When the world’s largest transactional insurance broker talks… you listen.
I’m talking about Marsh McLennan, a Fortune 500 firm with a global reach that wrote more than 1,000 Representation and Warranty (R&W) insurance policies in 2022.
Their Transactional Risk Insurance 2022: Year in Review report is an excellent resource for anyone involved in M&A, as well as the specialized insurance products like R&W that have become essential to deal-making. It’s a report worth taking a close look at…because in addition to reporting on trends from the past year… they are also looking ahead and forecasting what they believe will happen in 2023.
Not to mention, with their far-ranging reach and involvement in so many transactions, this report is based on a large and reliable sample size of deals and the insurance policies that covered them.
The Most Important Lessons from the Marsh Report
First off, we have good news – for deal-makers at least.
In 2022, we saw significant price drops for premiums for R&W insurance policies. This is largely the result of diminished supply in the fourth quarter of 2021. That drove rates up to just shy of $60,000 per $1M in coverage in the face of ongoing demand for this product in a banner year for M&A.
However, by 2022, we saw two things that brought the price for R&W coverage down:
- Insurance companies increased their capacity by hiring more underwriters to handle the demand, which increased the supply of insurance.
- As supply increased, we saw the price of coverage trend down in 2022 to where it had been in the past: which was between $33,000 to $36,000 per $1M in coverage. That’s a drop of more than $20,000, which is huge.
I don’t expect that prices will see a drop at that level again, of course. However, with increased competition among insurers, we could see the price go under $30,000. There is a caveat: claims in R&W are up. And that can put upward pressure on price.
I would also caution you to be careful with carriers who are overly aggressive in their rates as they may not be a long-term player, especially with the claims increase we’re facing now.
Tech, Healthcare, and Professional Services Continue to Lead the Way
Another notable trend outlined in the report is that as far as transactional insurance, tech, healthcare, and professional services companies continue to lead the way in terms of volume of deals being insured.
No big surprise there. But there was one unexpected trend of note – one very welcome in the insurance community.
Strategic Buyers on the Rise
In 2022, for the first time ever, the number of insured transactions involving Strategic Buyers outnumbered PE firms. Private equity has long regarded R&W coverage as a must-have for deals that qualify for it. In fact, rep and warranty was largely the domain of this sector.
But now it’s clear that others are realizing the protection and other benefits this coverage offers… and are seeking out this insurance in increasing numbers.
What You Need to Know About Price
It’s also important to highlight that the amount of coverage with R&W insurance falls between 10% and 20% of the purchase price. And as deal value goes up the percentage protected goes down. So any deal under $50M will probably be closer to carrying R&W Limits from 10% to 20% of the purchase price. Over $50M and you’re seeing a smaller percentage of the deal being covered (10% and lower).
The Benefit of Strict Underwriting
On this topic, you should understand that the strict guidelines of R&W underwriters have enabled Buyers to identify risks during the insurance quoting process. This has allowed them to take those risks and transfer them to the Seller.
They keep the Seller in the loop, of course. They tell the Seller they found a red flag and that it won’t be covered by insurance – it’s excluded. As a result, the Buyer gets a better, safer deal. And underwriters love it because there’s one less potential Claim they are compelled to cover, and all parties are aware of the exposure BEFORE anything happens.
Sometimes Buyers can be upset to hear about these red flags from underwriters. It can hurt their pride that they missed something in their own research of the target company. Plus, exclusions like this can be a bit of a hassle.
But from my point of view, it’s better to know about these potential issues upfront than not and have it blow up later. And you don’t have to buy as much insurance.
How do you deal with these known exposures?
The parties set up a “side escrow” to cover them. For example, say the Seller might not have paid the right taxes in a state. Discussing the issue with the Buyer, they maintain that, while it’s probably nothing, the maximum liability would be about $50,000.
That amount is placed in the side escrow, which is separate from the overall escrow. If the tax issue does come up, the $50,000 is there to cover it. If not, the Seller gets the money back.
A Price Break for Buyers
This relates to why Buyers are not securing more and more Limits as deals are getting bigger. They’re not going to buy $60M in Limits with a $300M transaction, they’re going to buy $30M.
The thinking is that with insurance they’ve reduced their risk, and they’re not going have a $60M loss. If something bad happens, it’s only going to be $30M bad… thanks to the thorough underwriting. That’s a huge benefit.
Deductibles Are Stable
As I say, claims on R&W policies do appear to be on the rise. This could be simply a function of the more policies being written overall. In fact, it’s likely.
Generally, in other lines of coverage, when claims go up, deductibles go up first, followed by increased prices. You see this, for example, in Florida after a hurricane comes through. Or in California after severe wildfires.
Despite this, deductibles for these policies remain steady – they are not increasing, as you might expect. This is a testament to the responsible way that underwriters have priced risk… and you can bet the insurers are still making a profit.
Where to Go From Here
I must stress that 2022 was a strange year in many respects… a reaction to the year before in many ways.
I view 2021 as an outlier, a time when demand really did outstrip supply in terms of transactional insurance in a time of record-making M&A activity due to so many deals being backed up during the pandemic.
Last year represents a return to normal in terms of more of a balance between supply and demand. And with the current macroeconomic headwinds, we’re also seeing transition into a period when Buyers enjoy more leverage in transactions, with a Buyer-driven slowdown in M&A activity as a result.
However, I do expect that, once Buyers adjust more fully to their newfound leverage, there will be an uptick in deal-making in the second half of the year.
The impact on the transactional insurance will follow.
If you have any questions on these trends or about how Representations and Warranty insurance could cover your next deal, please contact me, Patrick Stroth, at pstroth@rubiconins.com.