• The impact of COVID-19 on M&A activity in global markets has predictably had knock-on effects on global R&W insurance markets with deal flow slowing down. 
  • Due diligence is key. Brokers are seeing an increased focus on the impact of COVID-19 on current trading and the valuation of the target. 
  • Insurers are scrutinizing transaction documents in more detail and paying particular attention to the pre-closing period in transactions with split signing and closing and (a potential lack of) buyer protection through COVID-19 related MAC clauses. 
  • In the short term, policy pricing is expected to come down as competition increases among insurers who are looking to maintain premium flows. In the longer term, an increase in policy claims may drive up prices. 
  • General COVID-19 exclusions are becoming more prevalent in policy terms across the US, Europe and Asia. 
  • A resurgence of alternative M&A transaction insurance products is anticipated to help businesses protect against specific risks. 

The market

The R&W insurance market is still open for business, and appetite remains among a range of insurers. Brokers are reporting that deal flow has slowed, with processes now being stalled, put on hold or abandoned.

Although insurers are competing for a smaller number of deals, they are taking a more cautious approach to the sectors most obviously affected by COVID-19, such as hospitality, leisure, travel, public transport and entertainment and to the jurisdictions typically considered to have a higher risk environment for transactions. Insurers who offer general insurance products beyond transaction insurance are expected to be more cautious, reflecting a greater expectation in claims made across their products.

Distressed M&A is expected to increase in the coming months, and insurers will need to shift from underwriting profitable/fast growth businesses towards more challenging targets but their appetite for such deals is broadening. The general slowdown in M&A will free up time for brokers and underwriters to offer more tailored insurance solutions.

The combination of increased preparation time for auction processes expected to be launched later this year and record levels of unused fund capital ready for deployment by private equity is predicted to result in an extremely busy lead up to the 2020 year-end.

Impact on policy pricing

Insurers are competing for fewer deals, resulting in brokers experiencing an overall downward trend in pricing in both the US and Europe.

COVID-19 is not anticipated to lead to a change in policy pricing by insurers in Asia, where pricing remains generally higher than in the US and Europe, particularly in certain Asian jurisdictions that are perceived by insurers as having a higher-risk environment for transactions.

The downward trend in pricing is not expected to continue in the longer term as brokers anticipate a spike in claims and ordinary deal activity to eventually resume.

A more robust due diligence process

Insurers in the US, Europe and Asia are requiring more robust, up to date diligence.

Underwriters in the US and Europe want to see that buyers have been able to complete ordinary course due diligence, with insurers becoming more skeptical of the quality of diligence, given limitations created by social distancing.

In the US, there has been particular focus from insurers on requiring that target businesses demonstrate that they are communicating with their top customers and suppliers and that they are on top of key commercial relationships.

Diligence areas of focus for insurers:

  • business resilience and continuity;  
  • valuation and financial forecasts;  
  • supply chain disruption;  
  • terms of existing insurance policy coverages;
  • health and safety policies;
  • employment issues; and
  • consequences of non-performance of contracts.

Insurers’ attitudes on transaction documents

Where there is a material gap between signing and closing and where representations are to be brought down at closing, insurers tend to place transaction documents under greater scrutiny. In Asia, brokers have experienced more robust gap protections being sought to deal with the interim period, although these should always be measured against applicable antitrust (so-called “gun-jumping”) restrictions.

Insurers are testing the impact of COVID-19 on the target group where there are representations in respect of ongoing activities. Increased focus is being placed on breaches of representations relating to, among other things, customer contracts, HR issues, IT/data protection and supply chain issues.

Insurers are generally taking a skeptical view of representations that specifically reference COVID-19 or the effects of the pandemic on the target business.

‘Interim breach’ coverage, which provides protection in respect of breaches that occur and are discovered or disclosed in the interim period between signing and closing, is anticipated to be challenging to obtain or may carve out breaches relating to COVID-19 and its effects.

Where representations are brought down at closing, insurers are undertaking greater diligence efforts. In the US, bring-down calls at closing have become much more detailed and focused on COVID-19 related questions. In Europe, some carriers are requiring updated buy-side due diligence reports covering the interim period.  Sellers should also expect to need to respond to due diligence requests during the interim period (and in Europe at least, may be required to provide an updated disclosure letter at closing).

In the US, although some market commentary has suggested that insurers may be willing to provide more favorable policy terms where transaction documents include strong MAC clauses (i.e., clauses with limited exclusions which do not implicate COVID-19), sellers have generally been successful in negotiating carve-outs to MAC definitions for, among other things, are ‘epidemic’, ‘pandemic’ and ‘quarantine restrictions’ in response to the pandemic.

Brokers in Europe have noted an increase in the use of MAC clauses as a buyer protection, with these drawing greater attention from insurers as to how they address the risk of COVID-19 accelerating. If MAC clauses do not address this risk, insurers will want to understand how this risk is otherwise addressed in the transaction documentation.

How the COVID-19 risk is translating into policy wording

Brokers across the US, Europe and Asia have observed general COVID-19 exclusions being included in policy terms. The precise scope of COVID-19 exclusions varies by insurer and is likely to be more extensive for insurers offering a broad suite of insurance products.

Some insurers have been taking a strict approach requiring a global exclusion in all policies, whereas other insurers have been considering a COVID-19 exclusion (as well as the scope of such exclusion) on a case-by-case basis.

Exclusions seen in the market to date have ranged from exclusions encompassing all losses arising from COVID-19, through to more targeted exclusions covering specific consequences (for example, loss of key employees, factory closures, disruption to supply chains and decreases in revenue from material customers) or losses arising from breaches of specific representations (for example, those that reference the pandemic).

In that regard, it would be important to discuss the scope of diligence with the proposed insurer early in the process.

Enhanced R&W and alternative insurance products

Brokers expect there will be an increased use of alternative and innovative insurance products, such as wholly synthetic representation products (i.e., the insurer negotiating a suite of representations directly with the buyer), particularly in the context of distressed M&A or insolvency-led M&A where the selling party may not be willing or able to give business representations.

The transactional liability market offers a range of other solutions, and brokers are foreseeing a shift to these remedies to target existing risks (such as targeted tax, litigation and environmental liability insurance) and to free up cash for corporates and portfolio companies.

Navigating the R&W insurance market during COVID-19

Build in sufficient time for the underwriting processes to deal with additional scrutiny on diligence and the transaction documents.

Afford brokers and insurers as much time as possible to analyze and understand the exposure of the target business to COVID-19 to avoid the imposition of broad exclusions in policy terms.

Carry out extensive due diligence, with a focus on matters relating to business continuity, and seek to carefully craft representations and ensure representations can be disclosed against.

Where full due diligence is not possible (for example, when purchasing a distressed asset), consider engaging with insurers early to seek to agree upfront on the scope of diligence to ensure cover can be obtained and that the insurer has sufficient comfort. Insurers will be more focused on the credit of the target business and a distressed seller will not, usually, be a specific concern.

If you would like to discuss this post, please feel free to reach out to any of the authors or other regional R&W insurance contacts.

United States

  • Paul Tiger - paul.tiger@freshfields.com
  • Paul Humphreys - paul.humphreys@freshfields.com
  • Tomas Rua - tomas.rua@freshfields.com

Europe

  • Charles Hayes - charles.hayes@freshfields.com
  • Alexander Doorman - alexander.doorman@freshfields.com
  • Arend von Riegen - arend.vonriegen@freshfields.com
  • Victoria Sigeti - victoria.sigeti@freshfields.com
  • Guy Benda - guy.benda@freshfields.com
  • Saloua Ouchan - saloua.ouchan@freshfields.com
  • Chris Yarrow - christopher.yarrow@freshfields.com

Asia

  • Rob Ashworth - robert.ashworth@freshfields.com
  • Simon Weller - simon.weller@freshfields.com