International Restructuring Newswire
Discussing restructuring topics in Canada, the UK, Germany, the Netherlands and the US.
This article was originally published in Insurance Day on January 18, 2021.
Asia’s more favourable business climate post-COVID-19 presents huge opportunities, but also increased exposure risks.
M&A activity is expected to recover more quickly in Asia following the COVID-19 pandemic.
When considering the level of adoption of transactional insurance in Asia today, it is worth bearing in mind only 10 years ago it was scarcely known about, seldom used and offered by only a few forward-thinking underwriters.
Today, the product – and warranty and indemnity (W&I) insurance (known in the US as reps and warranties insurance) in particular – is a well-established and widely adopted feature of deal making in Asia, with numerous insurers competing to offer the product across virtually all markets and industry sectors within the region.
For a long time, one key headwind to the widespread adoption of W&I insurance in Asia was the absence of data on successful claims under such policies. Now, in addition to insurers’ own claims reports, there have been several high-profile instances where substantial claims have been brought successfully and paid out under W&I policies. Increasing consumer confidence these policies do pay out will go a long way towards increasing adoption, particularly among skeptical and cost-conscious North Asian consumers.
While Europe and North America still grapple with the health and economic effects of COVID and its restrictive effect on doing M&A, many Asian jurisdictions have weathered the storm relatively unscathed and are getting back to business as usual
Today, a handful of W&I underwriters and managing general agents have “boots on the ground” in Asia, generally in Hong Kong or Singapore. Other insurers write Asian business from outside the region – mainly from London – and there is frequently talk of others opening offices in the region.
The reason for all this interest is simple. With the exception of 2020 – the year of COVID-19 – merger and acquisition (M&A) activity across Asia has boomed in recent years. The rate of growth in Asian jurisdictions has surpassed anything seen in other more established international markets and is set to continue as emerging markets across the region begin to achieve their potential. Further, while Europe and North America still grapple with the health and economic effects of COVID and its restrictive effect on doing M&A, many Asian jurisdictions have weathered the storm relatively unscathed and are getting back to business as usual.
Accordingly, we can expect deal activity in Asia to return to previous levels quite quickly. In addition to Asia’s more favourable business climate and huge potential, the perceived heightened risk and reduced competition among insurers in the region means it is possible to charge higher premiums for underwriting deals in many Asian jurisdictions.
Historically, Asia has been an insurers’ market and policy terms – including breadth of coverage, exclusions and limitations and premium and retention levels – have tended to favour the underwriters. However, with more competition among insurers for deals, a more aggressive and sophisticated approach from brokers (often based on positions they have been able to achieve in more established and competitive markets, such as Australia or Europe) and a greater familiarity on all sides with the risks involved in the relevant Asian markets, over the past few years we have seen pricing has begun to come down, coverage has been getting broader and insurers’ appetite for risk has had to become much greater.
Insurers will now consider providing terms for deals involving target companies in virtually all Asian jurisdictions and markets. There has been a marked change in attitude towards China risk in particular – so much so is not uncommon now for underwriters to work with Chinese language transaction documentation and due diligence materials, typically insisting only on translations of executive summaries of reports or key sections of agreements.
This obviously places a much greater onus on the underwriter’s counsel, who need not only to have lawyers and tax advisers with local language skills and the requisite qualifications and experience who are familiar with the W&I process, but also need to be willing to take a more proactive role in the underwriting process generally, working closely with the insurer.
W&I insurance can help to get deals done that might otherwise fail, with some insurers being willing to underwrite a set of synthetic warranties covering the key issues for which a buyer might seek comfort, should a seller be unwilling or unable to offer any
Originally conceived as a sell-side product, helping sellers to offload their residual risk post-closing while also facilitating a cleaner and more complete exit, today around 95% of policies are buy-side, enabling buyers to receive a package of warranty-related protections they are comfortable with, even when the seller is not willing to provide this.
As highlighted earlier, underwriters today are having to accept risk they would previously have avoided. Coverage in relation to certain types of warranty that were traditionally subject to a blanket exclusion (for example, environmental, anti-bribery and corruption, warranties relating to adequacy or sufficiency) may now be subject to negotiation and underwriting such that, in relation to standard environmental warranties for example, it is now typical for insurers only to exclude warranties that relate to actual contamination and pollution, but to consider (subject to satisfactory underwriting) covering a warranty that relates to compliance with environmental laws.
A further illustration of how the market has shifted away from insurers was seen in 2020 during the early days of the pandemic. Initially, insurers sought to impose very broad exclusions relating to any issue arising as a consequence of COVID-19. However, under pressure from brokers and cognisant of the need to remain competitive, insurers were quickly forced to underwrite around the issue, with the result that in reality COVID exclusions, to the extent they applied at all, typically related only to very specific, identified risks and in most cases, having got comfortable through underwriting, no COVID-related exclusion was applied at all.
Traditionally, the insured was expected to suffer some financial pain by itself, covering an amount up to the retention/excess before the policy would begin to pay out. However, recently it has become quite common for nil retention policies to be written, especially in low-risk transactions, albeit the nil retention typically only applies in respect of claims under fundamental warranties.
Tipping retentions are also occasionally seen, whereby once losses exceed the policy retention, the insurer will begin paying out from a lower amount than the retention or even from nil. In addition, whereas in the past insurers used to want to see that sellers were exposed to some liability under the warranties in the sale and purchase agreement before the policy responded, to gain comfort that the seller had taken the negotiation of the warranties and disclosure exercise seriously, so-called nil recourse deals (where the seller’s liability is typically a nominal amount of, say, $1) are now relatively common and the insurer must establish for itself through underwriting how seriously the seller has taken the warranty and disclosure exercise.
Underwriters in the region are also now generally willing to quote for US-style coverage, where they do not exclude generally any information contained in (and therefore deemed known by the buyer) either the data room or the buyer due diligence reports nor seek to qualify the warranties in the transaction documents by means of a warranty coverage spreadsheet. However, to date the significantly higher premiums that would be charged for this enhanced protection have been sufficient to dissuade most consumers in Asia from taking up US-style coverage and, in reality, this is seen only rarely.
Last year may have been a mixed bag from an M&A perspective, but 2021 promises more and Asia is likely to lead the way, given the region’s expected swifter recovery from the pandemic.
Sadly, 2021 may also be a year in which distressed M&A becomes common¬place as the ruinous effect of the pandemic filters through and government support is eased.
In this context, W&I insurance can help to get deals done that might otherwise fail, with some insurers being willing to underwrite a set of synthetic warranties covering the key issues for which a buyer might seek comfort, should a seller (such as a distressed seller or incumbent insolvency practitioner) be unwilling or unable to offer any warranty protection, or at least insufficient protection from the buyer’s perspective.
Whereas W&I insurance seeks to cover only unknown risks, we will also see the further development and adoption of more specialist transactional insurance products, such as tax liability insurance and contingent liability insurance, which address certain known risks. These products are beginning to take off in the region and can be taken out on a standalone basis or baked into a wider transactional insurance policy that includes W&I insurance.In conclusion, Asia will continue to be an attractive and thriving market for W&I insurance providers, particularly given how early in their development most of the markets are and the huge potential they have. The scale of the opportunity will inevitably encourage new players to the market and the increased competition is likely to push pricing down further and cause coverage to become yet broader. As terms become more attractive and the product’s profile rises, adoption will increase and so the positive evolutionary cycle will continue.
Discussing restructuring topics in Canada, the UK, Germany, the Netherlands and the US.
The EU is very likely to push ahead with creating a carbon border adjustment mechanism, as soon as compliance with WTO rules can be assured.
© Norton Rose Fulbright LLP 2020