W&I – too expensive, too much hassle? Think again. It is fast becoming part of a buyer’s armour in M&A transactions.
While W&I insurance has increasingly been used over the past 5-10 years, initially it was perceived to be too expensive and inflexible but it is now recognised as a solution driven M&A tool. However, the major change for 2018 has been that, due to increasing competition among brokers and insurers,there has been a noticable shift to open the market up to deal sizes, warranties and geographies that little over a year ago would have been uninsurable but which are now regarded as economical to insure, including in an increasing number of SME deals.
What is it?
To recap, warranty and indemnity (W&I) insurance provides cover for losses arising from a breach of a warranty and for claims under a tax indemnity (and, in certain cases, other equivalent provisions) in connection with a corporate merger or acquisition (M&A) transaction. The warranties given under the terms of the acquisition agreement (typically a SPA) play an important role in the transaction and are often some of the most heavily negotiated provisions in a M&A deal.
The insurance protection under a W&I policy covers loss or liability arising from unknown and undisclosed matters and provides indemnification for financial loss. The insurer effectively “steps into the shoes” of the warrantors and assumes the risk for a warranty given by any of the warrantors being breached. The intention is that the W&I insurance covers the risk of breach of the warrantors for an agreed period on agreed terms - the aim is that the insurance tracks the limitations on warranties agreed in the SPA (or enhances the protection for warranty breaches if the sellers / warrantors will only agree limited cover under the SPA).
Who should use W&I insurance?
The need for W&I insurance arises particularly where the quality or level of financial recourse or the duration of the cover offered from the warrantors is limited – W&I insurance can effectively bridge the gap between what the seller is willing to offer as cover for warranty breaches and the level of cover that the buyer wishes or requires.
The leading insurance brokers report that nearly all policies currently being issued are buyer-side policies. The key advantages of these policies are:
Some of the main reasons for a buyer-side policy are:
As noted, there is an increasing use of W&I insurance is in the context of auction sales though frequently now the seller will seek to “staple” the policy to the transaction – this is frequently done where the seller negotiates a buyer-side policy, and staples it to the transaction as part of the deal terms, and requires the buyer to enter into a W&I buyer-side policy. This allows the seller to manage the deal from the outset and control the warranty package, and it can avoid lengthy negotiations on the scope of warranties.
Is it a guarantee?
No, the one thing to remember is that W&I insurance is not intended to replace or avoid the need for a buyer to properly diligence the target business.
In order to claim under a W&I insurance policy, a buyer would need to demonstrate the claim falls within the insurance coverage (the insurer may have excluded cover for certain warranties) and there will be a de minimis (i.e. small claims) amount under which the policy does not apply (similar to the small claims threshold in the acquisition agreement). There is also a policy attachment point i.e. the buyer (or often the seller) is required to bear some financial risk before recourse to the policy has effect (i.e. the first X amount of loss is not covered by the insurance and only loss above that threshold).
There is a duty on the insured (i.e. the buyer) to disclose all material facts to the insurer. Failure to do so could result in the policy being unenforceable. W&I insurance is designed to cover unexpected issues that arise after a deal has completed, however, this assumes that the buyer has conducted due diligence (both financial and legal) into the target business rather than simply relying on the policy for protection. To that end, an insurer will want comfort that there has been a proper disclosure exercise carried out – otherwise the policy may only be available at a higher premium (to cost for the greater risk of a breach).
And so what is the cost?
W&I insurance is paid by a one-off premium, payable in full when the policy is taken out. It is typically calculated as a percentage of the total limit of the insurance coverage ranging from 1-3%. Owing to competition among insurers, premiums for buyer-side policies are typically now being charged at around 1.3% including insurer’s and broker’s costs.
There is often a negotiation as to whether the seller or the buyer is liable for the cost of the premium (or whether the parties jointly contribute to it).
And the good news in the SME market is that new insurers are joining the market who are focusing on SME deals and who are reported to be offering limits of £5m for a £45,000 premium allowing smaller deals to make use of the W&I product. Transactions with deal sizes in the region of £5-30m are now able to access W&I insurance.
To summarise: W&I insurance is now becoming a commonplace tool to facilitate M&A deals and no longer remains a benefit for the king-size deals only. SMEs are able to make use of it too to facilitate fast, commercial deals without protracted deal negotiation.
If you would like to find out more then please contact Tara Walsh at firstname.lastname@example.org or on 0131 226 8233. Tara is a Director in the MBM Commercial's Corporate team with significant experience in dealing with M&A transactions and W&I insurance.