Although the surge in M&A activity during 2021 subsided, the deal market continued to be highly active, with M&A volumes and values in 2022 aligning with pre-pandemic levels, according to a new report from Howden M&A.
The same report noted that the notification rate for warranty & indemnity (W&I) insurance increased slightly to 9% in 2022 from 7% in 2021. Considering the long-tail nature of claims, this rate may also rise further in the next 12 to 24 months, as notifications from the M&A surge of 2021 come to fruition.
“As we enter a period of greater economic uncertainty, we expect more opportunities for deal makers to take advantage of current market conditions,” said Daniel Stock, managing director at Howden M&A. “With such opportunities comes a different set of challenges. The value of M&A insurance is clearer than ever in protecting buyers for undisclosed risk that goes to value.”
Analysing key trends across the UK and Europe, Howden’s annual M&A Insurance Claims Report identified a continuous increase in the average time elapsed between policy inception and notification.
In 2022, only 15% of notifications were reported within six months of the policy’s inception, marking a significant decrease from 25% in 2021. Moreover, 26% of notifications were made more than two years after policy inception, up from 13% in 2021, reflecting a sharp rise in unforeseeable third-party claims.
In fact, the report discovered that the majority (80%) of notifications made two years or more after policy inception were third-party claims, with most related to tax audits.
It also found that W&I insurance is increasingly being used for smaller M&A deals.
According to the report, while the notification rate for larger deals is anticipated to remain relatively stable, smaller deals have seen a significant increase in notifications. For deals worth €50 million or less, the notification rate was found to sit at approximately 10%, not far from the average rate of 9% across all deals.
Furthermore, the complexity of deals was found to have played a significant role in driving notification rates across various asset classes and sectors.
Real estate deals had a lower notification rate of 5%, while operational company deals had a higher rate of 13% due to the complexity of their customer contracts, supply chains, plant and machinery, and intellectual property.
Meanwhile, notifications in the financial and professional services sector remained stable at 17%, while education sector notifications increased from zero in 2021 to over 15% in 2022 due to the significant increase in deal volumes.
By contrast, notifications from hotels decreased from 14% in 2021 to just 2% in 2022, with tax issues being the main factor. Office deals also saw a significant decline from around 14% to under 5%.
As for breach events, tax issues were identified as the primary cause of warranty breaches for real estate in 2022, accounting for 35% of notifications, up from 16% in 2021. Most of these breaches were related to targets in the UK and Germany, indicating that tax authorities in those jurisdictions had intensified their actions.
Meanwhile, tax breaches in operational businesses declined from 21% to 11% in 2022 compared to 2021. Nonetheless, notifications related to compliance with laws surged from 4% to 18% of all notifications, with issues ranging from employment law violations to target products breaching applicable regulations and privacy law violations.
The report also identified a significant trend in the surge of full limit claims related to fraud.
According to Howden, this could be an early warning signal of an economic downturn, as all types of fraud escalate in this environment.
The rising level of fraud indicates that adequate insurance coverage is more critical than ever, the report added.
What are your thoughts on these M&A trends? Feel free to share your comments below.
