For Mergers and Acquisitions, the start to 2021 could not have been more different than a year earlier with the impacts of COVID-19 weighing heavily on Australian and New Zealand businesses. Considerably more optimism in the M&A market saw a steady number of deals in the first half of the year but, by mid-August, this turned into an unprecedented number of transactions.
This was particularly evident by an increased number of competitive sale processes which led to the greatest demand for W&I insurance the WTW team has ever seen in Australasia. While the “old normal” was being disrupted by the pandemic, the “new normal” resulted in record-making deal volumes and placement of W&I insurance in the region.
As we saw in the latter stages of 2020, the key driver for deal activity re-igniting in 2021 came from private equity (PE) firms and other forms of private capital.
They continued looking for investments in opportunistic or strategic bolt-ons for existing portfolio companies or sought to realise investments in portfolio companies that had performed well during the instability wrought by Covid.
Several industry sectors were over-represented in deal activity, including consumer, technology, healthcare/medical and telecommunications.
Several industry sectors were over-represented in deal activity, including consumer, technology, healthcare / medical and telecommunications.
Corporate boards were also encouraged by Covid impacts being less severe than first thought; corporate deal making and growth through acquisition or consolidation was also a major factor in 2021. The final quarter of 2021 was the biggest (by deal volume and deal size) the WTW team has ever experienced.
Despite lockdowns and restrictions on day-to-day businesses, the response by M&A insurers to the COVID-19 situation softened in 2021. Broad requirements for COVID-19 exclusions required in 2020 fell away in 2021 and M&A insurers were open to underwriting to the risk, based on the target group’s exposure and the impact the pandemic had on its more recent operations.
To minimise any exposure, most M&A insurers required a COVID-19 exclusion for the interim period (the period between inception of the policy and completion of the transaction); some larger M&A insurers were willing to remove the exclusion by endorsement if additional due diligence on COVID-19 risks were conducted by the insured at the end of the interim period. This additional due diligence was what any prudent buy side deal team would be doing to understand the impacts of COVID-19 and/or the lockdowns on a target business.
Extensive vendor due diligence (VDD) reports are stemming from the significant increase in competitive sale processes. Sellers are commissioning these and M&A insurers are more open to reviewing them and providing “VDD scoping gap memos” for the benefit of preferred bidders/ the ultimate insureds.
The intention behind this additional input from M&A insurers is to avoid the need for insureds and their advisors to scramble with additional due diligence workstreams and top up due diligence once the W&I underwriting commences. Where regard has been given to the M&A insurers’ feedback contained in these scoping memos, we have seen improvements in the coverage offered. Sell side teams also use these memos to message to all bidders that fulsome buy side diligence needs to be completed to avoid any gaps in coverage, which sits sensibly alongside the no recourse nature of these deals.
It’s important to note that while the VDD scoping gap memos provide high level input from M&A insurers on areas of underwriting focus, M&A insurers expect the insured and its advisors to ultimately determine the appropriate scope of work to be conducted.
The back end of 2021 also saw somewhat of a hardening in approach to general coverage and exclusions. A number of M&A insurers pushed deal teams for more comprehensive diligence or underwriting responses in order to get comfortable on a number of coverage items. There was also a consensus of additional “wordsmithing” by M&A insurers on the form and acceptability of the drafting of warranties.
In a “hard” market, our team’s experience and depth allowed us to have difficult conversations with M&A insurers to make sure the coverage being offered was appropriate and commensurate with the risk. As you would expect, each M&A insurer (and individual underwriters) are different in their style and approach. Here are some of the issues that were noted on deals.
This has been the most contentious area for all transactions where an Australian workforce is present. M&A insurers spend a considerable amount of time reviewing the diligence conducted on analysis of employment-related risks of a target business. In particular, M&A insurers are spending more time considering, in detail, the risks associated with the incorrect application of modern awards and industrial instruments.
M&A insurers want to understand if the due diligence conducted considers whether employees are classified in the correct award and at the correct level within the award, and whether the position descriptions are correct for the work the employee actually performs. On Australian deals the requirement for a sampling of the workforce in order to satisfy M&A insurers is now seen as standard practice. This area is constantly evolving with M&A insurers.
There have been some changes given recent case law in relation to casual employees and independent contractors and this is also a big area of focus for M&A insurers.
M&A insurers expect that the target group’s existing insurance policies cover the ordinary course of business risks up to completion and sometimes as part of a package of “run off” insurances as part of the sales process. M&A insurers typically require exclusions for professional indemnity, product liability, pollution, and cyber risks.
To mitigate the impact of these exclusions, we are seeing more instances of insureds conducting insurance due diligence, to ensure that the target has appropriate insurances in place to mitigate these types of business risks or to identify if a target is under-insured or lacking in any of these risk areas.
Record deal flow from about July 2021 onwards resulted in the first meaningful increases in W&I insurance pricing for over a decade. Given the small size of local M&A insurer teams, individual underwriters quickly became overwhelmed with the deal pipeline. This lead to M&A insurers being generally more selective on the deals on which they provided terms, and where terms were provided, pricing was close to 50% (and in some cases 100%) higher than pricing in 2020, for both primary and excess policies.
Record deal flow from about July 2021 onwards resulted in the first meaningful increases in W&I insurance pricing for over a decade.
Due to the large number of deals requiring W&I insurance coverage, resourcing and capacity constraints, M&A insurers were not always able to meet the more aggressive transaction timetables during the latter part of 2021. The typical W&I timetable was pushed out by at least a week by most insurers, with a typical buy-side deal requiring at least 8-10 business days from commencement of underwriting to inception of the policy. Competitive auction processes felt the brunt of this as well with M&A insurers generally only being willing to do one underwrite for one preferred/exclusive bidder.
The issues were acutely felt in the last six weeks before Christmas. If a client/advisor did not have their transaction on an M&A insurer’s dance card by mid-November, then it was pushed into January. Interestingly, it did not impact too many PE firms as they were probably already conditioned to the usual year end deal making crunch, and had reached out to us well before the “closed” signs went up.
To strategically deal with these delays and the capacity issues, lawyers and deal makers had to be creative and structure transactions to allow for W&I as a condition precedent, or in some instances a post completion obligation in the sale agreements, so that exchange could still occur prior to Christmas and without impacting the transaction timetable.
As a result, a large number of transactions from November and December 2021 spilled over into 2022, with policies incepting in January and February.
During 2021 we saw some M&A insurers requiring tax exclusions for tax matters outside of scope of tax due diligence investigations. This is particularly in regard to multi-jurisdictional transactions where the target had offshore operations. These exclusions were consistently applied regardless of whether an insured determined that international operations were not material from a revenue perspective.
Claims activity has been relatively stable in 2021. While we have noticed an increase in notification frequency, it hasn’t translated to a higher frequency of claims to what we have seen in previous years. Most were notifications of circumstances made on a precautionary basis, or losses which remain within the policy retention.
We continue to see claims in the employment arena and the WTW team has settled a number of these. Generally, these types of claims relate to underpayments to staff over a long period of time through the incorrect application of an award or a misclassification of staff under an award. We have also seen superannuation or payroll tax claims from these types of issues.
We recently settled a multi-million dollar employment claim of which approximately half related to underpayment of employees under an employment agreement and half on account of diminution in the value of shares in the target. The complex technical nature of these claims required detailed legal submissions from the respective lawyers but also competing submissions on accounting methodology from the respective forensic accountants. The complexity of these claims also leads to a longer claim duration.
Some M&A insurers produce valuable claims studies on an annual basis. The M&A insurers state they receive claim notifications on roughly 20% of policies placed. Our own figures, built up over many years, indicate this figure to be around 12–13% of policies. A significant number of these claims relate to the accounts warranties and this is pretty consistent with what our insurance partners report. Notifications relating to material contracts and either misstated accounts or undisclosed disputes regarding those contracts remains a contributor to our claims activity. However, the losses we are seeing in this space are quite minimal when compared to the employment or taxation-related claims.
As of February 2022, M&A insurer capacity constraints appear to have eased slightly (they probably all needed a good summer holiday). Likewise, COVID-19 has become just another factor to be included as part of the buy side due diligence process. The risk of new lockdowns has not completely gone away so M&A insurers continue to carve out that aspect on deals where there is a gap between signing and closing. COVID-19 risks remain an exclusion where new breach cover is taken out.
While we do not expect a second successive year of a record-breaking number of deals, it is likely that Australia and New Zealand will continue to be viewed as “safe harbours” and attractive investment destinations for foreign and domestic capital. We expect the technology, healthcare, consumer, renewable energy and financial services sectors will continue to remain active and that infrastructure funds will be busy participants as well.
While M&A insurers’ pricing has softened very slightly since the start of the year, we do not expect that rates will return to pre-August 2021 levels. The market is also likely to see M&A insurers continue to push back on aggressive timetables.
While M&A insurers’ pricing has softened very slightly since the start of the year, we do not expect that rates will return to pre-August 2021 levels.
M&A insurers will continue to be selective on the number of deals they place in the first half of 2022, so they can retain some capacity for the second half of the year. The increase in demand for M&A insurance would suggest, however, there is room for one or two more M&A insurers in the Australasian market who currently do not place M&A insurance in the region.
The fact that insurance premiums are now slightly higher than what is being seen in the UK and Western Europe while the claims track record is at a reasonably steady state should mean that further insurance capacity makes its way to Australasia.
This article was first published on the website of the Australian Investment Council.
