected across Asia. Whereas a few years ago pricing typically ranged from 2 to 5 percent of the limit of insurance and even higher, we are now seeing a range of 1 to 2.5 percent depending on jurisdiction, with bigger deals attracting higher rates. We are also seeing a fall in retention levels below 1 percent – typically based off the enterprise value – with 0.5 percent retentions now being quite common depending on the jurisdiction, with retentions even dropping to zero on real estate deals. In terms of claims, we are seeing an increase in the frequency and severity of claims notifications, especially on bigger deals.
FW: Are there any key differences in M&A insurance practice and coverage in Asia Pacific compared to the rest of the world?
Savage: Many of the deals we see in Asia Pacific are cross-border in nature. A typical transaction might involve a US buyer acquiring an Australian target with subsidiary operations throughout Asia Pacific. Each jurisdiction will have its own legal, tax and political systems, and its own distinct culture and practices. Each deal brings its own unique challenges, especially if you are trying to overlay the governing law of the policy and the sale and purchase agreement, which might be different, onto the local laws of each jurisdiction where the target operates. Foreign ownership restrictions vary from country to country across Asia Pacific which, along with separate tax regimes, adds a layer of complexity when structuring deals in the region. While there are some regional differences in how W&I policies are implemented, broadly speaking the coverage position is consistent from region to region, and coverage will be dictated more by the quality of the due diligence and disclosure exercise and the scope of the warranties, rather than by anything specific to a particular region.
Montgomery: At a macro level, M&A insurance practice and coverage, and importantly how M&A insurers think and consider risk, is reasonably similar across the globe. There are some underwriting and coverage differences between US-style deals on one hand versus Asia Pacific and European style deals on the other hand, such as the method of disclosure, policy wording and form of underwriting questions. That said, some recent Asia Pacific deals have used hybrid style cover and underwriting. This is largely client driven, and insurers are increasingly accepting of this. So, if anything, there is a trend toward convergence rather than divergence.
FW: What recommendations would you make to M&A dealmakers to get the best result with M&A insurance?
Montgomery: Seek out a trusted M&A insurance adviser that can work effectively alongside your deal team, counsel and advisers. Typically, they will have senior M&A legal and M&A insurance experience advising on complex cross-border deals. Involve them early to provide strategic advice on the structuring, timetabling, process, disclosure and due diligence requirements, as well as negotiation of coverage, to enhance not only the insurance outcome but also the overall M&A process. M&A insurer selection is important, not just in terms of coverage but also deal execution and claims. Dealmakers in Asia Pacific should then expect that a seller clean exit and strong buyer recourse position is a very achievable result with M&A insurance.
Savage: Engage with your insurer as early as possible in the deal process. While insurers do not necessarily expect a seat at the table, they will be able to provide potential insureds with a steer as to the insurability of a particular warranty or risk area, which will be useful for the deal teams during negotiations. Good quality due diligence and a comprehensive disclosure exercise will lay the foundation for good coverage under a W&I policy. Engaging appropriately qualified legal, tax and financial advisers, preferably with experience working on insured deals, including on cross-border transactions where there are material overseas operations, will help maximise coverage.
FW: Looking ahead, do you expect to see an uptick in M&A insurance as part of Asia Pacific transactions? What factors are likely to drive future trends?
Savage: We see huge growth potential across Asia Pacific. The use of W&I insurance has been a staple on Australasian deals for many years, with deal advisers very familiar with the process. In Asia, while we have seen a sharp rise in the use of W&I insurance in recent years, the product is still in its relative infancy. If you consider the size of economies such as Korea or Japan, for example, we are only just scratching the surface.
Montgomery: Growth potential is significant. Growth will be driven mainly by the increased confidence and understanding across M&A dealmakers that the product supports the key M&A deal drivers, is a deal enabler and pays claims. The penetration rate on the types of deals and jurisdictions that have not previously been insured will increase sharply. Future trends, and fundamentally the success of the product, will be driven by claims activity and the ability of the M&A insurance market to evolve and deliver effective and efficient solutions to dealmakers for known and unknown risks.
Darren Savage is an England & Wales qualified solicitor and an experienced M&A lawyer with significant experience in complex cross-border transactions with a particular focus on private equity. He is an expert in Asian and Australasian transactions, having been located in Hong Kong for several years, initially working for Clifford Chance in its corporate M&A team and as an in-house counsel in the telecommunications sector. Mr Savage joined the team in 2014 and is now based in the Melbourne office as M&A manager for Asia Pacific. He can be contacted on +61 3 9522 4975 or by email: darren.savage@aig.com.
A lawyer by background, Ami Kalmath has over 20 years of experience in commercial insurance and is a technical specialist in high severity financial lines and M&A claims. Ms Kalmath leads a Financial Lines Claims team in Australia and is the APAC M&A Claims lead. She can be contacted on +61 2 9240 1802 or by email: ami.kalmath@aig.com.
Terence Montgomery is head of M&A Asia Pacific for Willis Towers Watson. Regarded as a pre-eminent adviser in the M&A insurance space having led on many iconic deals in the region, he has over 13 years M&A experience in the region, firstly as a private practice M&A lawyer and external counsel to leading M&A insurers, and subsequently as a specialist M&A insurance adviser. He is a qualified solicitor in England and Wales and Hong Kong. He can be contacted on +852 9666 8598 or by email: terence.montgomery@willistowerswatson.com.
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