Eric Hoffman
August 28, 2023

Korea M&A Insurance
2023 Review & Outlook

Despite the overabundant rainfall from this year’s Jangma and Typhoon Khanun, the drought in Korean M&A deals continues ….. but is there a silver lining somewhere in those clouds?

M&A Insurance

2023 Review & Outlook

1H2023 Review

✔️ First half M&A deal flow continued the downward trend experienced in 2H2022 resulting in four quarters of sluggish dealmaking.

✔️ Ongoing challenges with inflationary pressures, the rising cost of capital, recession fears and global security issues overshadowed wishful thinking early in the year.

✔️ Korean banks freed up lending as 2023 started but it came at a high cost, prompting interest in alternative lending strategies, bigger equity checks, and club deals.

✔️ As 2023 progressed, weakness in Korea’s domestic and international commercial real estate investments added stress to banks, asset managers, and pension funds but tantalized distressed investment funds.

✔️ Despite the foggy investment environment, deals did get done with the health / medical / biopharma sector, smaller transactions, and inbound minority investments being a few bright spots.

✔️ Warranty & Indemnity (W&I) insurance was regularly used on private equity deals confirming that it as become an accepted and widely used de-risking solution for transactions.

Mergers & Acquisitions Insurance

2H2023 Outlook

✔️ Many of Korea’s positive macro-trends remain relevant:

➡️ Conglomerates and private equity seek growth prospects at home and abroad
➡️ Realignment of conglomerate business portfolios will generate carve-outs
➡️ Corporate restructuring and M&A are attractive for digital transformation, decarbonization, resilience, global expansion, and managing economic realities
➡️ Many family businesses need to resolve succession issues

✔️ Private equity has significant capital to deploy.

✔️ Several local PE firms have kicked off new fund raising efforts, but track record and quality risk management will be front and center in those discussions.

✔️ Private equity has ample aging investments to exit but are hampered by the value hangover from 2021

✔️ Interest in secondaries remains strong

✔️ Could strength in the stock market be a catalyst for increased M&A?

✔️ Overall, deal activity in 2H2023 seems cautiously optimistic especially if interest rates ease and the value mismatch between seller and buyer narrows

✔️ According to Bain & Company, “Dealmaking is likely to resume faster than many have anticipated” but the big question is …… when? Unfortunately, the consensus around Seoul seems to be that deal volume will remain weak for another three to four quarters.

Considering this elevated risk environment, quality due diligence and well-tailored transaction insurance solutions go-hand-in-hand and will be critical for acquisition, exit, and fund-raising success.

Warranty and Indemnity Insurance (W&I)
Representation and Warranty Insurance (RWI)

  1. The growing number of W&I inquiries and policies secured for Korea domestic and outbound transactions over the past few years demonstrates the value and acceptance of W&I in Korea.
  2. So far in 2023, W&I premium rates fell in Korea and abroad due to fewer deals and therefore, less demand for policies which prompted more competition among existing and new insurers. Similarly, lack of deals and insurer budget pressures are pushing underwriters to be more flexible on favorable coverage language and unique de-risking structures. In response to 2021’s robust M&A activity, insurers rushed to invest in additional underwriting and claims handling resources but are now needing to manage idle talent. Buyer friendly premium rates and policy wordings will continue for the foreseeable future and ARIA will closely monitor them as 2023 progresses.
  3. Distressed / insolvency deal inquiries are steady but W&I underwriters will still review these deals very selectively. Insurance can be secured but it is critical to get the narrative and structure right before taking it to insurers. W&I is being used where a buyer has credit risk concerns about a seller’s ability to stand behind its indemnity obligations or where a seller is unwilling or unable to provide indemnification.
  4. Insurers have been cautious about covering secondary transactions, but underwriters are now adapting their approach to the unique risk profile of these deals and are becoming more comfortable with them. For example, insurers previously would not cover Excluded Obligations for various reasons but have now started offering coverage. Knowledge qualifiers remain a challenge in secondary transactions, but we are seeing underwriter flexibility with the issue. For the best coverage outcome, the GP needs to be active in the underwriting process and be available with their internal and external compliance teams to discuss fraud and timing risks with underwriters.
  5. Inquiries are inching up for minority investments with W&I protection being structured so that minority investors are covered for their pro-rata share of a company level loss.
  6. Take-privates can be done but W&I insurer appetite will be affected by the deal structure and involvement of controlling shareholders and management who have requisite knowledge.
  7. Demand for W&I on cross-border deals is mixed. Korean investors have become more risk averse on going abroad due to capital costs, unfavorable FX, economic uncertainties, geopolitics, and regulatory complexities, however, minority inbound investments have been on the rise. Regarding outbound deals, keep in mind that pursuit of distressed assets abroad is often a key motivator and W&I can be used to facilitate such transactions, for example, 363 sales in the US.
  8. As deals are taking more time to complete and the interim period between signing and closing has widened, discussions on interim breach coverage has grown. Typically, coverage for interim breaches (breaches of the representations and warranties that both occur and are discovered during the interim period) are excluded under W&I policies, however, insurers are more open to offering interim coverage subject to the length of the interim period and other specific deal matters.
  9. Along with the increasing number of W&I policies issued for Korea transactions over the past few years, W&I claims in Korea are also increasing. We expect W&I claim activity to grow in Korea and across the region as economic realities impact portfolio companies and real estate investments that were covered by long-term multi-year W&I policies. In fact, we have received inquiries from insureds to review aging W&I policies placed by various brokers to see if certain representations involving struggling portfolio companies or real estate investments could now trigger coverage. Currently, various insurers report that roughly 20% of their W&I policies globally receive a claim notification and that claim amounts are growing, especially for complex transactions.
  10. Insurance brokers of all sizes in Korea continue to push W&I but most lack experience and broad M&A legal knowledge to negotiate innovative coverage wordings and to strategically settle claims. In other words, an M&A insurance specialist needs to see solid deal flow for a variety of Asia Pacific transactions to be knowledgeable of the latest coverage wording trends and claim issues. Korean offices of large global brokers still largely rely on regional expertise, but team turnover issues continue to be a challenge as teams built up after 2021’s robust M&A activity are not busy due to sluggish deal volume yet face tough budget pressures. As brokers move among firms, it is imperative to lock in experienced teams with a long history of working together and to ensure that your transaction is not handed off to a junior team. Regarding broker remuneration, full transparency can be an issue as some brokers may charge fees in addition to the commissions that are included in the premium.

With dealmaking being lethargic, private equity firms are “getting their houses in order” by reviewing their portfolios and refreshing value creation plans. As part of that process, we are seeing increased inquiries for insurance solutions to address nagging tax and contingent liability and regulatory issues.

Tax Liability Insurance (TLI)

  1. TLI coverage enables an insured to reduce or eliminate a known tax risk or uncertain tax position arising from the tax treatment of a transaction, investment, or other issue that may be challenged by the NTS or foreign tax authorities.
  2. Interest in tax insurance is steadily growing as tax authorities become more aggressive to address budget shortfalls …. and M&A transactions (past and present) are an area of focus.
  3. TLI premiums rates are coming down and coverage wording is more generous due to new insurers entering the market and growing underwriter budget pressures. Insurers will even consider coverage for tax risks that are in active litigation.
  4. We continue to see new and creative applications of TLI to address a range of tax concerns including those relating to transfer pricing, valuation, residency, partnership audit risks, and employee retention credits. In Korea, capital gains tax applicability and the identification of beneficial owners is a common concern that TLI can address. Also, GP-led secondary transactions can create unique tax issues that TLI can be structured to ringfence. ARIA has been successful in structuring several complex tax policies over the past few years and it is an opportune time to look at TLI solutions.
  5. For cross-border deals, tax is a growing area of concern for buyers as tax authorities are putting corporations’ tax arrangements under greater scrutiny, especially those with multi-country operations.
  6. On distressed deals, tax insurance can protect the debtor and/or buyer from unexpected tax liabilities relating to a debt restructuring, cancellation of debt income, ability to use a target company’s NOLs, etc.

Contingent Litigation Risk Insurance

  1. Ongoing litigation creates uncertainty and can have significant financial implications for litigants, lawyers, and M&A transaction buyers and sellers. Lawsuits can drag on for years, strong cases can unravel, damages can be difficult to estimate, and judges, juries, arbitrators, and regulators settle cases in unexpected ways. Contingent and liability risk insurance is designed to mitigate these risks by transferring known legal and regulatory liabilities to insurers.
  2. Private equity firms can ringfence existing litigation issues at a target company to improve valuation certainty and to remove an impediment to deal closure. Relatedly, PE firms can address known liability and regulatory matters at a portfolio company to preserve value and make it a more attractive acquisition target.
  3. Coverage can be used to lock in the value of a judgement issued by a court or arbitration panel where the judgement could be reversed or reduced on appeal or remand.
  4. Coverage can be structured to address a standalone single matter or a “portfolio” of several distinct issues that are in litigation.

The M&A transaction insurance market is changing rapidly with underwriters eager to consider new applications for warranty & indemnity, tax liability, and contingent litigation risk insurance. Give ARIA a call to discuss any unique issues you may have; we would be thrilled to create a solution with you.

Eric Hoffman

Eric heads up ARIA, where he utilizes 35+ years of global risk management and insurance experience to help organizations and executives to better understand and manage the risks they face in Korea and abroad.