The representation and warranties (R&W) market is still taking off in the region as local investors have little knowledge about the product and tend to turn to other tools such as escrow accounts at the time of dealing with potential liabilities emerging from M&A deals.
Global demand for R&W insurance has increased dramatically in the past decade. In a recent report, Marsh claimed to have placed $81.2bn in limits for the segment in 2021, compared to $46.8bn in 2020 and $3.9bn back in 2013.
Latin America still answers for a small share of that total, but sources says that the market is starting to move in the region too. Even though M&A volumes in the region have slowed down a bit in 2022, they are still taking place in healthy numbers. According to consultancy TTR, there were 2,455 M&A deals in Latin American in the first nine months of the year, which was 10% lower than in the same period of 2021, but still a significant number for the region.
At the same time, there have been remarkable sales of R&W policies in economies such as Brazil and Chile, the most dynamic M&A markets in the region, but also in places like Mexico, Argentina, Ecuador, Guatemala and El Salvador, according to sources.
But in addition to actual sales of policies, brokers and insurers have reported a growing number of consultations and submissions for R&W insurance placements in the region.
“Three years ago, we had one R&W submission a month from Latin American markets. But now we are seeing weekly submissions, including from countries that did not use the product before,” says Fernando Villasenor, the Head of the Southern zone at Liberty GTS.
The experts point out that there are two main reasons are behind the growth of interest for R&W insurance in the region. On the one hand, a growing number of international institutional investors are looking at Latin America as they expand their portfolio of renewable energy assets. This is particularly true with private equity companies
“International investors are providing a big boost to the market. They already know the product and when they invest in Latin America they want the cover too,” says Renée Guerra de Carvalho, the head of Private Equity and M&A at Marsh Latin America & Caribbean.
The second factor is fledging capacity. Carvalho notes that underwriters have allocated large amounts of capacity to the product in the US and Europe in recent years as demand for cover boomed, but the situation has now changed as the M&A market deflated in the developed world. With lower demand from their main markets, R&W underwriters have had more time and incentives to look elsewhere.
Latin America is one of the places where insurers are trying to make inroads in transactional insurance, and, if that trend is maintained, it could go some way towards solving what brokers consider the main hurdle to the development of the product in the region.
“The main issue in this market is the lack of capacity. We talk to clients and M&A lawyers to explain how the policy works, but when it comes to quoting the product, there is often no cover for tax and labour liabilities,” says Bruna Reis, the Private Equity and M&A Brazil leader at Marsh.
According to Carvalho, the market was picking up steam by 2019, but when the Covid-19 pandemic hit it came to a halt. It has started to recover now, and brokers such as Marsh are making an effort to explain what are the main risks involved in Latin America’s M&A deals.
A lack of capacity means that insurers have been carefully when offering R&W covers and have added exclusions and write-ins that are not always common in the US or other developed markets. For example, tax litigation, which has a knack of being costly and dragging for years in countries like Brazil, is a common exclusion. Other transactional products can however complement the cover, such as tax liability insurance. FCPA risks are also the target of standard exclusions across the region.
The market has had reasons to be cautious. A large multinational insurer offered local capacity for R&W insurance some years ago, and promptly wrote two policies in Brazil. It soon registered two large claims, following which the company withdrew capacity from the country.
“The size of transactions is also a limitation to the development of the market. We are talking of deals worth more than $30mn,” Reis points out.
But there are some signs that insurers are more willing to once again offer broader coverages to the region. Reis says, for example, that Marsh has recently obtained a quote in Mexico for R&W cover with tax liabilities included.
“Rates and retentions used to be higher than they are right now, which is to be expected as there is more competition in the marketplace for Latin American deals. And we are extending the coverage to aspects of transactions that three years ago would not be covered, like manufacturing companies, where risks can be considerable,” Villasenor says.
That said, insurers also must adapt their underwriting processes to local conditions. Villasenor notes for example that insurers that are used to the fast-paced M&A environment in the US need to adopt a more ponderous approach to Latin American deals.
“M&A transactions in the US tend to move faster. In Latin America, they tend to be lengthier processes,” he says. “However, many M&A transactions are governed by US law, or there is some kind of US involvement. It has really helped the product to grow in the region.”
“The period when potential claims can arise is longer in Brazil than in other countries, especially in sectors like tax and environmental liability. So contracts often provide cover for longer periods as well, and it has made R&W policies attractive for some buyers as a result,” adds Eduardo Castro, a partner at the Machado Meyer law office in São Paulo.
He stresses that the cost is another factor that has kept local investors away from R&W policies. Rates can be quite significantly, especially compared to the costs of maintaining an escrow account, which is the most common guarantee against future liabilities used in M&A deals in the region.
But Reis says that, once the rate is considered over the length of the policy life, the cost argument becomes much weakier.
“The management cost of an escrow account is lower than the insurance cover, but the money stays locked out in the account for several years. And if you consider the premium rate over the life of the policy, even if the rate is 4-6%, the annual rate ranges between 0.75% and 1%,” she says.
And a further factor that insurers are working on is the language of the policies. Traditionally, R&W covers for Latin American deals have been negotiated in London, with wordings in English that have to be adjusted to deal documentation in Spanish or Portuguese.
But now a number of insurers and brokers are now investing in the hiring of underwriters that can prepare contracts, negotiate covers and participate in underwriting calls in the local language. One of them is Liberty GTS, which has hired underwriters from Argentina and Colombia and has plans to the hire Portuguese-speaking professionals too.
“Now we can provide R&W insurance to M&A deals where the policies are fully written in Spanish. Two years ago, that was a hard thing to do,” Villasenor says. “And, in recent years, local brokers have become more interested in working with this product as well.”
