M & A 2015 CONFERENCE MINNEAPOLIS NOVEMBER 18 1
Representation and Warranty Insurance: Updates on This Important and Rapidly Changing Industry 2015 M&A CONFERENCE Linda Crow, Faegre Baker Daniels Jay Rittberg, AIG Craig Schioppo, Marsh USA Inc. Moderator: Kate Sherburne, Faegre Baker Daniels 2015 M&A CONFERENCE 2
Overview Protects against unknown and unforeseen losses arising from a breach of the representations and warranties in a purchase agreement. Why it is used: Remove or reduce escrow or holdback in the transaction; extend survival periods Provide recourse when no seller indemnity possible Distinguish bid in competitive auction Protect key relationships or passive investors Distribute sale proceeds faster 3
Types of R&W Insurance Policies Buyer-Side Policy (85+% of policies issued) Insurance replaces sellers potential indemnification liabilities Can enhance indemnification terms Extended survival periods, increased cap, materiality scrape Covers fraud by sellers Limited subrogation rights against sellers and management team Seller-Side Policy Sellers backstop their potential indemnification liabilities Mirrors indemnification terms in agreement Typically excludes fraud of sellers Knowledge between sponsors and management sellers can be severed 4
Insurance Market Evolution Broader coverage and better alignment with underlying agreement Speed of execution more streamlined underwriting process Significantly increased limits of liability available Material reduction in premium rates and deductible levels enhanced competition Greater market awareness Claims experience 5
How You ll Encounter It Private equity has been the early adopter Strategic encountering as a Seller-imposed requirement in an auction Middle market M&A emphasis and application, but growing in upper middle markets 6
Market Growth Already an established product in certain markets, has seen significant growth in North America over past 5 years: 1500 1000 500 0 Number of Submissions 1150 525 335 215 2011 2012 2013 2014 400 200 0 Number of Policies Bound 230 35 59 95 2011 2012 2013 2014 AIG expects approximately 2,000 submissions and 300 policies in 2015 7
Pricing Diligence Fee: generally $20K - $40K depending on nature of deal Premiums Typically 3.5% 4% of limit insurance (lower outside of U.S.; higher for smaller policies) Either party can pay Deductibles Limits Typically 1% - 2% of transaction value (no indemnity deals may be higher) Buyer-side policies often use escrow account as deductible Seller-side policies use a negotiated amount Drop-downs available and erosions available for loss outside coverage Up to $500M of limits available in global market Hard to insure a deal with a limit lower than $5M Can be used effectively in transactions from $25M - $3B+ 8
The Broker How to choose a Broker What the Broker should do for you What information the Broker needs to obtain quotes 9
The Insurer Preliminary information submitted to insurer: Acquisition agreement, financial information, offering memo Underwriting considerations: Identity of the buyer, seller and their advisors Sector of target business and location Quality of the transaction process Quality of due diligence/disclosures Value of transaction Scope of the warranties buyer or seller friendly? Seller s liability under the agreement Gap between signing and completion? Why do they want insurance? Do both parties know about the insurance? 10
The Process Give yourself at least 2 weeks to be comfortable (can be done faster, if needed) Engage Broker Broker delivers quotes; Negotiate NBIL (2-4 days) Diligence; pay underwriting fee (5-10 days) High level review of due diligence process (if buyer-side) or disclosure process (if seller-side) Access to legal, financial, tax, other DD reports (if buyer-side) Conference call(s) with deal team Negotiate policy (a few days, runs concurrent with end of diligence period) Works on a parallel track to purchase agreement Can incept at signing or closing 11
The Policy Conform coverage to your purchase agreement Common Exclusions Known issues identified in disclosure schedules and environmental reports Asbestos claims Losses covered in purchase price adjustments Issue known to a member of the insured s deal team Breaches of covenants Claims for non-monetary relief Criminal fines or penalties Fraud of seller (if a sell-side policy) 12
The Policy (Cont.) Exclusions that may arise depending on industry/facts: Product liability claims Underfunded benefit plans Healthcare billing practices California wage and hour law issues Big pharma issues FCPA Can expand coverage from purchase agreement: Materiality scrapes Survival periods Consequential and multiple damages 13
The Purchase Agreement Could be silent Might be fully baked (covenants, closing conditions, etc.) Indemnification provisions might reference as a first recourse May specify that escrow is only available for claims not covered by insurance 14
Claims Experience Industry-wide, claims payments have ranged from $500K - $25M Insurers have dedicated claims professionals and law firm relationships to offer claims solutions Brokers and independent advisors serve as advocates for insureds Examples of claims: Financial Statements: Recently paid $25M for a financial statementsrelated claim Accounts Receivable: Seller-side policy responds to claim brought by buyer for breach of financial statement R&Ws related to target s issuance of over $1M of unrecorded gift certificates Patent Infringement: Seller-side policy responds to third-party patent infringement claim 15
Frequently Made Claims Financial statements, compliance with laws, taxes, and undisclosed liabilities are the most frequently alleged breaches. 20% 15% 10% 5% 0% Type of w arranty breach Financials;AR;Inv. -18% Comp. With Laws/Lit. -17% Tax -14% No. Undisc. Liab. -10% IP -8% Contracts -5% Full Disc. -4% Emp. Ben. -4% Real Prop. -3% Other -16% 16
Timing of Claims More than half of all claims notices are received within the first 12 months of the policy s issuance. 17