Insights

4 Factors That Impact the Cost of R&W Insurance and 1 That Doesn’t
POSTED 11.28.18 M&A

When it comes to M&A transactions, the relatively low cost of Representations and Warranty (R&W) insurance makes it a no-brainer for those Buyers and Sellers who want a smoother deal process, more money at closing for the Seller, and a third-party (the insurer) ready to pay out to the Buyer if there are any breaches post-closing.

Right now, the cost of R&W coverage is a narrow range. The premium insurers will charge is 2% – 4% of the policy limit. And that number doesn’t appear to be going up anytime soon.

Add to that the Underwriting fee, which is $25k – $50K (depending on the size and complexity of the deal) and policy taxes determined by the Buyer’s state of domicile, which can range from 3% – 7% of the premium.

For the peace of mind you get with R&W insurance, it’s a small price to pay.

In general, Underwriters want to take on risks they’re comfortable with… something that’s not likely to result in a claim. Deals with little chance of a breach get more favorable treatment.

When Underwriters are faced with a risk that doesn’t meet their criteria, they’ll simply exclude it from the policy.

That’s different than auto insurance, where they’ll still insure you, but charge you more money.

In the case of R&W Underwriters, they’ll offer credits or discounts to risks they feel are more favorable.

That being said, there are some factors to consider as you approach insuring your deal with a R&W policy that could raise or lower the price. Even modest discounts start to add up.

1. No Indemnity Deals Cost (Slightly) More

The biggest material difference, cost-wise, comes with deals where the Seller provides no indemnity for breaches of reps or warranties as part of the purchase agreement.

In these transactions, the Seller has “no skin in the game” and the Buyer is assuming all the risk.

If this is the case, the insurer is likely to require a higher premium to protect against this perceived higher risk. (Because in this case, the Seller doesn’t have a whole lot of incentive to make sure all their reps and warranties are spot on.)

These transactions are now insurable, but run 15% higher than standard R&W policies.

Some insurance companies are offering dual pricing. One for traditional R&W insurance covering a standard M&A deal and one for no indemnity deals.

2. Is There a Due Diligence Memo?

When it comes to R&W insurance, the Underwriters count on the Buyer to do all the legwork and background research. The due diligence memo, essentially a roadmap prepared by an experienced M&A attorney for their client, is a key part of that.

The memo compiles and summarizes all the diligence and vetting of a target company. This is exactly the information that makes an Underwriter’s job easier, so they look more favorably on deals with this memo and will offer a modest discount on your premium.

3. Availability of Audited Financials

A big part of the risk of buying a company is finding out that the financials provided by the Seller turn out to be incorrect. That’s why Underwriters like to see these reports as well.

However, while in the past, transactions that didn’t include a target company’s audited financial statements wouldn’t have been eligible at all for R&W insurance… it’s a different story these days.

Now, if there are supporting reviewed statements, like quality of earnings reports, insurers feel comfortable proceeding. This type of risk, once ineligible, is now good-to-go, although it makes the policy slightly more expensive.

4. It’s Who You Know

It’s a dirty little secret. But an Underwriter’s familiarity with the deal team, either the insurance broker, the M&A attorneys, or the Buyer/policyholder, can lead to modest discounts on the premium.

If the insurer has dealt with you before, you save money, essentially. Credits, otherwise not available, are miraculously found.

5. The Industry

You might think that the industry or type of company might have an influence on the price of a R&W policy. But it’s not really the case.

However, it is something to consider because some Underwriters won’t entertain deals in certain industries or sectors. Some specialize in, say aerospace or digital entertainment, but don’t feel comfortable going outside that area.

Once Underwriters get familiar with a class of business and feel comfortable, they like to stay. So, if you’re rejected by one insurer, check out others.

Pricing for R&W Insurance to Stay Level

In the near term, I don’t see premiums going up. But there are other trends to watch in Representations and Warranty insurance.

The number of policies being written is steadily increasing as more insurers offer this product and more M&A attorneys and advisors (as well as Buyers and Sellers) realize its value.

Also, the threshold for deal size has dropped significantly, down to as low as $20 million. That makes this specialized type of insurance more attainable – and affordable – than ever.

How much would a policy cost you?

Here’s a free tool to help you calculate roughly how much an R&W policy would cost to cover your next M&A transaction. Download it here:

Representations and Warranties Insurance Cost Calculator