Warranty and indemnity insurance: Will euphoria give way to disillusionment?
Business in warranty and indemnity policies (W&I) may be booming, but it is complex and volatile. New analyses have shown that loss ratios are higher than many players in this challenging market think.
W&I policies are a new product introduced around 10 years ago on a broad scale to cover warranties and risks in connection with company takeovers. Private-equity companies are often behind mergers and acquisitions (M&A), and W&I insurances play an important part in their business models. A quick look at the benefits of the product tells us why.
Benefits of covering a transaction
How the market has developed
Beware of the soft market tendencies
The trend towards a soft market is being strengthened even more by the number of “buyer-side policies” written, which has been increasing for months. These policies cover buyers against financial loss resulting from the acquisition of a company. If the policyholder suffers a loss, it claims compensation directly from the insurer. This arrangement is likely to be especially hazardous if the risk assessment for underwriting is further simplified and the buyer’s due diligence is in future no longer submitted to risk managers or not submitted in full. Another critical point is that, due to the development of the market, insurers are finding it increasingly difficult to find qualified staff for the challenging risk assessment work involved.
Extensive loss database provides substantiated market insights
Due to the long treaty periods and the complexity of M&A transactions, losses are generally only reported once the first audit cycle has taken place, i.e. at the earliest 6 to 18 months after the sale or purchase of a company. Our database provides a reliable picture of the loss history for the entire market, especially for older transactions, and permits substantiated forecasting of future developments.
Our analysis shows that, following the favourable loss experience throughout the market in the years up to 2009, the combined ratios had already risen significantly by 2011. What is more, projections based on realistic assumptions for the years after that indicate combined ratios very close to 100% (cf. figure), barely sufficient to enable insurers to exceed operational break-even. Even minor fluctuations in losses or a further worsening of market conditions could put many insurers into the red in this business.
Optimism despite the high volatility
Nevertheless, the enormous potential of the market is cause for optimism. W&I insurances are currently being purchased for less than 10% of global M&A transactions. If that percentage increases significantly, the resultant higher total premium volume will, over time, reduce the high volatility of the losses. There is also hope that the market will learn from past losses – which is where our loss database comes into its own.
We make the statistics it provides and the expertise and worldwide market knowledge it gives us available exclusively to our clients so that we can work with them to improve risk management. Munich Re is thus able to provide its insurance partners with systematic support in their W&I activities, paving the way for profitable business – even in such a difficult environment.