A View From Me on for ’23 – Despite choppy waters ahead, there are reasons for optimism for W&I insurers

Tom Bourne, and John Kirkwood, partners at law firm Cripps believe the warranty and indemnity market can find opportunities despite the ongoing issues with the global economy.

After a turbulent few years, the expectation was that 2022 would be the year to re-build after the stormy waters of the COVID pandemic, but those businesses expecting plain sailing had to quickly set a new course to navigate what has been yet-another challenging year.  So as 2022 draws to a close, it is important to consider the emerging trends, risks and opportunities that lie ahead in the M&A market and the opportunities this presents to Warranty and Indemnity (W&I) insurers in this sector.

Despite the well documented challenges in 2022 and the ‘COVID hangover’ that remains, especially for sectors that are reliant on imports from China, the M&A market in the UK continues to perform strongly.  To many this may seem counter-intuitive, but the impact of flat economic growth has to some extent been counter-balanced by a weak pound making the UK an attractive place for international investors.  There will also be the inevitable ‘fire sales’ for businesses looking to divest under-performing parts of their business or arising out of insolvency processes if the worst does come to the worst.  History has also shown us that turbulent trading conditions can present opportunities to businesses who are looking to out-perform a flat economy by targeting growth through mergers / acquisitions.

Experience also tells us that sellers perceive there to be greater risk in uncertain economic times and we are increasingly asked, and recommend clients, to consider W&I insurance to help de-risk transactions.  Increased competition in the W&I market in recent years has seen the cost of premiums fall and the scope of coverage increase, making this a significantly more cost-effective solution to mid-to-lower tier transactions than it once was.  But does a tough economic outlook increase the risk profile for an insurer?

From the W&I insurers point of view, the warranties / indemnities that are typically entered into as part of a sale are fixed in time, therefore the theoretical (legal) risk-profile of the claim should remain constant, notwithstanding external economic factors post-transaction.  A warranty is either true or not at the time it is given and the future performance of the company should not impact on the merits of a claim for breach of warranty.  Moreover, by going down the W&I route the parties will be forced to ensure that a full due diligence exercise is undertaken, often on a more detailed basis than if the sellers were standing fully behind the warranties.

Otherwise, without a full set of due diligence reports from reputable legal/tax/finance (or other due diligence) providers, the scope of coverage on offer will likely be reduced, or the premium hiked to price in the increased risk.  Carrying out such an extensive review will also increase the chance of any significant issues being identified pre-signing, which can then be factored into the deal terms, rather than ending up as a claim against the W&I insurer.

Therefore, while we expect to see the upward trend in W&I coverage for lower/mid-market transactions continue in 2023, the legal risk of a claim should not be materially affected by the general economic conditions and this may present new opportunities to existing W&I insurers, or other providers who are looking to get into this growing sector.  Increased competition is also likely to drive premiums lower, which in turn will make W&I insurance more cost-effective and open up the market to an increasing range of transactions.