Insurance giant AIG is concerned.
Although the rate of claims from Representations and Warranty (R&W) insurance, which covers M&A transactions, has been steady since 2012 across the board, for deals of all sizes… they have noted a rising trend with how much they are paying out for smaller claims.
In a nutshell, they are paying more on smaller claims than before. This is for policies for smaller deals where the premium was a relatively small amount. In other words, the area where premiums are down, claim payments are up.
I consider this a signal from AIG. They’re saying this trend is not sustainable and that means the insurance market should look to solidify rates and potentially look at increases. I believe we should also be prepared for more stringent underwriting for these types of transactional insurance policies as well.
As they put it in their recent report, M&A: Small Deals and Emerging Markets Drive Claims Activity:
“This shift was picked up in AIG data between 2018 and 2021, and we expect that moving forward we’ll continue to see greater deal and claim activity in these segments. Almost without exception, the limited number of larger deals and deals overall, together with a soft market insurance environment has resulted in terms and conditions and, in particular, policy pricing that is not sustainable in the mid-to-long term.”
In other words, the area where policyholders pay the least, the insurer is paying out more.
The backdrop to this “warning” that they will raise rates is that I do not think AIG can attribute the whole rising trend to an issue with the claims themselves. Increased competition and a slowdown in deal-making – which caused a reduction in demand for R&W insurance – are also contributing factors. Granted, underwriting in recent years has also been less thorough than in the past. But that is simply insurers themselves trying to position themselves as more market-friendly.
In any case, whatever the cause, the impact is the same:
Prepare for insurers to be more diligent in their underwriting and for premiums to go up.
Causes – and Effects – of Less Stringent Due Diligence
More diligence in underwriting is not a bad thing.
Smaller companies – those under $250M – don’t have direct oversight in their financial reporting. They usually outsource that task to a third party, which means management is not scrutinizing financial statements as rigorously as they could. They can also be somewhat lax on compliance. (No wonder there have been a significant number of compliance-related claims.)
Also, compared to other larger organizations, these sub-$250M businesses have had more breaches of material contracts… because those are not thoroughly vetted in smaller companies.
This is because these smaller companies don’t have the resources to be more rigorous in their financial reporting and such, or they have allowed these tasks to fall by the wayside and let insurance take care of it.
In any case, insurers like AIG have been taking care of it, and now they are responding accordingly by cautioning that they could raise their prices for coverage.
The Impact on Cyber Liability
I see some serious parallels between this potential rising rates and increased underwriting scrutiny in R&W coverage… and what happened with cyber liability insurance.
This coverage was downright cheap and very easy to place.
But then, they started requiring companies to have multifactor authentication in place for their IT systems, as well as offsite backups.
Basic IT security best practices, basically. And if you did not have those, the insurer would not cover you.
At the same time, rates came up. And, all of a sudden, claims dropped significantly.
Insurance companies will always look for trends that are costing them money and then make efforts like these, and what they are doing with R&W coverage, to balance things out.
Really, it’s good for both sides. Insurers cut down on claims. But companies avoid claims too – because they are not suffering a loss. Being a little more proactive pays off and nobody is left to pick up the pieces.