Transactional risk insurance continued its rise in popularity in 2022 to become a global, mainstream feature on mergers and acquisitions (M&A).
Despite macroeconomic and geopolitical challenges, demand for transactional insurance remained resilient in 2022, according to Marsh’s latest report on the line of business. Insureds continued to seek deal protection through representations and warranties (R&W) insurance, as referred to in the U.S. and Canada, on transactions, increasingly supplemented by the use of tax and contingent liability insurance.
Looking at North America
Demand for transactional risk insurance in North America remained strong in 2022, although multiple challenges contributed to a 38 percent decrease in aggregate deal volume in the region compared to 2021.
Marsh’s North America team placed 1,007 transactional risk policies — primary and excess — on 608 unique transactions – an increase of 4 percent over 2020 but a decrease of 39 percent from 2021. These policies represented $19 billion, in U.S. dollars, in limits — similar to the aggregate limits placed by the team in 2019 and 2020.
Marsh’s deal activity remained relatively consistent throughout the year, with roughly 250 policies each quarter. U.S. M&A activity dropped in the final quarter of 2022 compared with 2020 and 2021. The correlation between Marsh’s results and M&A activity in the region demonstrates the enduring role of transactional risk insurance in the deal-making environment in North America.
R&W insurance pricing normalizes after the 2021 surge
The 2021 pricing surge peaked in January 2022, said the broker. Since then, pricing on primary layer R&W insurance decreased dramatically in North America, falling more than 200 basis points. Despite this drop, North America pricing remains higher than other regions.
Marsh said its portfolio experienced its highest primary layer R&W insurance rates in a generation, reaching 5.7 percent for deals bound in January 2023. As the deal-making environment softened, so did R&W insurance rates, dropping each quarter in 2022.
The insured-friendly rate environment is expected to continue in the short to medium term, Marsh added. Many of 2022’s macroeconomic headwinds are also evident this year, with ample underwriting capacity bolstered by new transactional risk market entrants joining an already crowded underwriter landscape.
Consistent utilization of insurance across all transaction sizes and sectors
In 2022, for the first time in Marsh’s experience, corporate and strategic buyers represented a majority of insureds in programs placed by Marsh, purchasing about 52 percent of all policies. Private equity firms continued to be active users of the products, purchasing the remaining 48 percent.
The decrease in median and average transaction size in the transactional risk market mirrored the North American M&A universe more broadly. For Marsh’s North American portfolio:
- The median transaction size retreated to $126 million in 2022, down from $150 million in 2021 and $130 million in 2020.
- The average transaction size decreased to $304 million, down from $405 million in 2021.
- Financing challenges led to a pronounced decrease in the number of deals of more than $1 billion in enterprise value completed in the region compared to the prior year.
- Marsh saw consistent utilization of transactional risk insurance and even distribution of policies across all transaction sizes, with no size tranche representing more than 26 percent of the overall portfolio.
According to Refinitiv, an LSEG business in the U.S., communications, media and technology (CMT), manufacturing and healthcare were the top industries in transactional risk placements in the U.S. and Canada. The top five industry sectors occupied identical rankings in 2022 and 2021.
Deductibles remain stable
Deductibles held steady at approximately 1 percent of enterprise value for most transactions in the middle market, with a dropdown feature to 0.5 percent of enterprise value 12 months after closing.
For transactions with enterprise values of $300 million or more, it is common for the deductible to be 0.75 percent of enterprise value. That figure can be lowered further on transactions with an enterprise value of more than $2 billion.
Total tax insurance policies bound by Marsh’s North America team in 2022 were up slightly from 2021, fueled by growth in renewable energy placements and on balance sheet risk policies. Overall, premium rates for tax insurance policies were relatively flat compared to 2021, with primary rates settling at or below 3 percent by the end of 2022.
Coverage for investment tax credit projects remained in high demand throughout the year. The Inflation Reduction Act of 2022 created or enhanced several renewable energy credits, which should increase demand for tax insurance for these types of projects.
Tax insurance policies placed to allow corporates and pass-through businesses to manage balance sheet tax risks also grew in 2022. Asset managers and family offices remained a growth area for tax insurance.
In 2022, there were 178 R&W claims arising from 115 transactions, an increase over 2021 but falling short of the peak numbers in 2020 with 255 claims and 131 transactions.
The number of claims should continue to rise throughout 2023 due to an increased volume in the last few years and the delay between closing a transaction and reporting a claim, Marsh reported.
The most claimed breaches in 2022 were consistent with previous years, with more than half related to compliance with laws (20 percent), financial statements (16 percent) or taxes (16 percent). However, insureds generally took longer to report claims in 2022 than in past years, with only 46 percent reporting within 12 months of a deal closing.
R&W insurers paid over $180 million on claims reported by Marsh clients (representing over $245 million in recognized losses). Nearly 85 percent of the payments arose from claims relating to financial statements, material contracts and compliance with law breaches.
Outlook for 2023
Dealmakers predict a rebound in M&A activity levels in North America in the second half of 2023, with expectations for the return of a more favorable financing market, coupled with private equity firms in the region sitting on more “dry powder” than ever before.
Transactional risk insurance is expected to remain a key component of deals in North America, with insurers expanding their underwriting appetite to meet client demand. In the short term, the robust number of insurers pursuing a limited number of transactions will likely contribute to a relatively soft rate environment with the potential for some hardening in the second half of the year, assuming that M&A activity accelerates as currently anticipated.