Warranty & Indemnity (W&I) Insurance allows the buyer and seller in an M&A transaction to transfer warranty breach risk to an insurance company for a fixed premium. It is an increasingly cost-effective alternative to the “traditional” means of addressing W&I transaction risks such as purchase price adjustments, escrows, hold-backs, guarantees, or walking from the transaction.
A decade ago in October 2007, Eric Hoffman (founder of ARIA) and Rick Glover (co-founder of RCA), introduced W&I Insurance to Korea’s M&A sector….. Happy Anniversary! We initially focused our efforts on educating private equity firms investing in Korea as well as Korean strategic investors acquiring abroad. Over time, we expanded our training to M&A professionals in the investment banking, legal, and consulting sectors. We also delivered presentations at local chamber of commerce events and M&A conferences. At the same time, we convinced AIG, a global leader in underwriting W&I Insurance, to have their policy approved by Korea’s insurance regulators which was accomplished in 2009.
Ready, Set, Wait!
All in all, it was a pretty good effort to raise W&I Insurance awareness in Korea, yet the first policies, three in total, were not written until 2013 and those all were for Korean acquisitions abroad. The main driver behind these policies was that the strategic investors were unfamiliar with the foreign acquisition jurisdictions so the W&I Insurance provided the additional comfort they needed to execute and close the transaction.
2014 saw the first W&I Insurance policy issued for a domestic Korean transaction involving a local seller, buyer, and target. Two additional “Korea centric” policies were purchased that year; all three were arranged primarily to provide a clean exit for the seller. The W&I Insurance environment in Korea was looking favorable for 2015, however, no policies materialized.
Wow, what gives? Only six policies placed in Korea since being introduced eight years earlier. Keep in mind that, over the same time, thousands of W&I Insurance policies were being underwritten and placed in the US, Europe, Australia, and the balance of Asia. In fact, W&I Insurance became so well understood and accepted in Australia that it is used on almost all private equity and an increasing number of corporate/strategic led deals there.
| Korea Closed W&I Insurance Policies | |
| Year | # Purchased |
| 2013 | 3 |
| 2014 | 3 |
| 2015 | 0 |
| 2016 | 5 |
| 2017 (YTD) | 7 |
| # Estimated based on various sources, includes domestic and outbound transactions | |
So why the slow start in Korea? Despite consistently receiving positive feedback from our meetings and training sessions with Korea’s M&A professionals, there was reluctance to pioneer this new value-adding risk management approach. Basically, no-one wanted to be the first to place a policy in Korea. We were regularly asked about what other policies had already been purchased in Korea. We assured them that policies were indeed purchased but details couldn’t be given due to confidentiality requirements. Even though Korea W&I Insurance policies are on the rise, concerns over being a first mover remain today.
Hockey Stick Time?
It turned out that 2015 was the “morning calm” before the storm. A little Korean joke there. The meetings and training sessions finally started to have an impact in 2016 when five W&I policies were placed for a variety of reasons (see Strategic Benefits chart below) and for local as well as outbound transactions. The majority of policies covered small deals but the year ended with Korea’s first mega-policy being placed that provided an insurance limit in excess of US$200 million.
In 2017, it appears that the reluctant “early adopters” became “fast followers”. Advisors’ knowledge has increased, repeat buyers emerged, and W&I Insurance was structured into deals early via the “sell-buy flip” (see below). To date, seven policies have been placed, another ten have been underwritten but not closed, and the number of inquiries is growing significantly. Mega-policies for large on and off shore transactions are becoming common with ARIA, working together with RCA, advising sellers and buyers on approximately US$5.5 billion of Korean domestic and outbound M&A transactions over the last 18 months. The drivers behind these policies covered the full range of strategic benefits.
W&I insurers also see potential in Korea’s M&A market. While AIG has had an approved W&I Insurance policy since 2009, Hyundai Marine & Fire and Ace/Chubb got W&I policies approved in 2016 and 2017 respectively. General / non-specialized insurance brokers of all shapes and sizes are now trying to get a piece of the action by flogging W&I Insurance around Seoul like it was a business auto policy. There is a danger in this, however, since W&I Insurance is a highly complex insurance contract and therefore, it is critical for your broker to have an expert team that has real M&A legal credentials as well as extensive experience in designing and negotiating W&I Insurance.
| Warranty & Indemnity Insurance Strategic Benefits Facilitates the transaction by bridging warranty and indemnity expectation gapsEases SPA negotiations, streamlines mark-ups, and limits related expensesTransfers risk to a creditworthy insurer for a low pre-determined costBest practice risk managementEnables board / investment committee approvalsMaintains good PR: claims usually settled by confidential out-of-court settlement | |
| For Sellers | For Buyers |
| Clean “nil-recourse” exit allowing for prompt distribution of funds which is key for PE fund, RE fund, and family business sales | Buyer can differentiate bid by accepting a lower warranty cap and shorter duration from the seller and then supplementing with W&I Insurance |
| Avoid or limit seller escrow and contingent liabilities | Added comfort when acquiring in unfamiliar jurisdictions or industries or with unknown sellers |
| Seller can maximize valuation and attract bidders by offering enhanced warranty package to bidders: higher warranty cap and longer durations | Claim on insurance rather than on retained management, founder during earnout, or ongoing joint venture partner |
The “Sell-Buy Flip”
No, this is not a gymnastic term. This refers to a W&I Insurance policy that is initiated early in the M&A sale process by the seller that is flipped or transitioned to the bidder(s) later in the sale process for final negotiation and placement. The sell-buy flip can give the seller comfort that W&I Insurance is available for the transaction and that the insurance underwriting will not slow the sale process as the policy will have been largely underwritten prior to the flip.
This structure effectively bakes W&I Insurance into the sale process to expedite deal execution, reduce SPA negotiations, enhance bidder valuations, and be used to deliver a clean nil-recourse exit to the seller. The buyer receives security via an insurance policy with a financially secure and highly regulated insurer whose reputation is contingent upon paying claims. In practice, the premium for a sell-buy flip can be borne by the buyer, seller, or split between them, it is a commercial decision.
The Million(s) Dollar Question – Are Claims Paid?
We cannot have a proper insurance article without addressing the age-old insurance
question: will insurers pay claims? The answer is yes. AIG’s 2017 report “M&A Insurance Comes of Age” noted that they had an 18% claim notification frequency on W&I policies they issued between 2011 and 2015. 20% of claims involved financial accounts, 15% compliance with laws, 14% material contracts, and 14% tax. 75% of claims were notified in the first 18 months with 90% being notified in 24 months / two audit cycles. Claims have consistently been paid with one in the Asia Pacific region exceeding US$100 million. And how about claims in Korea? All we can say is …… stay tuned.
Key Take-Aways
- There are many strategic uses of W&I Insurance and related benefits for sellers and buyers.
- After a slow start, W&I Insurance for Korea domestic and outbound M&A transactions is on the rise.
- It is critical to utilize an insurance broker who has a deep team with M&A legal credentials and extensive experience in negotiating W&I Insurance and settling claims.
- It is advantageous to start the W&I Insurance discussion with us early in the sale process.
For more information, please contact:
Eric Hoffman
Asia Risk & Insurance Advisors
M: +82-10-2267-2788
