The Maturing Market for Representation and Warranty Insurance

Ian Boczko and John L. Robinson are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton publication by Mr. Boczko and Mr. Robinson.

Representation and warranty insurance for corporate transactions has existed for approximately two decades. R&W insurance, as the name suggests, provides coverage for breaches of representations and warranties regarding the business acquired that were not known to the buyer at the time of the purchase.

While R&W insurance was viewed historically as a product of limited application, we have seen in recent years a significant expansion of the use and importance of these policies. Today, R&W insurance is generally viewed as an attractive product when deployed in the right circumstances, often providing for a longer period of coverage and higher limits than would be available in a customary seller indemnification arrangement. The increased role of R&W insurance in transactions is evidenced by a steep increase in underwriting: only five years ago, a few hundred R&W insurance policies were being written annually; in 2017, it is estimated that over 1,500 policies were written.

A number of aspects of this growing R&W insurance marketplace are notable and contributed to the dramatic expansion of this product:

  1. More than twenty insurance carriers are now writing R&W insurance. At least ten of these carriers are capable of writing primary policies, up from just a handful of carriers even five years ago. The total market capacity for a single R&W insurance placement has likewise increased substantially. It is now relatively straightforward to obtain a R&W insurance program with several hundred million dollars in limits and, based on recent experience, it is possible to obtain a billion dollars or more in limits for a single transaction.
  2. The increase in insurance markets writing R&W insurance has led to a competitive marketplace for both policy pricing and terms. Relatedly, policy terms have become somewhat more standardized across the industry.
  3. While R&W insurance in the United States was previously used almost exclusively in transactions with private equity sellers, the R&W insurance market has evolved. Public companies selling divisions or subsidiaries are sometimes expecting buyers to seek protection through R&W insurance; public companies wishing to limit exposure with respect to private acquisitions are sometimes purchasing R&W insurance; and R&W insurance has even been purchased in public company transactions, although this remains a less common approach.
  4. Carriers writing R&W insurance have traditionally been hesitant to cover a transaction in which there was no seller indemnity. Rather, the carriers’ view was that a seller needed to have some “skin in the game” and that R&W insurance should respond to a claim only in excess of a seller indemnity. More recently, however, carriers have been more receptive to writing R&W insurance in transactions without a seller indemnity. Note, however, that the lack of a seller indemnity may moderately increase policy pricing and result in enhanced carrier due diligence and tighter policy terms and exclusions.
  5. As the use of R&W insurance has increased and policies have become more standardized, the time needed to obtain such insurance (primarily, the time that carriers need to underwrite the risk) has decreased. While it is still preferable to have two to three weeks for carrier underwriting and policy negotiation, it is now possible to obtain R&W insurance in less time.
  6. While there is not a large amount of publicly available data relating to claims on R&W insurance policies, as the market expands, there has been an increase in claims being made and paid. (This is not to say that every claim is being paid or is being paid in full—and the process can be challenging.) Moreover, the marketplace is sufficiently competitive at present that carriers who develop a poor reputation with respect to claims handling put themselves at risk of losing business to those carriers who conduct themselves more appropriately.
  7. Just as new carriers have entered the marketplace, additional brokers are seeking to market R&W insurance. Potential purchasers should be aware of the importance of using experienced and sophisticated brokers when purchasing R&W insurance. Brokers play a more substantial and more substantive role with respect to R&W insurance than they do in some other areas of insurance.

Overall, through the expansion of the R&W insurance market, R&W insurance has become more useful, more accessible and more insured-friendly. Additionally, while it remains crucial to carefully coordinate the R&W insurance process with the broader deal process, the underwriting process for R&W insurance has generally become shorter and smoother. Finally, increasing underwriter familiarity with M&A transactions has also contributed to the growth of other related insurance products, including with respect to regulatory approval risks, break-up fees and certain tax-related risks—areas where we expect continued future expansion.

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