Our recently released 2021 claims briefing provides an in-depth assessment of M&A insurance claims by in-dustry, by region and by cause, thus shedding light on the types of deals that are most likely to lead to a claim, as well as highlighting current claims trends and pro-viding some useful claims handling tips. The key find-ings from the briefing include:
COVID-19 has not led to a surge in claims, but has changed the M&A risk landscape fundamentally
The view that M&A insurers could see a flood of claims resulting from COVID-19 has not yet materialized with the number of notifications received as a proportion of all policies bound remaining unchanged at around 20%. However, the pandemic has undoubtedly stretched and tested businesses and their employees in ways never before experienced and it will be a while, therefore, before we have a better picture of its full impact on claims. Nevertheless, we expect that COVID-19 will lead to new claims trends emerging in the next 12 months. These include:
an increase in claims relating to key customer in-solvency;
an increase in claims relating to the incorrect use of the various job retention schemes that were imple-mented by national governments in the wake of COVID-19;
more audits and more aggressive positions being taken by tax authorities; and
an uptick in claims involving financial statement is-sues as a result of the challenges that the pandemic has created for auditors.
Claims are being made increasingly quickly after policy inception
In 2019, 49% of our notifications were received in the first 12 months of the policy period. This increased to 57% in 2020. The figure currently stands at 66% for notifications received in 2021 YTD. The reasons for the increase are potentially varied, but the most likely expla-nation is that it is a by-product of both our increased policy count over the last few years and the fact that insureds are simply becoming better at identifying and notifying issues more quickly. However, it could also be indicative of the fact that the claims process is becoming ‘institutionalised’ with some regular users of the prod-uct, assisted by their deal lawyers, starting to carry out a post-closing reviews as a matter of course with the specific objective of quickly identifying potential breaches in respect of which they can make a claim.
A number of our “high” severity ($10m plus) claims have involved founder member deals.
A not insignificant number of our “high” severity claims have involved sales by founder shareholders. Some of these have involved suspected fraud by the founder(s). This may be because there is arguably a greater incentive for founder(s) to conceal issues deliber-ately. While these incentives are not unique to founder shareholder deals, these types of deals often involve smaller, less sophisticated businesses, which may not have the same robust controls or checks and balances that larger, institutionally-owned businesses typically have: this means that these types of situations can go either unnoticed or unchallenged, especially where the founder shareholder(s) exert significant control over the business.
There is a high degree of commonality in terms of the issues that are generating claims
An analysis of the most common causes of claims reveals that:
• We are seeing a high number of claims relating to revenue recognition issues. These claims have been responsible for some of our largest payments to date. There is a clear risk that these types of claims could become more common as the pressures and si-gnificant uncertainty associated with COVID-19 have placed increased top-line pressure on management.
• Stock and inventory issues remain a common source of claims. These types of claims are not specific to any one region and can be very large, with several of the examples that we have seen over the last few years being for amounts in excess of $50m. This has led to us focusing much more on this issue at underwri-ting stage and carefully scrutinizing the level of due diligence that buyers have performed into this area.
• We are finding material contract claims to be persistently costly. The most common issues involve the failure to disclose information relating to a change in relationship (e.g., receipt of a notice of an intention to reduce orders, terminate a contract or change the terms of doing business). We have also seen several large claims involving contracts that are said to be loss-making due to the costs of servicing the same being much higher than the target anticipated during the bidding process.
• Large ($10m plus) tax-related claims remain relatively uncommon, although “medium” severity ($1m to$10m) claims are coming through more regularly. The majority of these involve either corporation tax or sales tax issues. However, we also are seeing an increasing number of claims involving import taxes and environmental taxes. The former is indicative of the increasingly complex global supply networks that many businesses rely on. The latter is a by-product of attempts by governments to drive greener cor-porate practices via the tax system.
• Wage-related disputes are on the rise. These types of claims usually involve allegations that employees have not been fully compensated for working through man-datory rest periods or for working overtime or paid in accordance with minimum wage legislation and can be surprisingly expensive since they can result in additional tax liabilities plus an increased wage bill.
• We are seeing more IT-related claims as businesses become more digitally enabled and increasingly reliant on technology for all aspects of their operations. The most common claims relate to software licensing shortfalls. We are also finding that major IT projects which were part way through being rolled out at the time of the sale are becoming an increasingly common source of claims. These claims typically relate to missed milestones, or higher-than-expected costs or the failure of the project to achieve its stated aims.
• The increased instances of cyber-attacks is driving an uptick in the number of notifications involving cyber-related losses. This poses a problem for M&A insurers who see this as a risk that businesses ought to be managing by purchasing a bespoke cyber policy with suitable cover and adequate limits.
• We are receiving more notifications involving third-party claims: around 39% of our notifications so far this year fall into this category (up from around 21%in 2020). We expect this to become an increasingly common issue going forward as the economic fallout caused by COVID-19 is likely to lead to a rise in the number and types of disputes as attitudes harden and litigation is used as a means of raising revenue. This is leading to increased focus on the size of retentions, particularly on smaller deals.
We have paid out the most dollars on smaller deals over the past few years.
The majority of our paid claims from 2019 onwards have related to smaller deals with an EV of less than $250m. These types of deals accounted for around 65% of the dollars that we have paid out over this pe-riod. The data is somewhat distorted by one particular-ly large payment (of €50m), although — aside from this claim — we did make two other payments of more than $10m on deals falling within this deal size brack-et and, since 2018, it has accounted for a very high proportion — around 72% — of our “medium” sever-ity ($1m to $10m) claims. We tend to see far fewer payments on deals with an EV of $500m or more (due to the higher retentions on these deals). However, these payments, when made, can be sizeable as demonstrated by the fact that we have been involved in a number of large payments on deals with an EV of $500m or more in our capacity as an excess layer insurer in the last couple of years. This included a U.S. claim where our share of the payment was $27.5m.
Insurers are being increasingly judged on their claims service
We are finding that how insurers are set up to handle M&A claims is coming into much sharper focus fueled by an expectation among insureds that their claims will be dealt with by an experienced and specialist in-house claims team that has full control over their processes and decisions. This is only to be expected: M&A insur-ers compete on price, they compete on coverage, they compete on deal execution, but they should also com-pete on the quality of their claims function too.
For further insights and a full copy of the claims briefing visit www.libertygts.com/claims.
