Warranty and Indemnity (“W&I”) insurance is one of the many risk management options available to those carrying out merger and acquisition type transactions. We have seen an increase in the use of W&I insurance on transactions that we have worked on and more generally in the lower mid-market.
This has been an emerging trend over the last few years, as historically W&I insurance had been the preserve of much larger transactions. But what has driven this and what should someone who is going through a M&A transaction think about when considering a W&I policy? I spoke to two experienced brokers to help give some insight, James Wilson of RFIB Group and Jonathan Harrison of Henderson Insurance Brokers.
We’ve seen an increase in the use of W&I insurance in mid-market M&A deals, what are the key drivers of this?
JW – W&I insurance is an alternative to traditional transaction mechanisms which can “bridge the gap” between Buyer and Seller in negotiations, to help complete a transaction and manage risk. It is now cost-effective and easy to implement through a good broker.
JH – We think there are a combination of reasons why its use has increased:
- A growing awareness and knowledge of the product and the benefit it can deliver in limiting liability or providing a clean exit for sellers
- A growing demand for risk protection from participants in a transaction
- Affordable premiums and sensible excess levels. Historically W&I insurance has been seen as an overly expensive product, but it now represents good value with premiums typically between 1% and 2% of the policy limit.
How might an owner manager benefit from a W&I policy?
JH – Using a W&I policy, an owner manager could:
1. Limit their liability for a breach of a warranty they give about the business under the acquisition agreement
2. Free up their sale proceeds that may be tied up in an escrow account, or be otherwise ring-fenced. The owner manager has more or less immediate access to funds from the sale to either spend or re-invest into a new business
JW – It provides economic certainty regarding liability, allowing a clean exit for Sellers, enabling them to distribute sale proceeds immediately and with confidence.
The insurance process can start with the Seller and then flip to the Buyer, forming part of their recourse package, allowing the Sellers to have lower or little liability post completion. The Buyer can claim directly from the insurer, usually meaning that re-engaging with the Seller is unnecessary.
What considerations should someone who is thinking about employing a W&I policy, be making?
JH – Be properly advised and conduct proper due diligence; a W&I policy should not be perceived as a substitute for legal advice or due diligence. Indeed, insurers utilise such due diligence in their underwriting process. Specific risks/concerns should be flagged as early as possible.
Price is key, but not all that matters; reputation and track records of both the insurers and brokers you choose to engage with are vital, both in terms of executing the risk placement, and in the handling of claims. With regards to price, risk vs. premium expectation should also be taken into account.
JW – An important aspect to consider when contemplating using W&I insurance, is when to involve insurance in the sale process. Earlier is more beneficial for the construction of the policy, enabling more favourable pricing and policy coverage, whilst seamlessly moving alongside the normal negotiation of the underlying transaction agreement.
How does a good W&I broker add value through the transaction process?
JW – The broker should manage the insurance process for the Seller, liaising with the transaction advisers and addressing any liability concerns identified, to remove uncertainty from the transaction.
JH – A good broker will facilitate a smooth process, driving it to ensure it dovetails with the acquisition agreement. They will also work with the insurer to ensure risk is presented accurately and that W&I insurance proposals are competitive and well-structured.
What are the main issues/barriers to putting in place an effective W&I policy and how can they be avoided?
JW – As mentioned earlier, timing is key. Whether this be when the insurance broker is engaged or the flow of information surrounding the transaction documents.
Another important aspect to highlight is that these policies are not a replacement for due diligence and it should be conveyed clearly and quickly what can and can’t be covered in the W&I policy.
JH – The main pitfall is assuming that W&I insurance is a catch-all substitute for proper due diligence. It should be considered a tool to sit alongside thorough due diligence as a meaningful risk transfer mechanism. Partnering with a knowledgeable and supportive broker will ensure that W&I insurance can be utilised as a key asset in a firm’s approach to M&A activity. Premium has become far less of a barrier as pricing has become more competitive.
BHP Corporate Finance has considerable experience in dealing with M&A transactions which include W&I insurance. If you have any questions or wish to discuss how we can help you, please feel free to speak to a member of our Corporate Finance team.
By Andy Haigh
Director, BHP Corporate Finance