Overall M&A transaction volume is down in Korea (as it is globally) due to Covid-19, but deals are closing and M&A insurance continues to be utilized on many of them, and in increasingly creative ways for distressed assets, take privates, minority investments and a variety of tax issues. Accordingly, I thought it would be a good time to provide an M&A insurance update to highlight key developments.
Warranty & Indemnity Insurance (W&I)
- W&I insurance continues to be widely used on Korea related transactions however, Covid-19 has complicated the underwriting process a bit, most notably:
- Buyers can expect that W&I insurers will want to confirm that the transaction parties have considered the effects of Covid-19 on all aspects of the deal.
- Most W&I insurance policies now have a specific Covid-19 exclusion on them, however, the exclusion wording can be “softened” through proper negotiation. Clearly Covid-19 is a known issue, but its longer-term impact is less clear.
- W&I coverage remains available however, it takes more time to negotiate and resolve issues so start the underwriting process as early as possible.
- There has been little impact on W&I premium pricing so far which is due to the entry of new insurers who are keeping rates competitive for the time being. With that said, AIG announced in the U.S. that they plan to increase W&I insurance pricing by approximately 20% due to adverse claim experience. We have not yet seen other insurers follow suit but we are closely monitoring pricing levels in Korea and across the region.
- Interest in W&I for cross-border deals is on the rise, especially by strategics and real
estate investors. Pursuit of distressed assets is often a key motivator and W&I is being
used to facilitate such transactions, for example, 363 sales in the US.
- Distressed / insolvency deal inquiries are up but W&I underwriters will 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. ARIA recently worked with a bidder to put together a synthetic W&I structure (agreed directly between buyer and insurer) for a target coming out of administration. Tough to do but we got it done.
- Inquiries for minority investments is increasing with W&I protection being structured so that minority investors are covered for their pro-rata share of a company level loss.
- 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.
- Insurance brokers of all sizes in Korea continue to push W&I but most lack experience and in-country M&A legal knowledge to negotiate favorable wordings for clients and to strategically settle claims. Korean offices of large global brokers continue to rely on regional expertise, but there has been much turnover in these regional teams recently. Certain brokers are charging fees on top of the commissions that are included in the premium so it is recommended to ensure that broker compensation is fully transparent from the start.
- W&I claims in Korea continue to inch upwards, but none are Covid-19 related. We expect W&I claim activity to grow across the region as economic realities impact portfolio companies that were covered by long-term multi-year W&I policies. Currently, AIG reports that about 20% of their W&I policies globally receive a claim notification and that claim amounts are growing, especially for complex transactions.
- Tax Liability Insurance
- Coverage enables an insured to reduce or eliminate a known contingent tax exposure arising from a tax treatment of a transaction, investment or other tax position
that may be challenged by the NTS or foreign tax authorities.
- Interest in tax insurance is steadily growing as tax authorities become more aggressive to address Covid-19 driven budget issues …. and M&A transactions (past and present) are an area of focus.
- We continue to see new and creative applications of the product to address a range of tax concerns and ARIA has been successful in structuring a handful of complex tax policies this year.
- 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.
- 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.
Directors’ & Officers’ Liability Insurance (D&O)
- From the start of 2020, the global D&O insurance market has been hardening which means that insurers are seeking and getting higher premiums, higher deductibles, and more restrictive policy language upon policy renewals.
- Reasons behind the trend are: event-driven litigation, merger objection lawsuits, securities class-action suits and #MeToo related claims.
- More recently, Covid-19 is further complicating renewals with additional premium rate increases, insurers reducing limits and often adding insolvency exclusions. Insurers are being more selective on how they allocate their capital and we expect this to continue which will impact D&O renewals for portfolio companies and PE firms as well as D&O coverage for run-off situations and IPOs.
- Considering the tough market conditions, we suggest starting D&O renewals early, seeking quotations from competitive insurers and considering other risk transfer alternatives.
- Lastly, keep in mind that all insurance policies are legal contracts so the words matter and need to be reviewed carefully each year. This is especially true for D&O policies in Korea as the policy wordings vary widely amongst insurers. A recent example of the importance of insurance policy wordings and contract certainty can be seen in the recent debates on whether business interruption insurance should cover revenue lost due to Covid-19. Quite simply, there is no debate if a firm’s business interruption coverage wording has been properly tailored to address communicable disease risks.
For more information, please contact:
Asia Risk & Insurance Advisors
E: [email protected]