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Warranty & Indemnity – Insurance for unknown risks

written by Dr. Dennis Froneberg 13. March 2019
M&A Insurance

Introduction

Over the last years warranty & indemnity (W&I) insurance policies have become a well-established mitigant for certain risk exposures for sellers and purchasers within M&A and real estate transactions. A significant and ever growing number of M&A and real estate transactions now include a W&I insurance solution. Popularity varies depending on the parties as well as the jurisdictions involved. Transactions with PE involvement have historically been on the forefront implementing W&I insurance solutions, while corporates are increasingly exploring such solutions.

Within the framework of a W&I policy, AIG insures claims of a purchaser against sellers for breaches of warranties and tax indemnities included in the underlying transaction agreement. A W&I insurance, in principle, only covers unknown risks that have not, for example, been detected in the course of the due diligence. Therefore, a thorough purchaser’s due diligence is a necessary prerequisite for comprehensive coverage. W&I policies can be underwritten as either sell or buy-side policies whereby buy-side policies are far more frequently used in the current market.

Advantages of W&I Insurance

A W&I insurance has numerous upsides for the deal parties:

  • Sellers’ motivation to use W&I insurance is often driven by the possibility of a clean exit. W&I insurance facilitates minimizing the need for provisions for post-M&A liabilities, winding-up of fund structures and cash distributions; the use of escrows can frequently be avoided or escrow amounts significantly reduced when taking out W&I insurance.
  • Purchasers can increase their protection against unknown risks, as sellers can offer an extended catalogue of warranties than it would otherwise be prepared to subscribe to. A W&I insurance can therefore also be a crucial tool to “sweeten the bid” in a competitive auction progress.

W&I Insurance may furthermore help with otherwise stalled negotiations or ease future relations, as any claims pursuant to the transaction agreement can be resolved with the insurance provider as separate party.

Process and Commercials

The underwriting process for a W&I insurance usually takes between 4 and 9 business days following the deal timeline without delaying it. AIG and involved advisors will review transaction documentations as well as due diligence materials and conduct a brief Q&A process to assess scope and quality of the due diligence and the disclosure process. A lean process and tailor-made approach allow for a W&I policy to be adjusted to the particular transaction and the parties involved.
AIG can offer limits up to EUR 125m on a stand-alone basis for a single transaction; larger limits can be underwritten through a program of insurers. Prices for W&I policies typically range between 0.7 and 3 percent of the policy limit, depending especially on the type of deal as well as the geographical footprint and the industry of the targets. W&I policies usually provide for a retention amount between 0.5 (0.1 for real estate transactions) and 1 percent of the transaction value as well as a de minimis amount based on either the de minimis provided for in the transaction agreement or the materiality thresholds applied in the due diligence review.

Conclusion

Based on the approach and principles outlined above, W&I insurance has developed into a reliable and a broadly accepted solution for risk allocation within M&A and real estate transactions. Considering AIG’s track record with about 1,000 W&I policies placed worldwide and the current outlook on the M&A and real estate markets, the upward facing trend for W&I insurance solutions implemented in M&A and real estate transactions should continue persistently.


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