Protecting value: Insuring known risks in M&A

How companies can optimise M&A transactions

Protecting value: Insuring known risks in M&A

Risk Management News


Charles de Mombynes, AXA XL’s underwriting manager for M&A in France, explains why more companies are using contingent risk insurance to optimise M&A transactions.

What is contingent risk insurance and how does it differ from warranty and indemnity insurance?

W&I insurance covers unknown, or unidentified, risks in an M&A transaction. In contrast, contingent risk insurance is there to cover uncertainty in the identified risks and contingent labilities. Known but uncertain risks, like the outcome of ongoing litigation or an outstanding tax claim, can scuttle a transaction. There are many risks– either related to the transaction itself, or risks concerning the target company– that can be a deal breaker.

Is demand for contingent risk insurance growing?

This is definitely a growing area. In the past, many M&A players were not aware of the scope of risks that can be covered by contingent risk insurance. In discussions with M&A players and lawyers, they are often surprised by the number and range of different risks we can cover. But we have been doing a lot of work with brokers to raise awareness on the ground, and our underwriting teams in the US and Europe are seeing more interest in contingent risk insurance solutions. It’s only a matter of time before contingent risk insurance becomes an everyday part of the M&A process.

What types of risk are typically covered?

Contingent risk insurance covers a very wide range of risks – almost any type of risk that can be identified in the context of an M&A transaction can be covered. But it is particularly relevant for identified risks that are considered unlikely, but where a potential adverse outcome is severe enough to put the transaction at risk or justify the premium. These tend to be one-off risks related to tax or commercial litigation, such as disputes centred on patent or intellectual property rights, contractual liability, property, and environmental liability claims.

Who buys the cover, and who is the beneficiary?

That depends on the risk and the type of deal. There are situations where a seller needs to present a clean risk and will negotiate with an insurer to get a firm offer in advance. By arranging the cover up front, the seller demonstrates to the buyer that the risk is under control and that insurance is in place, enabling the deal to go through. More often, contingent risk insurance comes into play when risks are identified during the negotiation, and the premium is then likely split between the buyer and seller. The beneficiary is usually the target company, but there are cases when it can be the seller, such as in the case of a tax liability.

What are the benefits of contingent M&A cover?

Generally, contingent risk insurance protects buyers against potential adverse financial impacts of risks identified in an M&A transaction. It can a remove uncertainty and protect value for the buyer. And for the seller, it enables them to exit an investment with fewer liabilities, while at the same time make the deal more attractive to buyers and create certainty of price.

Contingent risk insurance doesn’t only cover the risk of making future payouts. It can also help companies monetise risks. For example, where a target company is pursuing another party for breach of patent, or is claiming for tax credit, contingent risk insurance can help secure these future amounts, and include them in the sale. The buyer is confident they will receive future income, which in turn is reflected in the price for the seller.

Are there examples of where contingent risk insurance has helped get a deal over the line?

We recently provided contingent risk insurance for a transaction where the purchaser of a hospitality asset adopted the position that the target company was not a real estate company (personne morale à prépondérance immobilière) for the computation of transfer taxes under the French Tax Code. If such position – leading to lower transfer taxes – was to be challenged by the French tax authorities, our contingent risk insurance policy would cover the tax liability that would result from such challenge. In another case, a company was selling a commercial property, but the buyer was concerned about potential litigation from the occupier of the property, who believed they had already reached an agreement to purchase the property. After analysing the documents and obtaining external legal opinions, we were able to insure the risk and enable the transaction to go ahead.

How does contingent risk insurance work within the M&A process?

Risks can be identified by the seller preparing the sale of an asset. If they want to sell a company that faces a specific identified risk, they may proactively consider arranging contingent risk insurance before they go to market to ensure they get the best price.

More often, the option of contingent risk insurance is raised during the due diligence process. If a buyer identifies a significant risk that raises a red flag, they could seek indemnification from the seller. But such risks are often the hardest to negotiate. The seller may not be willing to indemnify a risk they see as low, while the buyer will want to protect the value of the acquired asset against significant risks. And this is where contingent risk insurance comes into play. It enables the parties to externalise the risk and get the deal done.

Insurance also helps with the counterparty risk. A buyer may have the right to indemnification, but the seller may not be in a position to honour it. Contingent risk insurance provides a sleep easy through the recourse to a highly rated insurer should a contingent risk materialise in the future.

Is contingent risk insurance a separate cover to W&I insurance?

Contingent risk insurance can be sold separately, although there are benefits from buying it along with W&I insurance. For example, it may be possible to include contingent risks directly in the W&I policy to provide a comprehensive risk transfer for both known and unknown risks.

How do you underwrite such complex and unusual risks?

Contingent risk insurance is always tailor made and requires specialised underwriting skills to analyse the risks. Our teams also work with specialist external lawyers and experts who support underwriters and help them to understand and assess the risks. We also can draw on the expertise of the wider AXA group, such as our environmental liability, property or cyber teams, who can offer traditional and non-traditional solutions to identified risks that may help facilitate the M&A transaction.

What can companies do to get the best out of contingent risk insurance?

Parties tend to consider contingent risk insurance solutions relatively late in the process when negotiations are deadlocked or in the last, stressful, few days before the transaction date. In these situations, it can be challenging for underwriters to properly assess and analyse the risks.

So, I would advise the various players to identify risks that could be seen as an issue as early as possible, and contact their broker to understand the available solutions. They should also be careful to select an insurer that has the right expertise and is able to respond to the complexity of the risk. Make sure you partner with an insurer like AXA XL that is committed to this market for the long term and that it has the expertise and knowledge across a range of risks.  

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