Insights

The R&W Insurance Market Grows and Matures
POSTED 6.25.19 Insurance

It’s a good time to be alive for Buyers and Sellers in the M&A world.

The use of Representations and Warranty (R&W) insurance, is more widespread than ever, with deals as low as $15M considered insurable. That’s down from a minimal deal size of $100M just a couple of years ago.

What makes R&W coverage so attractive?

It protects both Buyer and Seller if there is a financial loss resulting from a breach of the Seller’s representations that were outlined in a purchase-sale agreement. 

The insurer covers the losses in case of a breach because they take on the indemnity obligation from the Seller.

Plus, the number of insurance companies offering this coverage has jumped from 4 in 2014 to more than 20 today.

The news comes from the latest report from one the largest insurance companies in the R&W and broader M&A insurance space, AIG. The report, their fourth in the Claims Intelligence Series report, is called Taxing Times for M&A Insurance.

When this report is released, those involved in the M&A industry and Private Equity pay close attention to the trends it highlights.

The bottom line is that more R&W policies are being written than ever before as both Buyers and Sellers come to understand the benefits such a policy will bring to their deal, such as…

  • Smoother, more efficient negotiations of the purchase and sale agreement.
  • More money at closing for the Seller (escrow is eliminated, and the indemnity risk is placed with the insurance company).
  • An easy route for the Buyer to recoup financial losses in case of a breach post-closing.

Both sides of the table have a better understanding of how R&W works, not just for their negotiations, but when the time comes for actually “using” their policy.

That calls to mind another trend of note: more claims are being reported in this space. It’s not surprising as there are more insured deals out there. But never fear, insurance companies do pay claims in this space readily, unlike with some other forms of insurance. And, as of now, the trend of claims isn’t outpacing the premiums generated by R&W, so pricing and retentions will remain steady. 

Plus, it’s clear that policyholders (the Buyers) are better prepared to work with the insurer to get their claims paid. The more policyholders purchase R&W, the more comfortable they’re getting as R&W impacts their negotiations as well as when a claim does happen, they are better prepared to:

A) Report a loss at a more favorable time (after the Retention level has dropped down 12 months after closing), and

B) When they do report a claim, they bring extensive supporting documents to help the insurer process the loss more efficiently and quickly. This comes from R&W claims representatives who work with policyholders directly on claims.

Note that 74% of breaches are reported to R&W Insurers within the first 18 months of closing. It’s more evidence that policyholders are more sophisticated in the use of R&W, with half of those breaches reported after 12 months when the Retention drop-down provision has been triggered.

Overall, this is a good sign that R&W insurance is steadily maturing and provides a sustainable tool for M&A.

Here are some of the raw numbers:

  • In their report, AIG notes that there were 580 claims from the 2,900 policies the company wrote for deals from 2011 to 2017. This finding is based on claims filed (including claims where the amount sought did not exceed the retention amount), not claims paid.
  • Claims were reported on 20% of all deals, with claim frequency at 26% for deals from $500M to $1B in size. Bigger, more complex deals register claims in one of every four transactions. So larger deals are experiencing claims more frequently (1 in 4 as compared with 1 in 5 for sub-$500M deals).
  • Claims severity grew, with the most material claims (valued over $10M), increasing from 8% to 15%, at an average of $19 million. Big losses are getting bigger. On the other hand, smaller Claims (those under $1M) are mostly falling below the policy retention, resulting in no payment by the insurer. Look for insurers to continue maintaining retention levels at the 1%-2% transaction value for sub-$500M deals. 
  • Despite the larger deals experiencing big losses on a more frequent basis, competition among R&W insurers will continue to force rates and retention levels at lower levels for the immediate future.
  • Most financial breaches are discovered during diligence. Undisclosed liabilities are harder to identify which is why they are the largest source (1/3) of financial breaches.
  • Tax related breaches follow right behind financial breaches, with compliance with laws and material contracts rounding out the majority. 

Buyers and Sellers interested in one of these R&W policies need a broker who specializes in R&W, works on these deals routinely, and is experienced in M&A.

I’d welcome the opportunity to speak with you further about how R&W insurance could benefit your next M&A deal. You can call me, Patrick Stroth, at 415-806-2356 or send an email to pstroth@rubiconins.com, to set up a time to chat.