Banking & Finance, Economic Development, and Human Resources

Transaction liability insurance gaining favor

M&A buyers and sellers are becoming more comfortable with the idea.

July 1, 2016
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For more than 20 years, transaction liability insurance has been an option for firms engaging in a merger or acquisition. But it’s only been recently that companies are beginning to take advantage of it.

Since the financial crisis, the market for transaction liability insurance has “exploded,” according to Kyle Kalinich, Aon Risk Solutions senior vice president of mergers and acquisition solutions.

Transaction liability insurance allows M&A professionals to use insurance capital in the infrastructure of the deals they’re creating, Kalinich said. Traditionally, a seller would put about 10 percent of the deal structure up against escrow, but with transaction liability insurance, that escrow is replaced by insurance capital, mitigating the seller risk while also providing the buyer with a more secure collection plan if the deal goes south upon completion.

“That’s very attractive to the seller of the business, and from the buyer’s perspective they get to collect from an insurance company instead of the seller,” Kalinich said.

Much of the growth in recent years has to do with insurers opting to drop their prices by as much as 50 percent to retain that business in the wake of the crisis. And in Aon’s case, the company hired a staff of former merger and acquisition attorneys to advise and help broker these deals. The combination of lower costs and a higher level of professional services being offered has resulted in a batch of growth for the industry.

“What we’re seeing now is that, against the last three years, the use of the product has gone up over 1,000 percent,” Kalinich said.

The types of companies utilizing the product have come across in waves. When interest in transaction liability insurance began to stir several years ago, it primarily was private equity firms using it. But recently, more and more corporate and strategic merger and acquisition firms are buying insurance.

Firms can create a more attractive bid if they loop insurance into the deal, which has facilitated this second wave of interest in the product, Kalinch explained.

“The use of representation and warranties and transaction liability tools is a strategic tool as much as it is a risk management tool,” he said. “For M&A professionals, they’re tools that can be used strategically in deal structure to increase the speed of the deal and just improve the overall deal execution.”

Aon provided insurance for about 230 deals in 2015, and though interest in the service is growing, Kalinich estimated the percentage of deals that use transaction liability insurance still is below 20 percent. Michigan remains on par with the national average in that regard.

As for when these options should be introduced into the deal, it depends on the deal. Kalinich said from an economic standpoint, it makes sense to consider transaction liability solutions in most deals. However, smaller acquisitions run into a minimum cost issue, where the rate of insurance doesn’t decrease, making it a more expensive option.

Increasingly, transaction liability is included in initial conversations, but often Aon has been called upon at the 11th hour to help bridge the gap between the buyer and seller.

“If they’re late in a tough negotiation, using insurance capital usually helps to take that friction off the table,” Kalinich said.

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