Warranty and Indemnity Insurance – the what, why and how of it?

The use of W&I Insurance in M&A transactions has offered stability to one facet of the sale process in what is a period of considerable economic uncertainty. Simultaneously, we have seen premium rates falling and average insurance limits increasing year on year.

What…you need to know

Warranty 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.