M&A insurances gaining traction in Asia as cross-border appetite grows

Singapore

MERGERS and acquisitions (M&A) insurances are gaining traction in Asia, from being mainly used by private equity buyouts, to all types of deals to mitigate potential risks and liabilities in a transaction, often playing a crucial role when negotiations hit an impasse.

Aris Wong, managing director of insurance adviser BMS Group Asia, told The Business Times that there is a growing appetite for warranties and indemnities (W&I) as more people understand the benefits and the certainty that the insurance offers.

"Asia is one of the main engine drivers of the global economy, and with the uptick in M&A activity in this region, there has been greater awareness of the need for protection of tail end liabilities which may result in significant financial exposure," Ms Wong said.

Users also adopt it as a matter of good corporate governance and accountability to shareholders, should a risk of a breach materialise and cause the balance sheet to take a hit. For instance, when a special purpose acquisition company (SPAC) or a shell company is involved.

Its use is particularly strong in the infrastructure and renewables, financial services, real estate, technology and healthcare sectors.

Cheow Ai Ling, managing director, PEMA and transaction risk Asia leader at Marsh, has seen more people using W&I insurance as a deal enabler in Asia.

"The number of deals has increased year by year since 2015 by double digit. From private equity clients being the first mover in the early days, to lawyers to financial advisors today who all see the benefits of using this product," Ms Cheow said.

Last year saw private equity overtaking corporates as users of W&I at 54 per cent of the market, compared to 38 per cent in 2019.

Ms Cheow attributed this to the fact that most deals in 2020 had to be done virtually and "private equities were more comfortable with such arrangements".

She shared that when Marsh first started its private equity and M&A practice in Asia, there was only one insurer in the Asia market. Today, there are six. Marsh has expanded its team to 40 people across Asia in the last five years to support the rapid growth in different geographies in the region.

Rates have stabilised around 1.6 per cent across Asia in the last few years due in part to competition, experts say. In general, the average limit of liability continues to be about 20 per cent of deal value, but for larger deals, the average limit is at 10 per cent.

The growth mirrors the uptick in M&As in Asia. Private equity funds are looking to deploy their capital, or exit portfolio companies. Companies, too, are turning to M&A as a catalyst for growth and renewal as they pursue new paths to profitability, adapt to market disruptions and reposition their companies to succeed in the marketplace.

"M&A in Asia-Pacific has been defying global trends, driven by the need to acquire new technology and access new markets throughout the pandemic," said Tracy Wut, Baker Mckenzie's head of M&A for Hong Kong and Mainland China.

Asia-Pacific saw 988 deals worth US$180 billion in the first quarter of 2021. Recent deals include the tie-up between Gojek and Tokopedia, Grab's SPAC merger and Singapore Airlines' potential privatisation as well as private equity firm Actis' divestment of major ownership in PS Gourmet, the operator of casual dining restaurant PS Cafe.

In a typical M&A, buyers engage advisers from the Big Four to conduct due diligence on the target companies.

Such thorough legal, tax and financial due diligence is paramount to fully assessing key risks associated with targets.

But no matter how rigorous the due diligence, high levels of risk are involved as there could be certain tail end liabilities that only surface after the buyer has taken over the target company.

"Risks may surface many months or even years post completion, and are latent unknown risks that due diligence advisers could not have uncovered in any event," Ms Wong said.

An example of this in Singapore is the underpayment of employees at Twelve Cupcakes, a local bakery.

The issue came to light only after the company was sold and the new management continued the illegal practices.

Elsewhere, one of the largest commercial damages claim made involved Asahi's US$1.3 billion acquisition of New Zealand beverage group Independent Liquor from Pacific Equity Partners and Unitas Capital in 2011.

Within a year of taking ownership, Asahi discovered that the business was far less profitable than it was led to believe, and sued for misrepresentation during the sales process and due diligence.

The Japanese brewer Asahi was able to recoup about one-sixth of its purchase price after reaching a settlement with the funds and their insurers.

"M&A insurance seeks to pass on these unknown risks to the insurers which create certainty in such a high-risk environment. The insurance allows buyers to create an environment where they know what they are getting themselves into," said Ms Wong.

While such insurances could be taken up by either the seller or the buyer, nine out of 10 policies placed are buyer-insured.

To mitigate these risks, buyers extract representations and warranties, which are essentially factual statements relating to the historical affairs of the target company.

In case of a breach, buyers can claim any losses from the sellers. It is equivalent to say, a consumer going to Apple when their iPhone is defective during the warranty period.

But the key difference here is that sellers often want a clean exit, and do not want to be bogged down with claims.

Sometimes, sellers wind up or become financially insolvent and are unable to respond to the claims when they arise.

This is where M&A insurance, or warranties and indemnities insurance, comes into play.

"By shifting the seller's liability to insurers and putting a price tag to this future contingent risk, sellers benefit from having a clean exit with little or no tail end liabilities, while buyers have certainty of recourse should they discover a breach of warranties post-acquisition," Ms Wong said.

M&A insurance has arguably become a game changer, given the ability to categorise unknown risks associated with M&A transactions, and to transfer them to an insurer, giving buyers peace of mind.

The majority of M&A insurance policies are issued in North America, the biggest M&A market. From 2008 to 2018, the total insurance capacity purchased there rose from US$540 million to over US$38 billion.

Prospects look bright in Asia, which remains under-penetrated. M&A insurance is still in its infancy in China, the Philippines, Thailand and Indonesia. In contrast, it has made inroads in Asian financial hubs such as Singapore, Hong Kong and Seoul, and is gaining traction in Japan, Malaysia, Vietnam and India.

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