Companies that opt for transaction insurance are most often acquirers trying to hedge against risks that are unknown or that can't be quantified through due diligence. Such risks are typically covered through an escrow account set up by the seller, but when the seller refuses or can't afford to put aside enough cash, insurance is an option. Sellers sometimes take out the insurance themselves to facilitate difficult deals.

"When you're doing due diligence, there's a limit on how many rocks you can look under," says Nancy Rodrigues, an M&A broker at Marsh Inc. Insuring against those unknowns provides a layer of comfort for company executives, board members and shareholders.

Recent enthusiasm aside, M&A insurance is still a miniscule sector and growth has been much slower than originally forecast. Less than 100 deals are insured annually, a tiny fraction of overall M&A activity.

"Most of the time in these transactions you're getting insurance from the seller through indemnification, a hold-back or part of the purchase price being put in escrow," says Jeffrey Ginsberg, chairman of internet service provider Eureka Networks, who has made seven acquisitions in the past three years and considered insurance. "The reps and warranties I've gotten from the seller have always been satisfactory."

One of the biggest deterrents to purchasing M&A insurance is the cost. Insurance premiums for representations and warranties or tax liability insurance typically amount to 5% to 10% of the coverage, with deductibles totaling up to 5% of the transaction price. The cost of other types of coverage, such as Synopsys' litigation buyout policy, can equal a third of the purchase price or more. While the insurance buyer technically foots the bill for the policy, dealmakers say the premium really comes out of the transaction price.

When representing an acquiring company in a deal several years ago, Norman Lange, U.S. director of risk management at Dutch publisher Wolters Kluwer, says the seller balked at taking on certain liabilities.

"We proposed that they buy the insurance instead," says Lange, recalling that underwriters offered the seller a pricey premium. "When they went out to look at the insurance, they were willing to shoot craps and take on the liability."

The economics of buying insurance alone takes more than half the market out of the game. For deals under $10 million, insurance is prohibitively expensive, and for those over $1 billion the risk is too high for any underwriter to assume. As a result, most insured deals are in the middle market, with policies ranging from $5 million to $50 million and averaging about $20 million.

Timing is the other big hurdle. It takes up to two weeks to secure preliminary bids through a broker, and then it can take another two weeks for underwriters to conduct their due diligence and come up with a policy. By then, the parties have often either resolved their disagreement or had time to conduct more due diligence that put them at ease.

"It's a risk allocation negotiation," says Peter Coffey, president of the Association for Corporate Growth and a lawyer at Michael Best & Friedrich LLP. "Most parties, once they're able to quantify the risk, are able to negotiate it."

Another reason why M&A insurance has been slow to catch on is that few people know about it, partly because companies that have bought M&A insurance are reluctant to publicize it. "People don't talk about it because if you buy this kind of insurance, it means something went wrong somewhere in the deal," says one broker who did not want to be named.

Plus, in the early days, lawyers say, underwriters did not explain the product well in their sales pitches, and confused customers with poorly worded policies. Early tax liability policies, for example, were simply revised Directors & Officers policies, says Richard Wolfe of Fried, Frank, Harris, Shriver & Jacobson LLP. "They were impenetrable to tax practitioners," he complains. "Over the past few years, they have become more understandable."

Underwriters and brokers have written primers to educate users, and carriers have staffed their M&A desks with former dealmakers who can communicate better with prospective clients.

Still, dealmakers are thinking carefully before calling their brokers. Insurance doesn't replace thorough due diligence, after all, and problems that arise post-acquisition most often result from issues such as lower than expected synergies or integration challenges that pose risks far too great for most insurers to even contemplate betting against. - Dalia Fahmy

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