AIG, Euclid, and Liberty, three leading Warranty & Indemnity (W&I) / Representation & Warranty (R&W) insurance carriers recently released their global claim reports so ARIA has reviewed them and below summarized the key insights that can help M&A professionals better focus due diligence in 2024.
Claim Notifications: As expected, the number of claim notifications to insurers has increased due to the robust post-pandemic M&A activity throughout 2021 and early 2022 …… simply, more policies lead to more claims. In line with that thinking, claim notifications are expected to decrease soon as M&A activity has been weak over the previous 20 months.
Claim Reporting Lags: This term refers to the time it takes for a claim notification to be made to an insurer after deal closing. Roughly 80% of claim notifications occur within 24 months of closing, which makes sense since financial issues, the most common breach type, tend to be found after a full accounting cycle. Looking farther out at tail risk, insurers reported that claim notifications after 36 months ranged between 5% to 20% of all their claims depending on the region. A notable comment from AIG stated that they had experienced a large number of 36-month post-close notifications in the UK and that many of them were tax related.
Breach Type Frequency: The most common breach types that lead to claim notifications (in descending order) are financial statements, tax, material contracts, and compliance with laws. Oddly, Euclid said that their claims relating to financial statement breaches more often come from audited target companies than unaudited targets. On smaller transactions, there is a greater incidence of compliance breaches which is possibly due to more limited legal controls at smaller firms and lighter touch due diligence. On larger transactions (above $1b EV), claims for intellectual property (IP) and tax representations are more prevalent which may reflect diverse IP portfolios and complex tax positions around the globe. For all breach types, about 20% of all W&I policies receive a claim notification and those notifications are rarely denied. According to Euclid, only 3% of their claim notifications have been denied and about .5% have led to arbitration or litigation.
Claim Payment Severity: The number of claim notifications that result in an actual loss payment from an insurer has been steadily increasing over the years and the number of claim payments above $1m are also increasing with financial statement and material contract breaches being main contributors to claim severity. AIG’s historical claim payment breakdown is as follows: 7% of their claims result in a claim payment over $10m, 25% are between $1m and $10m, and 68% fall below $1m. Euclid’s average claim payment was $5.8m, its largest paid claim was $36m, and claim payments of USD 10M or more constitute 64% of their total paid losses. While these data points are helpful, W&I claims can be significantly higher as large deals often stack several insurers to spread the risk of a large claim throughout limit layers that can exceed $100m. For reference, take a look at EQT’s potential +$700m US telecom issue — R&W market faces potential $1bn claim from EQT telecoms deal — and Asahi’s Independent Liquor claim that settled for $199m — Asahi wins $199 million settlement over Independent Liquor deal.
The W&I Insurance Market: Keeping with tradition, insurers annual claim reports generally deliver the message that they are paying claims and the current premium pricing is not sustainable over the mid-to-long-term. Currently, the low volume of M&A transactions has W&I insurers eager to underwrite new policies which means that we are in a soft market insurance environment where insureds benefit from generous terms and conditions and favorable premium pricing. On a related note, insurers are also very willing to underwrite creative solutions for other M&A issues that involve known tax, litigation, and credit risks. The message here is, enjoy the market while you can because higher premium rates, stricter policy language, and tougher underwriting processes will return when M&A deal flow heats up …… remember 2021!
The M&A transaction insurance market is eager for business, so it is an opportune time to address any unique issues within your organization or portfolio. Give ARIA a call, we would be thrilled to create a solution with you.
