Warranty and Indemnity Insurance – the what, why and how of it?
13 June 2017
Whilst the use of W&I Insurance in M&A transactions has been available for some time, its use has increased dramatically in the past few years, particularly in the technology, real estate and manufacturing sectors.
What…you need to knowWarranty and Indemnity (W&I) Insurance is a tailored insurance product that provides cover for breaches of warranties, covenants (including the dreaded tax covenant) and, in some circumstances, specific indemnities given by the seller under a sale and purchase agreement (SPA). W&I is by far the most common of the various M&A insurance products available and with falling premiums in recent years it is always an option for both buyer and seller to consider.
Why…everyone loves W&I insurance
For a seller:
- an almost clean exit: W&I insurance gives peace of mind to individual sellers and it enables institutional sellers to distribute sale proceeds to investors. Often escrow can be avoided altogether;
- manageable cap on liability: as part of SPA negotiations sellers often look to cap their warranty and other liabilities at a level the buyer isn’t comfortable with. Using W&I insurance, enables sellers to cap their liability for the buyer’s warranty losses at a far lower level than a well advised buyer would typically agree to otherwise;
- smoother transaction: the comfort of W&I insurance can dramatically speed up the negotiation around several particularly emotive areas of a transaction where many deals can stumble, if not fall; and
- reducing sell-side conflicts: where a group of sellers includes any special classes of seller, such as passive investors, trustees or institutional investors, these sellers would traditionally resist warranty liability to a large extent. W&I insurance plays a key role in reducing the scope for conflict amongst the seller group around this issue and can meet the competing objectives of most classes of seller.
For a buyer:
- extent of coverage: provided warranties are sensibly negotiated, a buyer will ordinarily obtain a broad and extensive warranty coverage when W&I insurance is involved and will reach agreement with the sellers far more quickly;
- duration of coverage: again, a ‘market’ duration is likely to be agreed fairly easily and often this can be extended by agreement with the insurer;
- shine (or don’t look dull) in an auction: typically a buyer offering to pay for a W&I policy will be far more attractive to a seller than one who will not;
- reduce risk of an insolvent seller: warranties are only as good as the liquidity of the person giving them, so claiming under a policy eliminates the risk associated with a seller’s solvency;
- don’t anger your management team: where sellers remain closely involved in running a target business, a buyer may be more reluctant to sue for a breach of warranty due to the possible collateral damage to the target. Claiming under a W&I policy dramatically reduces this potential impact.
How… much does it cost
Unsurprisingly each deal will differ but some guidelines on premium costs are:
- typical premiums: 1-1.75%* of cover sought (although we have seen lower than 1%);
- upper limits: up to £150m of cover would not be difficult to achieve and limits can reach far higher once insurers are comfortable with the deal;
- lower limits: there is no minimum cover but we have seen insurers set minimum premiums of circa £50,000-60,000*.
( * Premiums will be higher where specific indemnities, other than the tax covenant, are covered).
Predictions for the Future
We predict consistent year-on-year increase in the use of W&I insurance for many years to come.
The growth of M&A insurance in the USA outstrips all other territories, with elements of increased use and coverage enhancements moving to the UK and the rest of Europe. W&I insurance is likely to continue to grow globally, with particular growth in Germany, Netherlands and Denmark. Use in the UK will continue at a similar pace.
With current economic uncertainty putting some expansion plans on hold, the certainty offered by W&I insurance will doubtless be one of the factors to encourage hesitant buyers into the UK acquisition market.