Tax Insurers Eye Mega-Deals As Sector Hits $1 Billion Mark

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By Laura Davison

Nov. 25 — Tax insurance policies designed to protect against adverse rulings from the IRS are on the cusp of becoming a player in some of the biggest mergers and acquisitions.

These insurance policies are graduating from middle-market deals and insurers are nearing the point where they can collectively underwrite a $1 billion policy, insurance brokers and underwriters told Bloomberg BNA.

Tax insurance “grew up” over the past few decades, insuring the tax liabilities in sales of private equity portfolio companies and covering tax equity investors’ eligibility for credits in development projects. It is now becoming relevant to the largest publicly traded corporations, Gary Blitz, a managing director at insurance broker Aon Transaction Solutions, told Bloomberg BNA.

“It’s doing in insurance form what you might get from the IRS in a private letter ruling,” Blitz said.

As the Internal Revenue Service has restricted the issues on which it will issue private letter rulings, tax insurance has provided an alternative route to alleviate investor uncertainty. Policies are frequently written to ensure that an S corporation or real estate investment trust qualifies for their special tax status or that a spinoff will qualify as tax-free.

Tax insurance is an offshoot of representations and warranties insurance, which covers buyers or sellers against liabilities and risks in a transaction. Within companies, it is usually executives on the financial side or those who “would have to write the check if the deal went bad” pushing to buy the policies, Blitz said.

Policy Purpose

The policies are an “efficient way to nail down a risk,” David Schenk, a principal at PricewaterhouseCoopers LLP, said. If there isn’t time to wait months for a private letter ruling from the IRS, or the agency won’t grant one, insurance provides another option.

However, it wasn’t always that way. The IRS used to frown on any transaction that was insured and required that all covered deals must be reported to the agency. That stance was reversed in 2003. The IRS even suggested in Revenue Procedure 2014-12 that insurance was an option for tax equity partners investing in historic rehabilitation credit projects.

Tax insurance has grown at about a rate of 25 precent to 30 percent each year over the past four years, said Craig Schioppo, a managing director at Marsh USA Inc., an arm of Marsh & McLennan Cos. Marsh placed approximately $1.5 billion in transaction risk insurance, which includes tax, in 2013. The amount is projected to be about $6 billion this year, Schioppo said.

Aon said it placed about $3 billion in tax insurance last year and about $13 billion in all transactional risk insurance. Blitz said that accounts for about 90 percent of all tax insurance policies worldwide in 2015.

The industry is at the “precipice” of being discussed in the boardrooms of large publicly traded companies, said David De Berry, chief executive office officer of Concord Specialty Risk, which underwrites tax insurance. And he sees it growing quickly past covering deals. In five years, De Berry said he hopes companies will buy policies to insure tax returns or transfer pricing arrangements.

A few years ago, it took 10 insurers to underwrite a policy for a tax-free spinoff with a $350 million limit, Blitz said, but that’s “not a very relevant number to a Fortune 200 company.” After drumming up capacity by getting new insurers into the market, Blitz said a $1 billion policy is now possible.

Tax insurance isn’t a panacea to all risky deals. Had Yahoo! Inc. wanted to insure its now-defunct plan to spin off its stake in Alibaba Group Holding Ltd., then valued at $40 billion, it is unlikely there would have been enough insurance capacity to cover that deal in early 2015. It also is unlikely that any insurer would be willing to cover a corporate inversion, such as the one attempted by Pfizer Inc. and Allergan Plc that fell apart after new Treasury Department rules were issued in April.

Eye on the Prize

Blitz and De Berry have their eyes on larger-scale transactions. Earlier this year, Energy Transfer Equity LP terminated its $33 billion plan to buy rival pipeline company Williams Cos. after a Delaware court said Energy Transfer could back out of the deal because it failed to get tax lawyers to write an opinion.

“That kind of story is a great story for tax insurance,” De Berry said. “First, the tax issue arguably morphed as circumstances changed and, second, the issuer of a tax opinion is generally more constrained than is the tax underwriter. Had the seller obtained tax insurance prior to closing, there would have been no contingency for a tax opinion in order to close.”Tax insurance premiums usually cost about 4 percent to 7 percent of the cost of the policy coverage, depending on the complexity of the issue and how much coverage the company wants. It is usually paid in one lump sum and covers the company until the statute of limitations runs out in six or seven years.

Insurers and brokers are pursuing the product because it is relatively profitable. Traditional insurance products end up paying out 70 cents to 90 cents of every dollar of premium taken in. For tax insurance, it is about 10 cents to 20 cents per dollar, Blitz said.

“There is a lot of runway left in this market, as evidenced in the growth over the past three years,” Marsh’s Schioppo said. “I see it continuing to grow.”

The need for tax insurance, as evidence by the breakup of the Williams Cos. deal, IRS acceptance of the coverage and the increase in insurers’ willingness to write policies signal that the market is poised to continue to become more significant, De Berry said.

“All the forces are conjoined now so that tax insurance can be relevant now to the public companies, to the unique tax uncertainties confronting multinationals,” De Berry said. "“We are ready to launch on larger-scale tax issues.”

To contact the reporter on this story: Laura Davison in Washington at lDavison@bna.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bna.com

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