2023 was clearly a challenging year for anyone whose living is based on the volume of M&A transactions. High interest rates in most global economies have reduced the viability of many PE plays, and this has impacted the number of deals and transactions everywhere.
While this environment was the status quo from long before the beginning of 2023, what was not understood was how long these conditions would linger. The recovery in M&A that all sides had thought we might see by Q4 2023 failed to transpire, and M&A transaction volumes remain flat. Further, these market conditions look set to continue for at least the first half of this year, a situation that is particularly unattractive to the ears of well-staffed M&A insurance teams; buoyed up by years of high deal volumes and growth in this particular insurance sector.
The news is still worse for the many small MGAs who have launched into the M&A sector. Those without deep pockets and diversified lines of business will be suffering lean times, and we may, quite possibly, see some contraction in capacity as a result. Make no mistake, these are tough times for many M&A insurance specialists.
However, the situation does have some upside for those who can offer specialist products other than Reps and Warranties/Warranty and Indemnity insurance to company owners who wish to release capital or return cash to shareholders. When disposals or organic growth through acquisition are not viable ways to do this, companies and their advisors turn to more creative (and legitimate) solutions to clean up and improve their balance sheet performance.
The year of the creative
As a result, the story of 2023 has been the growth of the niche product. Contingent Legal Risks Insurance and Tax Insurance have both grown much more rapidly than expected. Brokers have focused on new ways to support boards and investors. These have included neutralising or replacing tax liabilities through specific insurance solutions. They have also included buying insurances that collateralise court judgments and crystallise them within a protective insurance cover that indemnifies the business and allows them to free up cash, or borrow more to grow prior to final adjudication and settlement of the judgment.
Ultimately, many businesses are looking towards the growth phase of the economic cycle and are hungry to invest, in order to generate cash and deliver back to their shareholders. Insurance that allow them to do this are attractive if they find themselves trapped without access to any kind of restructuring deal.
So the picture of the year has been mixed. Certain parts of our niche market have boomed, with growth in products that are uncorrelated to the market cycle. However, for ‘vanilla’ reps and warranty products, this has been a contracting year, and we have seen reduced premium across the market.
I like to call 2023 the ‘creative’ year. The malaise in M&A has led to inventive investment bankers thinking outside the box. They have had to use new tools to deliver value, and they have, increasingly done so. In the long term this is good news. Once investment banking and specialist broking teams use these products, they will retain them in their toolkits. Even when M&A volumes return, we are unlikely to see contraction in these new products, simply because the more they are used, the more users realise how useful they are.
With this in mind, at Liberty GTS we are confident that these products are here to stay and are looking to invest and expand the team globally. We have just hired our first dedicated team member in Asia on the contingent side and have hired a second tax underwriter in Singapore, giving us the largest underwriting team in Asia. Although it has been a mixed year, there are still pockets of creativity and optimism while we wait for the green shoots of recovery in global M&A volumes.
New specialist insurances will support business restructuring after insolvency
One positive that will benefit insurers who have the right underwriting teams and products, is continued high demand by management teams for specialist contingent and tax insurance products, particularly within insolvency situations. We have seen a rise in insolvencies following COVID (and subsequently) as the cost of borrowing has risen. Insolvency practitioners and restructuring experts are increasingly making use of insurances to protect themselves and enable earlier distribution of insolvent company funds.
Meanwhile, there are also specialist policies being sold to provide warranty protections for situations where management want to re-launch parts of a failed business. Buying an insurance policy can free them up to do this without having to worry about the liabilities that may emerge from the prior business structure – the insurance they buy will cover this. Some brokers have recently been making headway with the proposal that the cost of insurance is part of the price dynamic in this situation. As demand for this grows, I think that may fuel some growth in reps & warranties cover in 2024.
M&A deal prices will be lower
The M&A deals that do get done next year will see deal multiples that are considerably lower than in 2022. Given the extreme change in most business’s trading environments, insurers will pay close attention to pricing dynamics and valuation of assets; particularly intangible assets. Not only may valuations of assets change rapidly in a tricky market, but there is also a heightened risk of fraud, one that we are already seeing playing out in our claims basket for 2023. In the worst cases there is a risk that the management can be fraudulent; but in the medium case willful blindness can also be a real problem for insurers and buyers alike.
Smart underwriting teams must navigate global trends.
The market overall for M&A insurance is likely to be tepid for much of 2024. However, there are some possible bright patches. Asia has been something of a hot spot for M&A recently, and insurers have flocked there to take advantage of it. For me this will be a market to watch in 2024, and it could go either way. I question whether there is enough activity in the market to nourish all the new entrants. My bet is that there could be a rather rapid contraction of the Asian M&A market, leaving only the really experienced in control.
Overall, 2024 will be a tough year, but creative thinking and smart underwriting management will see a raft of survivors – and perhaps more than a few losers – as the year plays out.
