As the spread of COVID-19 accelerates, and as governments ramp up their response to increasing cases of COVID-19, every sector is assessing the impact of the novel COVID-19 virus on their business. Here, we consider how COVID-19 might impact the warranty and indemnity insurance market and what considerations may come into play for operators in this space.
Impact on Transaction Volumes
The W&I market has seen tremendous expansion in recent years, with an ever increasing proportion of M&A deals utilising W&I insurance as a tool to mitigate risk. However, the increase in absolute numbers of policies written is contingent on an active M&A market.
“Whilst most deals that have already been at an advanced stage as the sense of crisis has mounted have stayed on track, transactions at an earlier stage are generally being put on hold. We expect to see immediate reductions in M&A activity in sectors directly affected, such as retail and travel, but also where businesses are dependent on supply chains to affected areas, and M&A in other markets are expected to be at reduced levels due to the availability of funding on commercially reasonable terms or at all,” explains Rebecca Bothamley, a Partner in Mayer Brown’s Corporate and Securities team in London.
Given the significant increases in capacity in the W&I market, this will inevitably mean more underwriters chasing fewer deals. As a result, we expect the trend for a steady reduction in premiums to continue, or even accelerate, as the crisis unfolds. However, given the potentially increased claims risk, which we discuss below, we also expect that underwriters will resist further loosening of policy terms and conditions.
Underwriters will be actively re-reviewing the warranties in ongoing deals as the COVID-19 situation develops, as government advice and restrictions change across the globe, to assess the potential change in risk profile of a transaction.
The most obvious area of risk is, of course, warranties relating to target’s business continuity measures, but given the tremendous practical and economic disruption to business, trade and supply chains, we see increased risk in underwriting material contracts warranties as they relate to both suppliers and customers. There has been much comment by business and politicians around the response of business interruption and other insurance, or lack thereof, and so particular care will need to be taken around the wording of warranties relating to adequacy of insurance arrangements. Around all of these issues, we anticipate that underwriters will be taking an even closer look at the due diligence that has been carried out by prospective insureds.
Will underwriters look to introduce COVID-19 exclusions? Events are moving apace, and governments may be forced to take actions not contemplated as deals sign and as policies go on risk. Where there is a split signing and completion, with warranties restated at completion, there is a danger that warranties that could comfortably be given at signing get overtaken by events, giving rise to breaches at completion, particularly where there is no provision in the purchase agreement for further disclosures to be made. We may also see specific COVID-19 related warranties, which buyers can use as a helpful tool to flush out disclosure.
If insurers do not wish to pick up the risk of COVID-19 related disruption in their W&I book, exclusions may be an effective tool, but, as ever, these need to be carefully drafted to properly reflect the risk insurers are comfortable to assume.
Claims arising directly from COVID-19 may ultimately be rare: the nature of warranties is that they are given as at the time of signing and, going forward, we expect risks arising from COVID-19 to be the subject of careful disclosure and diligence. However, we do expect COVID-19 to impact on the overall volume of claims in the market.
“What seemed like a good purchase 12 or 18 months ago might not be so good in hindsight,” explains Jane Childs, a Partner in Mayer Brown’s London Insurance team. “Purchases that are not now performing so well in light of the economic impact of the coronavirus will no doubt result in buyers looking to recover losses however they can, and they will be paying particular attention to their W&I policies and whether there are any breaches of warranty that could allow them to make a recovery.”
Over the coming months, therefore, we anticipate an increase in claims activity, particularly in those sectors most affected by COVID-19, including retail and travel.