Share the Insights:
Transaction Liability Insurance Claims Study:
An update on claims activity in North America and EMEA during an unprecedented year
Download the report
Foreword
Highlights
COVID-19 Impact
2020 Claim Frequency
Multiplied Damages
Other Claim Trends
EMEA Claim Trends
Foreword
Highlights
COVID-19 Impact
2020 Claim Frequency
Claim Payments
Other Claim Trends
EMEA Claim Trends
Foreword
In spite of market uncertainty throughout much of 2020, claims activity never truly slowed
Data Privacy
Legal
Cookie Notice
Contact Us
Aon.com
© Aon plc 2021. All rights reserved.
No part of this report may be reproduced, stored in a retrieval system, or transmitted in any way or by any means without the written permission of the copyright holder, application for which should be addressed to the copyright holder.
The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of their particular situation.
Any forecasts, estimates, projections, opinions or conclusions included in this document depend on macroeconomic conditions (including the COVID-19 pandemic) over which Aon has no control. They cannot not anticipate possible changes in conditions that could materially impact outcomes. This document is not intended to constitute advice or encouragement regarding the advisability of any investment or other strategy. Any person or business relying on any statement does so at that person’s or business’s own risk.
Aon is not a law firm nor does it provide legal advice. This article is based solely on Aon’s experience as insurance practitioners.
Aon recommends that you consult with your own legal counsel as respects the content of this article.
Download the report
Frequency by Type of Breach
Figure 4 illustrates the types of representations and warranties alleged to be breached most frequently when claims made in 2020 are taken into account (either individually or in connection with other alleged breaches): 18% of breaches reported during the study period related to inaccuracies in the financial statements, 13.5% arose from undisclosed liabilities, 13.3% related to non-compliance with laws or government regulations, 11.5% related to tax matters and 9.8% related to a breach of the material contracts representation.
Figure 4 also makes a comparison between the frequency with which each type of breach is cited in a notification against the total percentage of claim payments that are attributable to that breach. Perhaps not surprisingly, while financial statement misrepresentations account for 18% of all claim notifications, this type of breach received the largest percentage of the total claim payments made between 2013-2020 at 37%. Material contract breaches also comprised a high percentage of the total claim payments at 17% despite only counting for 9.8% of all claim notifications. Finally, compliance with laws breaches received the third highest percentage of total claim payments at 16%, which is also higher than the 13.3% of claim notifications citing this type of breach.
Frequency by Type of Breach
Timing for Discovery of a Breach
Click the heading to find out more
Financing Prospects
For 2021, it is not wholly surprising to find that more than 76% of respondents expect financing conditions over the next 12 months to be more challenging than they were in 2019, including 46% who expect them to be much more challenging.
The pre-pandemic financing environment already seems like a lifetime ago.
But financing prospects are looking up. After a punishing first half to 2020, equity and debt financing has eased in 2021 so far on the back of some positive news. The vaccine rollout has proved effective - increasing investor confidence and pointing to a brighter outlook for companies and their financing needs.
The pandemic has altered investors’ risk calculations, making them more selective in what sectors and companies they are willing to back – and at what price.
62% of respondents view PE and 44% consider non-bank lenders as the primary candidates, over debt capital markets, traditional bank lenders and cash reserves.
Sources of capital
Download the report
Download the report
Risk and Risk Mitigation
A risk landscape turned on its head
Risk mitigation strategies
Due diligence: An even higher priority
Specialized Diligence
Credit Risk
What we heard
A risk landscape turned on its head
Putting the COVID-19 pandemic to one side, numerous other downside variables have the potential to impact upon dealmakers and the M&A targets they are seeking out.
Difficulty in accessing deal financing is the primary concern, cited by 38% of respondents as among the top two impediments standing in their way
Tax Risk
Litigation Risk
Tax Risk
Unlike other risks that may be more visible, tax risk can be harder to predict since it is at the whim of political policy or other unforeseen circumstances. A forward-looking perspective is vital.
Litigation and Tax Risks
Business disruptions caused by the COVID-19 pandemic have elevated risk to investors pursuing M&A. The unpredictability of the external trading environment and its potential impact on a deal target’s employees, key vendors and customers places priority not only on deeper due diligence but also taking out R&W insurance.
“Getting a general idea about the taxation norms in any region is not enough. We have to delve into additional details that are relevant to the industry and uncover discrepancies in the information provided in good time. Use of technology has been vital to streamlining
this process and mitigating risks.”
- U.S. Director of Strategy and Corporate Development
The value of Technology and Technology Enablement
Intellectual Property Diligence and Insurance to increase with TMT activity
Risk Mitigation through R&W insurance
Deeper Due
Diligence
Trends for the year ahead
The year 2020 has been a defining moment for M&A markets, bookending a decade-plus run. Over this period, there has been a steady uptake in R&W cover and other M&A insurance policies. Despite market challenges, deal activity has demonstrated resilience and, so far, record deal figures have been recorded in 2021.
Resulting in higher relative levels of insurance as investors continue to grow accustomed to this vital risk mitigation and capital efficiency tool
Innovation has become the standard for insurers to find new approaches to protect against risks on the behalf of investors
Download the report
Download the report
Frequency by Type of Breach
Timing for Discovery of a Breach
Regulatory Headaches
While insurance is a valuable and necessary risk management tool, prevention is ultimately better than a cure.
Regulatory Headaches
“Sourcing and research teams are crucial in mitigating the litigation risks early on. Selecting the pool of targets and collecting background information is crucial to the process.”
- Head of M&A, German Corporation
Investors are highly aware of heightened litigation risk in M&A situations in the wake of the coronavirus pandemic and the sheer breadth of litigation risks can be overwhelming.
Litigation Risk
Litigation Risk
Regulatory Headaches
Tax Risk
Risks mitigation strategies
The heightened risk environment of 2020 and into 2021 forced investors to think smart and readjust their M&A strategies.
34% of our respondents participated in more minority deals and joint ventures and another 34% reduced the size of their deals
32% adopted distressed strategies to align with the deal environment
Risk mitigation strategies
Due diligence: An even higher priority
In these times of economic stress and uncertainty, deeper, more rigorous diligence is often warranted to triple test assumptions and ensure the fundamentals of the target business are as advertised.
An overwhelming majority of respondents - 96% - say they are dedicating more resources to due diligence because of current economic conditions
Understanding the likely performance of a given sector or sub-sector is as important as determining the company’s performance within that space
Due diligence: An even higher priority
Specialized Diligence
Diligence comes in various forms and our research indicates no one type takes absolute priority.
28% of investors are paying particularly close attention to operational due diligence, putting it ahead of all other types of due diligence
Commercial or market due diligence with 22% of respondents prioritizing and intellectual property due diligence with 20% are not far behind
Specialized Diligence
Credit Risk
The COVID-19 pandemic has unquestionably impacted companies’ credit risk. Businesses within sectors hit by the crisis, namely industries that rely on physical interaction and face-to-face working, have seen their revenues collapse in 2020 amid lockdown measures and the economic downturn.
Sturdy credits in industries such as technology and non-discretionary retail, which have demonstrated extreme resilience to the effects of the pandemic, are highly sought after among lending institutions and bond investors and should not have trouble tapping markets to raise cash
Highly exposed companies will have to pay high coupons in order to access debt, especially in high-risk periods if the pandemic continues to wax and wane
Credit Risk
What we heard
What we heard
A risk landscape turned on its head
52% of respondents say macroeconomic factors are among the top two risks over the coming 12 months and 36% cite tax as a one of two major risks
Risks that impact deal targets
Top risk mitigation strategies employed
Top risk mitigation strategies being considered
When looking forward, a greater number of respondents, 52%, indicate they will pursue more minority deals or joint ventures
26% are looking to reduce with another 26% looking to engage on more inwardly focused activity
“Adequate due diligence preparation is essential to mitigate any litigation risk. Not just the target’s performance, but the external factors and geopolitical risks should also be measured appropriately.”
- Managing Director, Chinese PE Firm
“Dealing with credit risk will be challenging because financing opportunities are also limited. To ensure that operations are functioning at par with expectations, capital investments are required. If this is not possible, it will affect goals”
- Managing Director, Canadian Investment Bank
“The unpredictable nature of the pandemic and its downstream effects on companies and their suppliers also make credit risk open to a greater degree of interpretation. Terms of the agreement and warranty discussions are taking longer to formulate. Credit risk will also depend on perception, as we see in the case of varied opinions during valuation discussions between buyers and sellers.”
- Managing Director, Australian Investment bank
“Because Covid-19 has been a massive shock to operations, relying on the company’s most recent financial data is of limited help in judging credit risk”
- M&A Group Director, French Corporation
“It is vital to evaluate the external climate and its effects on the target, without discounting the company’s actual potential”
- U.S. Private Equity Firm
A large majority of respondents, 80%, say litigation risk is more acute now than in the recent past
Antitrust
In our research we see that investors are primarily concerned with litigation connected to data protection and intellectual property antitrust issues
Labor Laws
With many companies under financial and operational stress in today’s environment, the potential for such issues to arise has increased. It is therefore important that investors pay close attention to what exactly their R&W insurance covers regarding labor representations and, if relevant, the target company’s IP
“We prefer emphasis on following the prescribed due diligence standards and timelines given the reputational damage that can be caused should a legal case be brought.”
- Head of M&A, U.S. Corporation
However deep diligence processes go, insurance will always be used as a last line of defense to protect acquirers in the event of a worst-case scenario materializing
The speed and severity with which the pandemic has buffeted companies has only increased the subjectivity of credit risk calculations
Weaker turnover and earnings in turn inhibit the ability of a company to repay its existing liabilities, increasing credit risk
The vast majority, 80%, of respondents say that tax risk is a more serious threat to deal success now than it was in the recent past
The greatest concerns identified in our research include increased rates, 34% and proliferation of anti-abuse rules, 26%
Tax insurance absolves this by transferring this unpredictable risk away from both parties and, like R&W insurance, means vendors can avoid holding capital in escrow, therefore improving their liquidity
6. How do you expect financing conditions over the next 12 months to compare to conditions in 2019?
7. What do you believe will emerge as the primary sources of financing over the next 12 months?
10. What are the biggest risks you foresee at potential M&A targets over the coming 12 months?
11. What steps have you taken to change your M&A strategy since the start of 2020?
12. Considering the current economic environment, are you dedicating more resources than in the past to due diligence processes when considering a transaction?
13. What steps do you envisage taking in the future?
14. Are you paying particularly close attention to any of the
following types of due diligence?
19. How much more acute is tax risk to deal success now as compared to the recent past?
17. What types of M&A litigation has your organization been involved in over the last 24 months?
20. Which of the following tax-related issues is of the greatest concern to you?
In 2020, Aon’s M&A and Transaction Solutions team in North America placed more than 725 representations and warranties, tax and contingent liability insurance policies, and helped clients navigate in excess of 150 claims – exceptional volume which has continued through the first half of 2021.
The size and scale of the Aon business makes Aon uniquely positioned to offer insight into current mergers and acquisition (M&A) and tax claims activity. In our 2020 study, we continue to focus on representations and warranties claims, examining trends that are emerging with respect to claim size and frequency on policies placed between 2013 and 2020 in North America. However, we also surveyed insurers in the representations and warranties space about their claims experiences and incorporated this further insight into our findings. Additionally, as part of this year’s study, we examined Aon’s tax and international claims data to provide an expanded view for our clients on what is happening in our other lines of business and in other jurisdictions around the world.
Last year was one that no one could have anticipated. At the start of the COVID-19 pandemic, there was an unprecedented global impact on the
M&A market which in turn affected the representations and warranties insurance business. While the uncertainty wrought by the pandemic led to many transactions initially being put on hold as they were re-evaluated or re-negotiated, the claims activity on representations and warranties policies never really slowed. In fact, consistent with the growth in the number of representations and warranties policies placed by Aon in 2018 and 2019, Aon saw a 23.5% increase in the number of claims filed in 2020 versus 2019. While this meant that insurers and their advisors were busier than ever, for the majority of the year we did not see a significant change in the claim process with respect to the investigation and analysis of claims, or the willingness of insurance carriers to pay claims.
Towards the end of 2020, however, we did begin to notice a shift in the approach that insurers and their consultants appeared to be taking in validating representations and warranties claims, taking more time to verify claim details and applying greater scrutiny around loss calculation. That said, despite the challenges that 2020 presented to the representations and warranties market, we continued to see many claims reach a successful resolution and result in fair claim payments.
Foreword
M&A 2021
Identifying opportunities
Financing Prospects
Risk and Risk Mitigation
Litigation and Tax Risks
Trends for the year ahead
Foreword
M&A 2021
Identifying opportunities
Financing Prospects
Risk and Risk Mitigation
Litigation and Tax Risks
Trends for the year ahead
Highlights:
Aon clients have filed more than 500 claims on representations and warranties policies since 2013. Of those claims, by the end of 2020, 20.5% settled within the retention, 14% became inactive over time, 12% resulted in a payment by the insurer, 3.5% were denied coverage, and 50% remained active.
and warranties insurers paid more than $500 million to Aon clients in North America
with almost $375M of that amount being paid in 2019 and 2020.
The frequency of claim notifications appears to have remained consistent since 2015 when adjusted to account for multiple claims being made on one policy. The average percentage of policies notified of a claim when taking into account policies placed
in 2015 through 2018 was 20.7% or one in five policies).
The average claim payment in 2020
was slightly lower than the average claim payment in 2019, but Aon does not believe that this suggests that overall claim severity is decreasing. In fact,
Insurers reported paying 76% of representations and warranties claims on policies between 2013-2020 on a dollar-for-dollar basis, while 24% were paid on the basis of applying a multiple to damages.
28% of tax policies placed between 2013-2020 had a pre-claim notice of a general audit submitted by the policyholder. Notice of a formal claim (indicating a targeted review of a covered tax position arising from the audit or the beginning of a formal contest with the tax authority) was submitted on 7% of policies.
Between 2017 and 2019, Aon saw claims notified on an average of 16.6% of the warranty and indemnity policies placed in EMEA. By the time of publication, 7.6% of the warranty and indemnity policies placed in EMEA in 2020 had been notified of a claim (not including Italian and German statistics).
loss arising directly out of COVID-19, although it may have played an indirect role in the amount of loss that insureds experienced. The increase in the volume and limits of policies placed in the last several years, is the simple and most likely cause of a corresponding increase in the number and size of representations and warranties claims.
Nevertheless, remnants of the pandemic, in the form of COVID-19 exclusions introduced by representations and warranties carriers in 2020, may come into play on future claims that are submitted on policies placed during this period. Many of these exclusions started broadly but narrowed as the year went on and became more tailored to the COVID-19 risks of each individual target company. The effect that these exclusions will have on claims activity and the payment of claims under representations and warranties insurance remains to be seen.
As the pandemic spread in 2020, Aon closely monitored the representations and warranties claims activity to determine whether the changes in deal flow or the introduction of new COVID-19 specific exclusions would impact the number, type or size of claims that were submitted. At the start of the year, claims activity appeared to be mostly consistent with what was seen in Q1 2019. In mid-to-late March 2020, as much of the world entered lockdown, there was a slight slow-down in
the pursuit of existing claims and in new claims being made as clients focused on mitigating the impact of the economic halt on their businesses. However, this lull did not last long. By April there was an uptick in the number of new claims being filed and, shortly thereafter, insureds had submitted multiple significant claims, some alleging nine figure losses.
It is not clear that we can attribute the volume and size of claims that we have seen in 2020 to the pandemic. We did not see any claims alleging
COVID-19’s Impact on Representations and Warranties Claims
Frequency on Aon client policies and the average claim frequency for all representations and warranties insurance policies placed between 2015 and 2018 is 20.7%. These statistics are consistent with the claim frequency reported by insurers in the 2020 Insurer Survey, where the average claim frequency between 2015-2018 was 20.5% (see Figure 2).
Last year, we reported that claim frequency appeared to be rising year-over-year, with the percentage of policies notified with a claim increasing steadily between 2014 and 2016. We anticipated that claim rates would continue to inch up for policies placed in 2017 and onwards. When we adjust these numbers to account for multiple claims being made on the
same policy², the percentage of policies notified of a claim was 20% for policies placed in 2015, 23% for policies placed in 2016 and 23% for policies placed in 2017. When viewed this way, as illustrated
in Figure 1³, there is less of a rise in the annual claim.
Claim Frequency
² This adjustment effectively reduces the number of claims being counted because a policy which receives multiple claim notifications will only be counted once for the purpose of determining the frequency with which representations and warranties policies in North America were notified of a claim.
³ Figure 1 illustrates the percentage of policies by Aon placed in each policy year that were notified of a claim between 2015 and 2020.
In early 2020, we reported as a notable trend that claims appeared to be increasing in size in recent years, and we saw indications that this will continue with the claims that were submitted on representations and warranties insurance policies throughout the rest of the year. In fact, we saw a greater percentage of claims filed in 2020 seeking a payment above the policy retention than in 2018 or 2019. In addition, the initial calculations of loss put forth by insureds at the time of submitting the claim exceeded numbers seen in previous years. On claims filed since the beginning of 2020, Aon saw an average estimate of loss of just over $17 million, and 22% of all claims that provided an estimate of loss calculated that the loss exceeded $20 million. This is up from an average loss estimate of just over $15 million in 2019, and 14% of the claims made that same year estimating loss in excess of $20 million at the time the claim was submitted. While initial loss calculations are not determinative of the amount that will be paid under a representations and warranties insurance policy, they do provide insight into the direction that claim sizes are trending.
When reviewing the claims paid in 2020, the average claim payment was $8.8 million, less than the $10.7 million average payment in 2019. In 2020, Aon also saw a lower percentage of payouts above $10 million (21%), as compared to payouts above that threshold in 2019 (26%). Nevertheless, given the number of claims made in 2020 that allege significant loss, Aon anticipates that the average claim payment will at least remain steady, if not increase, in the future. Because it can take some time for large claims to reach a resolution, the loss arising from the larger claims filed in 2020 may not show up in the claims data until 2021 or later.
As illustrated in Figure 3, when accounting for claims paid in 2020, Aon continued to see smaller deals receive a higher volume of claim payments, although they account for the smallest percentage of the total claim payments made. While larger deals see claims less frequently, where a
claim results in a payment, there tends to be a greater amount being paid out above the policy retention. Figure 3 illustrates that while over 40% of the paid claims were on deals with an enterprise value of less than $100 million, these payments accounted for only 16% of the total amount paid out to date by insurers. By contrast, deals with an enterprise value in excess of $1 billion accounted for only 8% of all policies with paid claims but received 26% of the total amount paid out.
Our data continues to indicate that there is no difference in the likelihood of a claim on deals with a small versus large enterprise value. On Figure 3, the grey line tracks the percentage of the total deals completed by Aon’s M&A and Transaction Solutions team between 2013-2020 that fall within each deal size category. The percentage of overall claims attributable to each deal size category is almost directly in line with the percentage of Aon deals that fall within each deal size category.
Interestingly, when the average percentage of the policy limit that is paid on claims is viewed by deal size, deals with an enterprise value between $500 million - <$1 billion were paid an average of 37% of the policy limit, the highest out of any of the deal size categories. Deals with an enterprise value between $100 - <$500 million were the next highest with an average payout of 32% of the policy limit, while deals with an enterprise value <$100 million had an average payout of 29% of the policy limit. For the largest deals, with an enterprise value in excess of $1 billion, the average payout was 20% of the policy limit. So while large deals still seem to result in large claims when viewed as a numerical value, the Aon data suggests that mid - sized to smaller deals are more likely to have a majority of the policy limit being paid on any one claim.
Update on 2020 Claim
Frequency and Size Trends
Claim Frequency
Claim Size
Claim Size
Claim Payments on the Basis of a Multiple
In the Aon claim study released in early 2020, it was postulated that the increasing size of the deals using representations and warranties insurance and the larger policy limits being placed were likely the primary driving factors around claim size. However, another element that may be playing a role in claim size is the frequency with which a multiple is being applied to damages and the size of that multiple.
A buyer’s right to recover consequential damages, indirect damages and damages based on a multiple often is negotiated in the drafting of the acquisition agreement. For many buyers, the ability to recover multiple-based damages where a change in earnings would impact the purchase price is crucial to allow the buyer to fully recover its loss in the event that a breach of representations and warranties results in recurring loss on a dollar-for-dollar basis or a diminution in the value of the acquired company. Thus, a question that often is asked by policyholders is whether representations and warranties insurers will pay a claim where the damages are calculated on the basis of applying a multiple. Barring an exclusion or other language in the policy that explicitly prevents a policyholder from seeking damages on the basis of a multiple, the ability to seek coverage for loss on this basis should be available. Of course, not every claim will warrant the application of a multiple to loss, and the question of whether multiplied damages are appropriate in the context of any particular claim is complex and can only be determined based on the individual facts of each claim.
When we asked insurers in the 2020 Insurer Survey what percentage of claim payments involved loss paid on a dollar-for-dollar basis versus applying a multiple to damages, they reported that 76% of claims made on policies between 2013-2020 had a loss that was paid on a dollar-for-dollar basis while 24% were paid on the basis of applying a multiple to damages. Representations and warranties insurers were also asked whether they had seen any change over the years in the number of claims seeking damages on the basis of a multiple: 50% responded that in recent years they estimate there has been an increase in the number of claims seeking multiplied damages, while 30% estimate there has not been a noticeable change, 10% estimate there were fewer claims seeking a multiple and 10% did not know if there had been any change.
Financial Statements and
Material Contracts Breach
at Healthcare Company
In a claim resolved in 2020, in the months after acquiring a majority stake in a company in the healthcare industry,
the insured discovered multiple breaches of representations and warranties in the underlying purchase agreement. These included a failure to recognize expenses related to the performance of a material contract, errors in billing codes,
and a failure to disclose known or anticipated changes to the company’s customer base in certain areas. These matters were believed to constitute breaches of the transaction agreement with respect to financial statements, material contracts and commitments, and relationships with key third parties. The insured alleged that the impact of these issues resulted in a diminution in the value of the company and that the valuation multiple should be applied to the damages incurred.
Aon worked closely alongside the insured to facilitate discussions with the primary and excess insurers and their advisors, in order to educate them about the complexity of the business and the nature of the breaches as well as their
impact on the company. Ultimately, the primary insurer agreed to pay its full policy limit, and the first excess insurer agreed that several of the representations had been breached and paid a significant portion of its policy limits as well.
In the end, a multiple was applied to the loss incurred, and the insured received a payout that was tens of millions of dollars above the policy retention.
If the majority of insurers surveyed are correct that there has been an increase over time in the number of claims alleging loss on the basis of a multiple, multiples trending upwards or downwards may be reflected in the size of the claims made on representations and warranties insurance policies. As of Q4 2020, Pitchbook data indicated that the median EBITDA multiple across all PE deal types has increased since Q1 2013 from 8.6x to 14.1x. If this trend endures, it may contribute to ever larger representations and warranties insurance claims.
Aon has seen many claims under representations and warranties policies alleging that a multiple should be used to appropriately calculate the damages arising from a breach. In our experience, this usually is something that will be thoroughly investigated by an insurer, including verifying that a multiple was used to value the target corporation. To date numerous claims have been paid where a multiple has been applied to the loss, but due to the complexity that can be involved with determining the appropriateness of applying a multiple to damages, these claims often
take longer to resolve than those seeking a dollar-for-dollar recovery.
As discussed last year, claims alleging a breach of the material customer representation that apply a multiple to loss continue to garner close scrutiny from insurers. Carriers remain focused on various factors that may impact the analysis around whether it is appropriate to apply a multiple, such as the length of the contract, the type of business, and typical customer retention expectations. Understandably, when buyers value a business, their models typically assume that material customers/contracts will not be terminated in the near-term, and therefore they view the termination of any such material contract or customer as having an impact in the form of lost future revenue beyond a mere dollar-for-dollar loss. In the end, these claims, like all others, are dealt with on a case-by-case basis, with detailed analysis of the applicable facts and circumstances.
Other Claim Trends
One factor that may play into the large percentage of total claim payments attributable to financial statement breaches is the fact that this type of breach is more likely to result in a claim on the basis of a multiple than some other breaches. As discussed above, claims where loss is calculated by applying a multiple to damages will in many cases result in a higher amount of loss than a claim seeking coverage for dollar-for-dollar amounts.
Aon’s findings with respect to the frequency by type of breach were consistent with what was reported by insurers in the 2020 Insurer Survey. Figure 5 illustrates the type of breaches that insurers identified as being the top three most commonly cited (each color indicates whether insurers ranked the breach as the first, second or third most common). In the survey, 60% of respondents also named the financial statements representation as the representation most commonly cited in a claim notice. Another 20% of respondents cited tax representations as the number one breach, while 10% cited the compliance with laws representation and 10% cited the undisclosed liabilities representation. While there is some variance in the order in which the top breaches are ranked, in both the Aon and insurer data it appears that the same types of breaches are generally resulting most often in claims being notified under representations and warranties insurance policies.
EMEA Claim Trends
In Europe, the Middle East and Africa (EMEA), Aon warranty and indemnity policies have been notified of more than 150 claims since 2015. Between 2017 and 2019, Aon saw claims notified on an average of 16.6% of the warranty and indemnity policies placed in EMEA. By the time of this publication, 7.6% of the warranty and indemnity policies placed in EMEA in 2020 had been notified of a claim. The difference in claim notification frequency between EMEA and North America likely has been attributable in part to the differences in the indemnification and disclosure practices in Europe which set a higher standard for a buyer to establish a breach. As shown in Figure 10, of the claims submitted in EMEA between 2013 - 2020, the top three most common breaches alleged are a breach of the tax warranties or pre-closing tax indemnity (22%), a breach of the financial statement representations (18.4%) and a breach of the disclosure of information representation (9.6%).
When reviewing the time that it takes for a claim to be notified on EMEA policies, Figure 11 illustrates that only 46% of the claims submitted were made within 12 months of the close of the transaction, while 54% of claims were submitted after 12 months. Interestingly, 29% of all claims were submitted more than 18 months post-close. When compared with the long-tail risk seen in North America, where a larger majority of the claims (61%) were filed within the first 12 months post-close and a smaller percentage (20%) were submitted more than 18 months post-close, the EMEA warranty and indemnity market currently is experiencing more long-tail risk. Given the available data, it is too early to make any definitive findings, but this is a trend with respect to EMEA claims that Aon will continue to watch.
Since 2017, Aon has been notified of claims on policies from 100+ deals
insured in EMEA
2017
2018
2019
2020
16.3%
16%
17.4%
7.6%
Claim Resolution
The EMEA warranty and indemnity market is currently experiencing slightly more long-tail risk than what has historically been seen in North America. It is too early to know if this is a trend that will persist and it is something that Aon will continue to track.
Claim Resolution
Claim Process
This section discusses Aon’s experience with bespoke tax insurance policies as opposed to claims for breaches of the tax representations under representations and warranties and warranty and indemnity policies, which is discussed above. Due to the extended nature of tax contests as well as the large volume of programs placed in the last five years, Aon is beginning to see increased claims activity on tax insurance placements.
To date most of Aon’s claims experience on tax insurance policies has involved situations where a formal contest has been initiated by a tax authority and a successful claim for defense costs has been made by our clients, but where it was ultimately determined in the contest that no tax was due. Nevertheless, Aon clients have collected more than $30 million in payments for losses under tax insurance policies. Overall, since many years may pass between the placement of a tax policy and a determination regarding taxes owed, most of the activity our claims team is currently involved with relates to the audit process and the collection of defense costs during ongoing litigation on policies placed in the previous three to seven years.
In the 2020 Insurer Survey, it was reported that 28% of tax policies placed between 2013-2020 received a pre - claim notice of a general audit and 7% were notified of a claim, indicating a targeted review of a covered tax position arising from the audit or the beginning of a formal contest with the tax authority. In our experience, Aon clients have seen multiple general audits become more targeted and result in a claim. Currently, most of these placements are still working their way through the audit or appeals process. It is our expectation that over time, as the tax contests progress, the percentage of claims resulting in a payment will climb.
When handling Aon client tax claims, insurers generally have been responsive and cooperative when claims are brought or when approvals are needed during the audit process. Their approach has been collaborative, as the insurers typically view the tax claim as a partnership in the defense of the covered tax position with their insureds and counsel. It would be highly unusual for a tax insurance claim to require mediation, arbitration or litigation, and to date, every resolved claim under an Aon tax policy has either been paid, settled within the retention, or ultimately no tax was owed to the tax authority.
Tax Insurance Claims
Aon has been involved in more than 500 claims that have been made by its clients on policies placed in North America since 2013. Of those claims, 20.5% settled within the retention, 14% became inactive over time, 12% resulted in a payment by the insurer, 3.5% w ere denied coverage, and 50% remain active. Outright claim denials continue to be rare, and while historically most disputes centered around the quantum of loss, in 2020 we began to see more claims with extended discussion around the establishment of a breach. Nevertheless, as evidenced by the low percentage of denied claims and the continued low rate at which claims proceed to alternative dispute resolution or litigation, the majority of these still reach a successful resolution. Representations and warranties insurers also confirmed that in their experience most claims are
resolved through the claim process, responding in the 2020 Insurer Survey that only 2% of claims on policies placed between 2013-2019 ended up in arbitration or litigation.
Beginning in 2013 and through the end of 2020, Aon has seen eight claims go to mediation, five claims go to arbitration and three claims result in litigation since 2013. Mediation has aided resolution between the parties in most instances where it is utilized. Of those claims on Aon client policies that have used mediation to try to achieve a settlement, only two have been unsuccessful and have gone on to arbitration or litigation (one has since settled while the other is ongoing).
Because of the small sample size around claims going to mediation and arbitration, Aon’s observations largely are anecdotal, but over the past two years claims alleging breaches of the material customer representation have been mediated and litigated at a greater percentage than any other type of claim. As discussed above, this may be influenced by the fact that there appears to be an added complexity to the determination of loss arising from these claims, including the potential for various viewpoints on the appropriateness of applying a multiple to the calculation of damages.
Seller Indemnity vs. No Seller Indemnity
Claim Resolution
Claim Resolution
Claim Process
Representations and warranties insurers paid more than $150 million to Aon clients in North America in 2020 alone and recognized more than $200 million in total loss (when factoring in erosion of policy retentions). This results in a total of more than $500 million paid by 18 different representations and warranties insurers to Aon clients in North America since 2013, with almost $375 million of that amount being paid since the beginning of 2019. The total loss recognized since 2013 now exceeds $700 million. The payments made on individual claims in 2020 ranged from $94,000 to more than $30 million. Of these payments, the majority were less than $1 million but, as shown in Figure 13, 22% were above $10 million.
The breakdown of claim payments between 2013- 2019 from the 2020 Insurer Survey is shown in Figure 14. Insurers reported that 83% of claim payments were made on primary insurance policies and 17%
were made on excess insurance policies. Insurers reported that the majority of these claim payments were between $1 million and $5 million, but 10% were over $10 million. It should be noted that the survey results are based on individual insurer responses, so while there was no payment reported above $30 million by any one individual insurer, there have been claims on Aon client policies where the total amount paid by multiple insurers is well in excess of $30 million. Several ongoing representations and warranties insurance claims allege loss in the nine figures, including 10 claims filed in 2019 and 2020 that allege loss in excess of $100 million, and we anticipate that insurer payouts in the higher payment brackets likely will increase with the resolution of these claims.
Claim Process
Aon continues to monitor trends around seller indemnification and whether the presence or absence of a seller indemnity impacts the likelihood of a claim. On North American deals that closed in 2019 and 2020 where Aon placed representation and warranties insurance, 63% had seller indemnity while 37% had no seller indemnity. When reviewing the claims made to date on the policies placed in 2019 and 2020, 30% of those claims were on deals with no seller indemnity while 70% were on deals that did have seller indemnity. Even with the still-incomplete sample size, given that the percentage of claims on 2019 and 2020 policies where there is no seller indemnity is actually less than the percentage of overall Aon deals from 2019 and 2020 that have no seller indemnity, the data suggests that the absence of seller indemnity has no meaningful impact on the likelihood that a deal will be notified with a claim.
Last year we reported that insurers were increasingly utilizing lawyers and financial accounting experts on representations and warranties claims and this trend continued in 2020. Of the claims filed in 2020,
insurers hired legal experts to assist 28% of the time and financial accounting experts 14% of the time. When only claims paid in 2020 are analyzed, these numbers increase significantly - insurers utilized legal counsel on paid claims 71% of the time and financial accounting experts 50% of the time. This likely is a reflection of the fact that there is an increasing number of claims being investigated at the same time, as well as the fact that there appears to be a rising number of large and complex claims being made by representations and warranties policyholders.
Use of Counsel and Experts
Condition of Asset Breach Results in Lost Profits
The insured acquired the target company for the purpose of utilizing its existing assets, in particular a manufacturing plant, to increase
its capacity to service its customers. Prior to close, the insured had the seller test the plant to ensure that it was able to run at the intended capacity post-close. However, shortly after the close of transaction, the insured discovered that the plant was not properly designed, resulting in the need to shut down the plant completely for repairs and necessary upgrades. The insured filed notice of a claim with the representations and warranties insurance carrier alleging a breach of the condition of assets and compliance with laws representations.
After the production of supporting information and a meeting to walk the insurer’s experts through the details of the claim, the insurer found that there was a breach. While there was initial disagreement around how to properly calculate the resulting loss, the insurer ultimately agreed that the costs to repair the plant and make it suitable for the intended use, as well as the profits that were lost while the plant was shut down, were covered under the policy.
Claims
Claims
Foreword
Highlights
COVID-19 Impact
2020 Claim Frequency
Claim Payments
Other Claim Trends
EMEA Claim Trends
Claims
Foreword
Highlights
COVID-19 Impact
2020 Claim Frequency
Claim Payments
Other Claim Trends
EMEA Claim Trends
Claims
Timing for Discovery of a Breach
As shown in Figure 6, when we look at the average time between the close of a deal and the filing of a claim for all years (2014 - 2020) we still continue to see the majority of claims (61%) filed within the first 12 months. However, over time we are seeing a slight increase in the average number of months that it takes to file a claim because as the data matures there is more opportunity for some claims to be filed later, leading the annual average time for filing a claim to creep up year-over-year (see Figure 7). In 2018, the average time between the close of a deal and notice of a claim was 11.4 months, this increased to 13.8 months for claims filed in 2019 and for claims filed in 2020 the average increased further to 14.1 months. So while the large majority of claims are still expected to be filed within the first 12 months post-close of a transaction, it is not uncommon for claims to come in later, some even after 24 months.
As shown on Figure 8, where claims arise more than 12 months post-close, the results of the 2020 Insurer Survey indicated that these were most likely to be a financial statements breach (40%), a breach of a tax representation (40%), litigation (10%) or products related (10%). It is surprising that 40% of insurers reported financial statements breaches frequently being notified more than a year post-close, as in Aon’s experience this is the type of breach that is more likely to be found within the first audit cycle which is usually completed within 12 months after the buyer has taken control of the target company (although Aon has seen some financial statements breaches arise later in the policy period).
Aon’s data indicates that third party claims (tax claims or litigation matters) are most likely to be notified more than 12 months post-close, comprising 52% of all claims that are notified later. While, financial statement breaches accounted for 10% of the breaches notified more than 12 months post-close, undisclosed liabilities accounted for 8% of the breaches notified later and both compliance with laws and material contract breaches were responsible for 4% of the claim notifications submitted more than 12 months post-close (see Figure 9).
Foreword
Highlights
COVID-19 Impact
2020 Claim Frequency
Claim Payments
Other Claim Trends
EMEA Claim Trends
Claims
Foreword
Highlights
COVID-19 Impact
2020 Claim Frequency
Claim Payments
Other Claim Trends
EMEA Claim Trends
Claims
Foreword
Highlights
COVID-19 Impact
2020 Claim Frequency
Multiplied Damages
Other Claim Trends
EMEA Claim Trends
Claim Resolution
Foreword
Highlights
COVID-19 Impact
2020 Claim Frequency
Multiplied Damages
Other Claim Trends
EMEA Claim Trends
Tax Claims
in the average claim payment at least remaining steady, if not increasing, in the future.
Aon continued to see claims filed in 2020 estimating significant loss amounts
representations
since 2013
which if paid, would likely result
Half of the insurers surveyed believe that there has been a rise in the number of claims seeking multiplied damages in recent years.
While the frequency and severity of claims being seen on warranty and indemnity insurance policies in EMEA is not yet at the same level as what has been seen in North America, there appears to have been a shift in the last year with more large, complicated claims emerging.
Foreword
Highlights
COVID-19 Impact
2020 Claim Frequency
Multiplied Damages
Other Claim Trends
EMEA Claim Trends
Tax Claims
Claim Resolution
The Aon Advantage
The Aon Advantage
Aon’s Transaction Solutions team has been leading the creation and advancement of transaction liability insurance since the market’s inception. Comprising former senior M&A and tax attorneys and other senior M&A leaders, we bring a depth of knowledge and passion for developing tailored solutions to your complex deal risks that are unparalleled in this industry. We know firsthand that the timing and sensitivity of a deal are paramount to its success and work closely with your deal teams and insurance providers to advise and execute solutions that improve your deal outcomes.
Aon believes that it is important for us to work with our clients beyond the placement of the insurance policy to ensure that they are not left to navigate the process alone when faced with a claim. With the assistance of the brokerage team, the Aon claims specialists partner with clients and their advisors to navigate the claims process from when an issue is identified until the time that a claim is resolved, assisting with notification, facilitating discussions with insurers, and leveraging knowledge gained from past claim resolutions. The experience of the Aon claims team sets us apart in the brokerage arena, and it has resulted in significant benefits and positive outcomes for Aon clients in the context of representations and warranties insurance and tax insurance claims.
For more information about this study or about Aon’s dedicated claims advocacy, please contact:
Stephen Davidson
Managing Director
(212) 441-1467
stephen.davidson1@aon.com
Jennifer Drake
Senior Vice President
(416) 868-2432 jennifer.drake@aon.ca
If you have any questions about your specific coverage, or are interested in obtaining coverage, please contact your Aon broker.
COVID-19 Impact
Highlights
Foreword
2020 Claim Frequency
Multiplied Damages
Other Claim Trends
EMEA Claim Trends
Tax Claims
Claim Resolution
The Aon Advantage
As of the end of 2020,
When handling Aon client tax claims, insurers generally have been responsive and cooperative when claims are brought or when approvals are needed during the audit process. Their approach has been collaborative, as the insurers typically view the tax claim as a partnership in the defense of the covered tax position with their insureds and counsel. It would be highly unusual for a tax insurance claim to require mediation, arbitration or litigation, and to date, every resolved claim under an Aon tax policy has either been paid, settled within the retention, or ultimately no tax was owed to the tax authority.
Claim Resolution
The Aon Advantage
Tax Claims
The Aon Advantage