Transactional liability insurance outlook
2021 saw extraordinary M&A deal volume and more transactional liability insurance policies underwritten than ever before (including specific tax and contingent risk insurance products as well as traditional warranty and indemnity (W&I) insurance policies).
Despite disruptions caused by the Ukraine conflict, M&A activity remained relatively strong in the first half of 2022 – helped by the dollar's strong performance against other currencies, which encouraged a flow of investment in Europe by cash-rich US corporates. The demand for transactional liability insurance products remains high (both in general corporate and in private equity deals, and across a broad range of sectors).
New underwriters and managing general agents continue to enter the transactional liability market, driving competition and innovation. In this article, we highlight certain trends in the market and forecasts for 2022 and beyond.
Coverage focus areas
Cyber and ransomware attacks have risen significantly over the last few years, causing particular concern for businesses which rely on their IT systems more than ever before, and the insurance market generally, which is still working to redress issues caused by historically low cyber insurance pricing. In this context, W&I insurers are expected to have particular focus on IT and cyber in their underwriting processes. The due diligence undertaken by transaction parties in these areas is becoming more specialist and technical – not only in respect of target companies in the technology sector, but also in other sectors including financial services and healthcare.
Where cyber is not generally excluded under a W&I policy, coverage may only be available on an “excess of and no broader than” basis (i.e. on the same terms as the target’s existing underlying insurance with recovery only possible once such policies are exhausted).
In the current geopolitical climate, insurers are also taking a particularly firm approach to exclusions relating to sanctions risks.
Environmental, social and governance (ESG) considerations have become increasingly high-profile in recent years and can often be a value driver in M&A deals, with various companies mandated to make more sustainable investments and increase transparency around "green" issues. Greater legislative and public scrutiny of ESG issues is anticipated in the coming years, which is likely to lead to buyers seeking ESG-specific deal protection (for example, warranties that the target has adequate ESG policies, that there have been no ESG claims, and that the target complies with the Task Force on Climate-Related Financial Disclosures-based reporting). Comprehensive diligence by an ESG compliance expert to assess and mitigate the risk may become more common and will be a helpful tool for insurers when determining whether and to what extent to cover ESG specific risks.
W&I insurance in SME deals
SME deals in the UK with an enterprise value of £250,000 - £10 million represent a huge potential growth area in the W&I insurance market, with the market estimated to be worth $8 billion in gross written premium. Historically, such deals have been uneconomical to insure, however certain insurers have developed innovative tech / AI driven underwriting techniques which have opened-up this market by enabling a quicker, simpler and cheaper underwriting process. We expect such products to continue to develop and grow.
Synthetic products continue to increase in popularity. A traditional W&I policy covers warranties that have been negotiated between the buyer and seller in a purchase agreement. A synthetic policy however, simply attaches a standalone "synthetic" set of standard warranties that the insurer is prepared to stand behind – removing the need for negotiations between the buyer and seller.
Traditionally, synthetic products have been used most frequently in respect of tax. While we expect this to continue, we also anticipate an increase in the use of synthetic products in SME deals (see above) and distressed M&A.
Synthetic products are a useful tool to unlock distressed transactions by enabling buyers to obtain a level of comfort on such deals that would not ordinarily be available from a distressed seller or a trustee in bankruptcy.
For more detail on synthetic warranties, please see our blog: W&I Insurance: The rise of synthetic warranties?
Standalone cover has become more commonplace for specific tax and contingent (known) risks that would typically be excluded by a traditional W&I policy. In respect of tax, particular areas of note for standalone cover include cross-border investment structures (including permanent establishment and residency-based risks where companies could be subject to tax liabilities in jurisdictions other than the jurisdiction of their incorporation), forward-looking cover for future dividend and interest payments and tax risks already under audit.
We have also seen an increase of interest in specific title insurance policies, which can address key red-flag issues identified in diligence, for example title concerns resulting from a defective share buyback.
In the W&I Insurance chapter of our Annual Insurance Review 2022, we noted that claims trends in 2021 remained largely unchanged from previous years; in particular, notification frequency (at a rate of approximately 1 in 5 policies) and breach type (tax; financial statements and accounting; material contracts).
It is too early to confirm whether this remains the case in 2022, but it seems likely that the record-breaking number of policies underwritten last year will ultimately translate into a higher absolute number of claims notifications over the next few years. Further, a more aggressive approach by tax authorities in light of budget deficits may well lead to an increase in tax claims.