While the quality of assets, financing challenges and global geopolitical issues continue to impair the economic landscape, we are still witnessing high deal volumes. Like the majority of 2023, the market remains dominated by smaller transactions (see below) that have been less affected by the aforementioned headwinds.
The last few weeks have shown a noticeable increase in enquiry volume for larger processes due to launch in Q4 2023. This aligns with the sentiment from our M&A dealmaker clients, who are cautiously optimistic of a return to a more typical M&A market in 2024, with many mid-market deals in the pipeline.
Recently, we have seen increasingly granular vendor due diligence, as sellers have to work harder to strike a deal with potential buyers. Confirming the scope and detail of top-up buy-side due diligence (DD) with the Paragon team remains crucial, to ensure broad cover and allow such buyers to move at speed. Whilst vendor diligence can be helpful, insurers continue to see independent and robust buy-side analysis as essential for the purposes of underwriting any transaction. As activity picks up, insurers (plagued by claims from 2021 / 2022) will expect the same detailed DD to remain, as light-touch work was often the cause of said claims.
- Sub £25m/SME Transactions: We have been kept increasingly busy this year with instructions on SME transactions. While platform acquisitions remain relatively rare we have seen an uptick in buy and build strategies being deployed by our fund clients. We’ve also seen a significant increase in corporate clients using M&A to bring the supply chain in-house, with lenders seeming more willing to back transactions that have an immediate impact on margins.
- This is the area where we’ve seen the greatest amount of progression and innovation in the M&A insurance space. This is with a small bracket of insurers offering lower costs (which can be as low as £25k including fees), complexity of process and time commitment compared to ‘traditional’ underwriter processes.
- These more streamlined processes do not require underwriting calls (removing the associated time and costs), have fewer underwriting questions and the more SME-focussed underwriters take a more commercial approach without compromising on cover. As we mentioned in a previous update, this is having an impact on the broader W&I market, with underwriters historically focussed on larger transactions having to adapt their approach. That said, the nuances of SME transactions, principally the sensitivity to cost and the impact this can have on DD, means that specialist underwriters who recognise that internal DD can be just as sufficient and granular as external DD. They remain best placed to support clients on such transactions.
- There has also been a renaissance in sell-side policies on small deals, the clear advantage being that underwriters do not require access to buy-side DD. Instead they rely upon direct access to the sell-side / management team to address underwriting questions.
There has been a lot of incorrect speculation in the M&A deal sphere about the prevalence of insuring public to private transactions. The Paragon M&A team has worked on several of these transactions over the years. Whilst they are a tall order, P2PS can be insured providing the parameters of a deal line up in terms of the structure, timing, warranty provider and the suite of warranties. From experience, these parameters have proved more aligned in Australia, France and Eastern Europe, rather than in the UK. This is due to the current regulatory landscape in the UK meaning insuring P2Ps will remain, for the time being, unworkable.
The slowdown in deal activity, coupled with ongoing insurer competition (noting that there have been several new entrants to the market in 2023 with others expected in 2024) has meant that pricing has continued to drop since our last quarterly update. Despite the continued rise of claim frequency and severity, ballpark rates (premium expressed as % of limit) are hovering around 0.8 – 0.9% for operational businesses and 0.45 – 0.55% for asset heavy infrastructure/real estate transactions. Multi-national transactions continue to represent the majority of our engagements and, whilst rates are slightly higher at c. 0.9 – 1.3 % for operational businesses, significant competition between insurers has meant the pricing has remained low (often unpredictably so). As claims continue to bite and deal flow picks up we expect pricing to stabilise over the next 6 months, with more established underwriters increasing rates in the medium-term.
For the last three years, policy retentions – being the amount of loss which the insured must suffer prior to receiving a policy pay-out – have dropped alongside pricing. 0.25% of EV seems to be the new standard and whereas 6 months ago a tipping to nil structure at this level was uncommon, we are now seeing multiple underwriters offer this. A tipping retention, unlike a traditional fixed retention, enables the insured to claim for the full amount of loss, once the retention has been eroded and not just the amount in excess. This enhanced position comes at an additional cost but is something we recommend our clients opt for where available to them. The competition for transactions, due to both reduced deal flow and new market entrants, means these lower / tipping retentions are not having an impact on coverage or underwriting processes. Underwriters seem to be taking sufficient comfort from the policy de minimis currently.
While the Italian economy exhibited slightly more robust GDP growth in the initial quarter of 2023, compared to fellow EU nations, macroeconomic variables like inflation, the burden of debt, exchange rate fluctuations, and others played a significant role in shaping the investment strategies of financial institutions. These factors compelled private equity funds to direct their attention toward sectors that displayed resilience or growth prospects. These sectors included the transition towards renewable energy, digital transformation, pharmaceuticals and healthcare. The small to mid-sized M&A market turned out to be more resilient than the large-cap segment.
Consistent with trends observed in various jurisdictions, premium pricing in Italy has undergone a notable decrease across all sectors. Specifically, rates now commence at 1.2% for operational business transactions and 0.6% for real estate deals. Additionally, retention rates have hit record lows, initiating at 0.25% of the target company’s enterprise value when using fixed amounts. It’s worth noting that a cluster of insurers have also started offering a tipping to nil retention option for operational deals. This approach marks a departure from the traditional practice of utilizing fixed retentions on operational deals.
Our Claims team continue to see a rise in terms of frequency and severity of claims and there are now several large claims progressing through the European insurance market, alongside high profile claims in the US (https://www.ft.com/content/359ad3a1-7c94-403b-8caa-0134a0443d1c). Whilst claims under these policies remain relatively low compared to other types of insurance the traditional 10% of EV limit opted for is looking increasingly inadequate.
Tax Risk Policies
Alongside the W&I market, the contingent tax insurance market has also experienced a similar slow-down. While there are some (very) large tax risks being insured in the market, these are few and far between. Most of the enquiries we are seeing are in the SME space which presents some challenges in terms of the extent and quality of tax analysis which is available to support the risk. However, given the quieter market, we have seen insurers taking a more commercial approach to assessing tax risks and the continued competition has kept the pricing low at 1.5%-2.5% ROL for most risks (subject to minimum premium levels).
Contingent Risk Policies
We continue to see demand soaring for these policies, especially from the US, in light of increased scrutiny in DD processes, with buyers pushing back on known risks to sellers and insurance being used to bridge the gap between them. Insurers continue to bolster their teams with an increasing number of former litigators bringing know-how, experience and understanding to enable those insurers to widen their risk appetite to areas outside the transactional sphere and reduce cost.
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