Woodruff Sawyer is a market leader in private equity, venture capital, and transaction risk advisory services. We have been working with private equity and venture capital firms at the fund level for over 25 years. Fund-level insurance is intrinsic to our DNA.
Across our client base of 350+ funds in the United States, a wide variety of issues are fundamentally reshaping how GPs, CFOs, COOs, and GCs view and consider risk pertaining to the funds. The first portion of our 2021 Private Equity and Transactional Risk Trend Report offers an in-depth analysis of the current trends and how funds can adequately prepare themselves as we move into 2021. This year, we’ve also expanded our research and analysis with survey results from some of the largest insurers underwriting General Partnership Liability (GPL) programs at both the primary and excess layers.
On the transaction side, our M&A advisory team consults and advises on over 150+ transactions per year, ranging from growth equity deals, strategic acquisitions, traditional private equity buyouts, and SPAC transactions. The second portion of our 2021 Trend Report focuses on trends and projections in the Representations and Warranties Insurance (RWI) space and includes a general market update, claims analysis, and the influx of SPAC deals and how RWI solutions are impacting that new and evolving deal mechanism.
Top Trends: General Partnership Liability and Transactional Risk
A Perfect Storm in General Partnership Liability
In 2020, we identified several trends that have continued to develop throughout the year—namely how the GPL market is hardening and will continue to do so for the foreseeable future. We believe this hardening of rates, terms, and conditions will continue over the next 12–18 months.
Chief among the reasons for the hardening market is the overall need to right the ship in terms of pricing and structure of GPL programs. Over the past several years, pricing has been dropping to a point that is not sustainable. Add to this the billions of capital flowing into the private equity and venture capital community and the effects of COVID-19 on underlying portfolios, and a perfect storm scenario is quickly developing. However, there are several ways to mitigate the effects of a changing GPL landscape. As General Partners, investors, and BoD seat occupiers are increasingly held responsible and accountable for incidents not only within the funds themselves, but also downstream at the portfolio companies, we recommend performing a comprehensive review of any fund-level insurance programs in place heading into 2021.
Transactional Risk is on the Rise
COVID-19 has affected the R&W market as it has everything else, and we’ve seen different underwriters react in very different ways. Over time, this has evolved to where we now have the ability to underwrite the risk on many transactions with limited or no exclusions. The other major trend we have seen is the increase in SPACs and their use of R&W to help them move fast and protect themselves. Going forward, we expect to see greater use of this product for the distressed sales that are sadly coming, as well as increased use of contingent liability and tax products. The market continues to seek new ways to help deals get done in creative ways.
Market Update: General Partnership Liability
Given the hardening market conditions in the GPL insurance marketplace and differences in underwriting guidelines and processes at each of the major insurers, private equity and venture capital CFOs, COOs, and controllers would be wise to perform a comprehensive review of the fund-level coverage terms, conditions, and pricing heading into 2021.
Broadly speaking, a GPL program includes fund-level directors and officers liability, employment practices liability, professional liability, and outside directorship liability. Across Woodruff Sawyer’s client base of over 350+ fund-level clients and in working alongside underwriters across the United States, we are seeing a variety of trends developing. While the PE landscape is a bit ahead of their VC counterparts in terms of uncertainty and need for rate, we believe these trends hold true for both investment vehicles.
Top 5 Trends:
- Geographic Discrepancies
- Increasing Rates, Decreasing Capacity, and Retention Rebalancing
- Portfolio Company-Centric Underwriting
- Claims Uptick
- COVID-19 Coverage Updates, Bankruptcies, and Outside Directorship Liability Risks
What Private Equity and Venture Capital Fund CFOs Should Expect in 2021
As we move into 2021, we anticipate that the GPL insurance marketplace will continue to harden. Depending on geography, we believe rates will increase, retentions will remain constant or increase, and insurers will continue to limit their capacity at both the primary and excess layers. We believe there will be a much more focused approach to portfolio company underwriting, and additional information will likely be required to underwrite the same risks that did not need that level of detail previously.
For limits less than $5 million and funds with less than $100.0 million assets under management (AUM), we continue to expect appetite to be low. Fund managers should expect minimum retentions of $150,000, with the market largely heading towards $250,000 and minimum premiums of $25,000–$30,000 per million of coverage.
Above $5 million, we believe the marketplace will move more towards the $500,000 retention, with the potential for $250,000 with no claims. A key driver of retention negotiation will be the structure of the fund. VC firms will not experience as significant of an increase as their PE leveraged-buyout counterparts, largely driven by the bankruptcy concerns noted above from overleveraging the portfolio companies.
As fund managers and general partners approach 2021, we would highly recommend a comprehensive review of any and all fund-level insurance coverage in place. There are myriad ways to structure and approach a GPL program in terms of manuscript endorsements, coverage enhancements, etc. As the marketplace continues to harden across the country, a review and benchmarking analysis of current coverage and expectations for the upcoming renewal will only benefit the fund and GPs.
General Partnership Underwriters Survey Results
As part of our comprehensive approach to client advocacy, a good broker will listen to their insurer and underwriter partners to better understand their view of the world, including their current appetite for risk. The Woodruff Sawyer Private Equity and Venture Capital Practice is in conversation with the top GPL insurers every day.
This year, we’ve expanded our market analysis and trending to include a survey of 22 insurance partners with whom we place fund-level GPL insurance around the United States. We asked questions regarding the current risk environment, fund size specialization, future retention and pricing expectations, and differences in approach to primary versus excess layers of coverage. Our survey includes responses from top GPL insurers including: CNA, Chubb, Travelers, AIG, CV Starr, Great American, The Hartford, QBE, Argo, and Sompo, among others.
Market Update: Representations and Warranties Insurance
It has been a disruptive year to say the least, and M&A deals are no exception. COVID-19’s impact on transactional insurance like representations and warranties is coming into clearer focus, but continues to evolve—as are mergers and acquisitions.
The good news is that we are starting to see more deals and the exclusions in reps and warranties policies are becoming more specific (rather than the broad COVID-19 exclusions we saw earlier this year).
Pricing for coverage has remained fairly constant and we’re seeing a slight trend towards minority investments, which comes with specific considerations for reps and warranties coverage.
Do Reps and Warranties Policies Actually Pay Claims?
The representations and warranties insurance (RWI) product has become ubiquitous in the M&A world. Over 75% of deals done by private equity firms now use RWI and that number is around 50% for deals done by strategic buyers. The reps and warranties insurance policy, if properly negotiated, brings with it several benefits. Some of these include, among many others, the deal parties’ ability to eliminate escrows, to structure the deal with a minimal or zero seller indemnity, and to shift the risk of a breach of the seller’s reps from the deal parties to a AAA-rated insurer. But the logical question that follows is: Do these policies actually pay claims?
The answer seems to be yes. In an August 2020 published survey conducted by Lowenstein Sandler, 87% of survey respondents said that at least a partial payment was negotiated for all reps and warranties claims that exceeded the self-insured retention. The survey respondents, however, noted that a large percentage of the claims resulted in a loss that fell entirely within the retention amount set in the policy. This outcome likely had some buyers questioning the usefulness of the RWI policy, at least in relation to run-of-the-mill losses. Like for any other product on the market, the utility of the RWI policy must be considered in relation to its pricing.
More SPACs are Using R&W Insurance
The SPAC market exploded in 2020. SPACs (Special Purpose Acquisition Companies) are formed to raise capital through an IPO and to use that capital to acquire and operate a business. Over the last few months, SPACs have been increasingly considered an alternative and safer investment vehicle and, as a result, have seen a huge increase in investor interest in this year’s volatile market. As a result, SPACs have taken up a large chunk of the overall 2020 IPO market by both deal count and deal size (around 45%) and are now culminating in larger, often multi-billion-dollar M&A transactions. Some of the recent large ($700 million+) SPAC IPOs include those completed by Churchill Capital Corp. III and IV, Pershing Square Tontine Holdings, Ltd., Artius Acquisition Inc., and Social Capital Hedosophia Holdings Corp. III.
Why SPACs Need to Consider R&W Insurance
Many of the current SPACs are also sponsored by private equity firms. As a result of the influx of the private equity firms into the SPAC market and the SPACs’ overall increase in size and sophistication, more and more SPAC teams are exploring the use of R&W insurance for their business combinations. The main benefits of the use of R&W insurance for SPACs include the ability to:
- Execute deals with limited or zero seller indemnity
- Reduce the time spent on representations and indemnity negotiations, especially when a SPAC is coming up on its business combination deadline (typically 18–24 months after IPO)
- More effectively compete with PE firms who are using R&W insurance to sweeten the deal for a popular target
- Eliminate the need to file breach claims against the SPAC’s new management team inherited from the target entity
- Have the insurer serve as an extra set of eyes on the diligence during the acquisition in order to highlight any potential risks not picked up by the SPAC’s diligence team
- Protect the SPAC from seller fraud (e.g. Modern Media’s acquisition of Akazoo)
- Enhance the SPAC team’s reputation through good corporate governance and reduced risk of failure
For more in-depth information on these trends and what you need to know in M&A for 2021, download the complete 2021 Trend Report.
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