M&A and Transaction Solutions
Representations and Warranties Insurance: Streamlining M&A Negotiations
October 30, 2023
Buyers and sellers have a
lot at stake during the M&A process. They also have different goals and
motivations.
Buyers typically want to protect their investment as much as possible by doing their due diligence, seeking broader representations and warranties, requesting more comprehensive indemnities and requiring larger escrows and holdbacks.
Sellers will often look to make as clean of a break as possible, seeking to reduce their transaction indemnity profile risks. As such, sellers tend to want fewer and narrower representations and warranties with shorter survival periods. In addition, sellers typically request limited indemnities and smaller or no escrows and holdbacks.
Because of these unique goals, there is often a
disconnect between buyers and sellers, with neither wanting to accept more risk
than is necessary. Representations and warranties insurance, or R&W
insurance, is a type of M&A insurance that is often used to facilitate
deals, providing both buyers and sellers more flexibility and peace of mind
when it comes to risk allocation.
What Is Representations and Warranties Insurance?
Representations and warranties insurance is a specialized form of insurance that compensates a buyer or seller for financial losses due to a breach of contractual representations or warranties made as part of a purchase agreement. Once a merger or acquisition deal has been finalized, reps and warranties insurance can cover unforeseen costs caused by breaches of the seller’s representations.
In an M&A deal, reps and warranties insurance replaces the need for a large escrow account with a relatively low-cost insurance premium. This can help streamline deal negotiations.
While the majority of policies are written buy-side, both buyers and sellers can benefit from reps and warranties insurance. In addition to cash conservation, R&W insurance benefits include the following:
Representations and Warranties Insurance Policy Characteristics
Because reps and warranties insurance is not a standard policy, it can vary from organization to organization. However, many policies share the following characteristics.
Coverage
In general, these policies are tailored per transaction. It is not uncommon for reps and warranties insurance policies to provide blanket coverage for breaches of the seller’s representations and warranties found in a purchase and sale agreement. In some instances, a party may purchase R&W insurance without the consent or knowledge of the other entity involved in the deal.
Retention and Deductible
Representations and warranties insurance policies will often contain a self-insured retention or deductible. These will vary between transactions based on an insurer’s risk assessment but typically fall between .75% and 1% of the total value of the transaction.
Duration of Coverage
Policyholders can negotiate the duration of reps and warranties insurance coverage. However, insurance will typically match the survival periods of the general and fundamental representations and warranties found in the purchase and sale agreement. Policy purchasers may extend coverage as needed.
Coverage Limits
Limits will vary between policies. Limits can be set and negotiated up or down based on indemnification provisions under the purchase and sale agreement.
Pricing
Pricing of reps and warranties insurance policies depends on the nature of the insured risks, the amount of the retention, the length of the coverage and the coverage limit. Generally, pricing can range from 2.85% to 3.5% of the policy limit.
Representations and Warranties Insurance Policy Exclusions
It is important to note that R&W insurance policies often contain a number of exclusions. Generally, these policies do not offer protection for known issues and any breach of a representation or warranty when any member of the deal team has knowledge of the breach at the time the policy’s coverage begins. Policies may also have exclusions specific to the transactional risks insurers aren’t willing to cover. While representations and warranties insurance can help parties speed indemnity negotiations, it doesn’t replace the need for thorough M&A due diligence. Further, the intricacies of securing this specialized insurance require knowledge and experience. Depending on the deal size, not all brokers or insurers will accept the challenge.
Selecting a Representations and Warranties Insurance Broker
A deal worth $30 million requires the same expert care as a deal worth $300 million. Adding a reps and warranties professional to the deal team requires the same diligence as hiring a lawyer or accountant. Look for the following:
Appetite
The reps and warranties insurance broker should be eager, not just willing, to take on the assignment, committing senior-level talent to the project, not associates or junior members.
Experience
The broker should know how to efficiently resolve problematic issues and clear last-minute hurdles to help close deals. Ask for references.
Formal Processes
The reps and warranties insurance professional should establish expectations, timelines and communication protocols, maximizing transparency so the team is confident in the decisions being made. He or she must move expertly at the speed of M&A to help deals make it across the finish line.
Diplomacy
M&A negotiations can be tense. As part of the deal team, an experienced insurance broker professional should be able to ease tensions among team members.
Professionalism
While advocating strongly for the client, a broker must also work respectfully with insurance carriers. In addition to securing favorable terms and conditions today, a good partnership means the carrier will be willing to work on future deals with the team.
Learn More
Hylant helps deal teams minimize transaction risks, resolve problematic issues and optimize the value of M&A transactions, divestitures, public-to-private partnerships, commercial loans and structured financial transactions. If you would like to discuss how we can help streamline and protect your next deal, contact a member of our team.
Related Reading: M&A Due Diligence Must Include Insurance Due Diligence
The above information does not constitute advice. Always contact your insurance broker or trusted advisor for insurance-related questions.
