© Getty

About one is seven merger and acquisition deals leads to a dispute that results in an insurance claim, according to data from AIG. The company has for the first time released details of how M&A participants use insurance when transactions turn sour. 

Last year was a record one for M&A activity, with $4.6tn of deals, according to Dealogic. It included the two biggest months ever for global M&A volume. 

But along with the growing activity has come increasing concern about what happens if the asset being bought is not all it seems. AIG says sales of representation and warranty insurance, which covers either the buyer or the seller for problems discovered after a deal has completed, grew by 70 per cent last year. 

“Until three years ago R&W insurance was chugging along, but in the last three to five years it has got a foothold, especially in the UK and Australia. It has become a mainstream way of doing deals,” said Mary Duffy, global head of M&A insurance at AIG. 

Private equity groups have been particularly enthusiastic users of the policies. According to a report from insurance broker Marsh last year, private equity houses accounted for 61 per cent of policies placed in 2014. 

Three-quarters of the policies studied by AIG were taken out by the buyers in a deal: “If a buyer can offer better deal terms, which give the seller a cleaner exit, it gives them a competitive advantage,” said Ms Duffy. Sellers often have to hold back some of the deal proceeds to cover possible claims from the buyers. If the buyers have insurance to cover those claims, the deal can often proceed more smoothly.

AIG analysed R&W insurance policies on 1,000 deals worth more than $200bn completed between 2011 and 2014. Nearly 14 per cent of them resulted in a claim.

The most common reason for a claim was misrepresentations on financial statements. This takes many forms. “There can be seller fraud involving artificially inflated [earnings before interest, tax, depreciation and amortisation] through channel stuffing,” said Ms Duffy. “Other claims involve issues around inventory, where a significant proportion is obsolete or unsaleable.” Other common reasons for claims included tax, contracts and intellectual property. 

Although buyers are more likely to take out policies, sellers were more likely to put in a claim, with nearly one in five doing so. And larger deals — those worth more than $1bn — were more likely to result in a claim than smaller ones. 

Get alerts on Mergers & Acquisitions when a new story is published

Copyright The Financial Times Limited 2019. All rights reserved.
Reuse this content (opens in new window)

Follow the topics in this article