Use of insurance for M&A deals growing

NEW YORK — The fear of mergers-and-acquisition agreements’ going sour increasingly is being eased by insurance, according to industry experts.
With private-equity and other M&A activity gaining steam, “transaction facilitation” insurance indirectly protects advisers’ clients — many of whom are investors and stockholders in companies being acquired or making acquisitions. The insurance covers losses if transactions are tarnished by contract breaches or events that due diligence failed to anticipate.
The policies get their name from their ability to grease deals that might otherwise be delayed — or abandoned altogether — because of fears involving potential liability, contract breaches or other unanticipated events.
Liability concerns
ACE USA last month announced a “legacy liability” policy and established a division within the Philadelphia-based insurer to underwrite the coverage. The policy covers successor liability, liability from discontinued products and services, and other potential losses that may come to light after the deal is completed.
“In an acquisition, there are always questions regarding future liabilities arising from the seller’s products that are already in the stream of commerce or services and operations that have already been completed,” said Mitch Schmidt, senior vice president of ACE’s casualty risk division.
The buy-sell agreement — that is, a contract that spells out the responsibilities of the buyer and seller — covers the parties’ responsibility for future claims related to the seller’s products and services, he added.
In the typical scenario, the seller pays the premium for the policy, which covers losses stemming from the products and services for up to five years after the acquisition is consummated, Mr. Schmidt noted.
ACE — which he said is the only insurer actively soliciting this type of business — can write limits of up to $15 million. The minimum premium is $25,000 but can go up to $500,000 or more for large acquisitions.
Another type of insurance being used in M&A deals is “representation and warranty” coverage. Although the insurance has been around since 1998, it is “taking off” now due to the increase in private-equity deals, said Donna Barron, senior vice president of the M&A group at Willis Group North America Inc. in New York.
Insurers that write the coverage include American International Group Inc. in New York, Continental Casualty Co. in Chicago, The Hartford (Conn.) Financial Services Group Inc. and Lloyd’s of London syndicates.
Potential buyers sometimes dangle the insurance policies in front of sellers to make their bids look more attractive, according to Alastair Burns, London-based head of the private-equity M&A unit at insurance broker Marsh Inc. of New York. Sellers like the idea of knowing they are getting the full purchase price with no strings attached, he noted.
The policy covers breach of representations and warranties outlined in the buy-sell agreement’s indemnification provision. That can include tax, employee benefit, accounts receivable, environmental and other problems that may not have been uncovered during the due diligence process. It does away with the need for large escrow accounts and holdbacks, permitting the parties to account for the full transaction price more quickly, Ms. Barron noted.
Escrow and holdbacks can be up to 15% of the purchase price and may have to be held as a liability on balance sheets for several years, according to the industry experts.
“The purpose of the policy is not to make escrow go away, but it can free up cash needed to pay taxes or for other purposes,” Ms. Barron added.
A typical premium is 4% to 7% of the transaction price, and there is a minimum self-insured retention of $1 million, she said. Either the buyer or seller can apply and pay for the policy, depending on their agreement.
The policy term, typically 12 to 36 months, can run for up to six years for claims involving taxes and the Employee Retirement Income Security Act. Underwriters consider the reputation and due diligence of the buyer’s management, accountants and lawyers when determining acceptability of the risk and the amount of the premium, Ms. Barron added.