What a year 2020 has been. In almost every sense it has confounded expectations, from the sudden COVID-led deep-freeze of the US M&A market in March to the unexpected thaw this summer, which culminated in one of the strongest final quarters of the year for a decade. Forecasts for the M&A insurance market were written down by half and then doubled back up again, in a remarkable turn of events that may never been seen again in our business lifetime.
Not all of the turmoil in the market has been COVID-related. The US election added fuel to the deal fire as many firms rushed to complete deals pre-election, mindful of the potential for changes in regulation and/or government supervision that a new administration can bring about. Meanwhile, the tax uncertainty surrounding a potential regime change also had many companies looking to crystallise their tax liability exposures.
Looking to 2021
The key trend in the M&A insurance market for the coming 12 months is the impact of the withdrawal of a number of insurers from the market. While available underwriting capital in the market has grown steadily in recent years and increased competition has lowered prices and widened terms and conditions, the recent sharp rise in claims is now causing a contraction in capacity. As weaker players disappear, it is likely that terms for insurance contracts will become more stringent, and pricing will rise; I believe by as much as 25%-30% in 2021.
This will mean that those underwriting in 2021 will enforce greater discipline in how they look at risk. For example, the pressures of COVID-19 and “stay in place” orders have meant that some key aspects of due diligence – inventory control for example – have been much harder to complete accurately. This has been exacerbated by the fact that the time for due diligence been compressed, sometimes by over half, in the rush to get deals done.
In a difficult year for all parties, insurers have initially stepped up to bridge the gap by paying claims but their attitudes are beginning to change, and many are remembering the mantra: ‘we are not here to replace due diligence’. We believe that one of the features of the M&A market in the US in 2021 will be the closing of that loophole in M&A policies. As a result, buyers will have to either assume some of the risk themselves or do better due diligence.
M&A will continue at pace in 2021
Although the deal flow in 2021 is likely to be down from this year, there will undoubtedly still be considerable activity. Whilst no one wants a global recession, one could lead to a rising number of distressed asset sales in some obvious sectors – leisure, hospitality, retail for example. Pricing for companies looks set to remain subdued, with lower multiples already the norm, and a need to reorganize driving many deals rather than a rush to take profits.
However, there is a big ‘but’ here. In times of uncertainty, buyers like to know where their “floor price” for the deal is and sellers want the comfort of having divested themselves of historical liabilities, so there is an increased incentive to insure the deal, creating certainty and closure for both sides. As a result, at Liberty GTS, we expect the number of insured deals will increase as a percentage of the whole.
With post-deal insurance claims in mind, I also very much hope to see a slower pace for deals in 2021, with less desperation on timing, allowing due diligence to be done more thoroughly.
If these two things can be achieved, 2021 should bring more stability and predictability to the M&A insurance market, with pricing more rational and better protection wrapped around deals via appropriate insurance cover. Let’s hope nothing in the order of the COVID pandemic occurs to disrupt that again in the coming year.