Warranty & Indemnity (W&I) Insurance
In respect of M&A transactions, the insurance market – first in the United Kingdom – has developed suitable warranties with insurers with the aim of externalising part of the risk transferred to the buyer by the seller. Indeed, in the aftermath of the transaction, it is not unlikely that a liability both the seller and buyer should not be aware of occurs while being already underlying before the transaction takes place. Buyers accordingly guard against this additional burden by using W&I, which those insurance policies try to partly externalise. The ultimate example is the tax risk carried by a company that did not comply with its obligations prior to the transaction but that actually turns out once the deal is done.
Contractual freedom fully plays its role by allowing the seller to transfer part of the consequences of their liability, in the event of a loss due to occurrences that took place prior to the acquisition. Being the most common option, it enables setting the transaction price by partially disposing of uncertainty related to professional indemnity.
In addition to supplementing or standing in for the seller’s creditworthiness, W&I insurance often provides a psychological benefit: in return for paying a premium – even high – the parties earn a form of tranquillity allowing them to take the next steps of the negotiation, even to close the deal.
Types of W&I insurance policies:
In practice, there are three types of W&I insurance policies:
- Representations & warranties (R&W) insurance
Encompassing the majority of contracts, R&W insurance aims to protect against unknown losses at the time of the transaction arising due to the seller’s breach or inaccuracy of certain of its representations in the acquisition agreement, or because the seller’s liability is invoked after the transaction.
- Contingent liability insurance and/or litigation buy-out insurance (LBI)
This type of insurance, although less common, focuses on known issues such as the risks inherent in outstanding litigation, notably in labour law or environmental law. Thus, the hazard does not depend upon whether the event is occurring or not, but upon the financial consequences of dispute resolution.
- Tax opinion insurance
This type of insurance focuses on a known tax risk. It may be regarded as a subcategory of contingent liability specifically protecting against the consequences of the acquired company’s tax litigation.
The major takeaway of the three types of insurance mentioned above is that it is much less common to provide a protection against a known risk and that usual W&I covers are those that hedge the unknown transactional risk. More specific insurance policies are only considered for larger transactions and when the identified risk is known. Those policies pave the way for an easier agreement by disposing of a meaningful impediment between the seller and buyer.
Liability insurance or property and casualty insurance
For the cover to be granted, any liability insurance policy assumes that the policyholder (the seller) is liable in law – in this case liable for a breach or inaccuracy of certain of its representations. Thus, there is a risk that in order to deny the policyholder the cover, the insurer pretends that the insured knew the risk when he or she took out the insurance policy, which would add up to a lack of hazard letting the insurer deny to grant the cover.
That is the reason why as to the W&I insurance, a property and casualty insurance policy taken out by the buyer is preferred, since it does not require to prove the seller’s liability. The cover will be easier to get; however, the related premium will necessarily be higher than for a liability insurance policy. As to the payment of the premium, if it theoretically falls to the policyholder, i.e. the buyer in the case of a property and casualty insurance policy, it may easily be conceived that this premium comes under consideration when it comes to setting the transaction price.
A British trend booming in France
If the British W&I insurance market is well established with about 200 W&I insurance contracts being concluded every year, it is more hesitant elsewhere in Europe where contracts number a few dozen per year and per country.
The total amount of premiums collected by insurance companies for W&I insurance in Europe is estimated at 550 million euros per year, versus 1.1 billion euros for company representatives’ professional indemnity as a comparison. The average premium of those contracts is between 2 and 3 million euros.
In Europe, five main insurers – AIG, Ambridge Partners, Liberty Mutual, Euclid, and Tokio Marine-HCC – are sharing the major part of the market. The remaining segment is served by around ten other insurers which include Aviva, AXA XL, Zurich, Beazley, or NV. Japanese Sampo and German Amaniki may also be considered as they are specialised in W&I insurance. The major brokers in the French W&I insurance market mainly include Marsh, Willis Gras Savoye, and Siaci Saint Honoré. The complexity of due diligences that come before establishing W&I covers necessarily limit the number of intermediaries to those whose the size makes it possible to utilise all the skills that are needed in order to analyse the risk. To some extent, the insurer may also use the due diligences of the target performed by the buyer’s team.
If insurance premiums may amount to around ten million euros, the current trend shows an increase in small-volume transactions thus in premiums that may go down to 300,000 euros. If the theoretical maximum capacity of covers is 450 million euros, highest covers provided in France hardly ever go over 150 million euros. We have also been witnessing an increase in W&I insurance contracts for smaller transactions.
For two years, being in line with the American trend, an increasing number of buyers – as opposed to sellers – have been taking out W&I insurance policies. Likewise, as the corresponding covers are the result of long study, some sellers pre-negotiate W&I insurance before the transaction to make it run smoother. The buyer is therefore proposed to buy the cover that has been already negotiated.