The use of warranty and indemnity (W&I) insurance in European M&A rose in 2015 and is expected to continue in this year’s deals. But the device has been questioned by some market participants unhappy with high costs, poor record of successful claims and regional discrepancies.
W&I insurance protects both buyers and sellers from losses caused by inaccuracies in representations and warranties included in deal documentation.
First introduced in 1998 in the US, the insurance cover has now become a mainstay of M&A transactions. Last year it featured in roughly 25% of European deals; the figure rose to 45% on private equity-backed M&A.
But according to speakers at IFLR’s European In-House Summit in London last week, questions surround the usefulness of W&I, particularly its cost. “From my point of view the cost of W&I can be prohibitive,” said Ailsa Harding, legal counsel, E&P, Centrica. “Sometimes it’s considered that if you are doing your due diligence properly then you shouldn’t need it,” she added.
- Warranty and indemnity insurance in European M&A rose in 2015 and is expected to continue in this year’s deals;
- But some market participants are unhappy with high costs, poor record of successful claims and regional discrepancies;
- In 2015, coverage on UK deals was typically 10-20% of deal value, with premium costs generally one to two percent of deal value;
- While there is a consistent level of premium in UK deals, prices rise for US deals and it is almost impossible to secure in certain African jurisdictions;
- There are exclusions that fall outside W&I coverage including anti-corruption issues and certain tax issues.
Despite this sentiment, the costs of W&I insurance have dropped as its popularity has risen. In 2015, coverage on UK deals was typically between 10% and 20% of deal value, with premium costs generally one to two percent of deal value.
The process of assessment has developed too. “The insurers are sophisticated now, they take a holistic view of diligence, what the reports and disclosures look like and who the advisers are,” said Laura Brunnen, partner at King & Wood Mallesons. That assessment then gets built into the pricing, which is partly why pricing has come down, added Brunnen.However, there are costs beyond the premium paid to the insurer, such underwriting fees and broker fees. And because the proceeds take the form of a taxable receipt, not all of a claim will go to the buyer if successful. “In which case you will need to factor in the gross amount into your premium which starts pushing up premiums again,” said Brunnen.
There are also huge discrepancies between regions' approaches to W&I. There is a consistent level of premium in UK deals, but prices rise for US deals. And there are certain African jurisdictions where it is almost impossible to secure.
"The insurers are sophisticated now, they take a holistic view of diligence"
Under a seller policy W&I, the buyer claims against the seller under a sale and purchase agreement (SPA) and has no direct claim against the insurance. Under a buyer policy, the buyer claims against the seller up to the agreed cap under the SPA, and then claims against the insurance for liability above the cap.
But W&I insurance doesn’t offer full protection in deals, according to Brunnen. “These insurance packages are not a panacea to all types of risks,” she said.
There are exclusions that fall outside W&I coverage. For example, in a locked box situation W&I won’t cover price adjustment mechanisms such as leakage from a locked box. It also omits anti-corruption coverage and certain tax issues, according to Brunnen.
Others were more in favour of the cover, despite occasional the need to educate parties on its importance. James Hodges, general counsel and company secretary at Hydrodec said that the trade buyers he deals with, who only work on M&A sporadically, are often surprised when W&I insurance is raised. “But I think it is good to get it in to the mix. The potential value and flexibility provided is, generally, quickly appreciated,” said Hodges.
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