As we head into the second half of the year, where deal flow is expected to be even more congested, R&W (representations and warranties) insurance may take more time, money and effort than you may remember from previous years.
Just like the M&A market, the R&W insurance market has become inundated. The demand for the product has grown faster than the supply, and this trend has become more acute since Q3 2020. Most insurers have already reached their target number for 2021. Underwriters are currently receiving more submissions than they can process, making them selective about which deals to quote based on variables like the target’s industry, deal size and parties/advisors involved. Some carriers may decline due to staffing or high volumes on the particular week they receive the submission from brokers, so if the deal timeline shifts, it may provide an opportunity to obtain additional quotes. We have seen a few transactions where the parties chose to forego R&W insurance and revert to a traditional indemnity structure due to lack of competitive terms.
The premium for R&W insurance has increased significantly in the last 12 months. While the “rate on line” (premium divided by the policy limit) has been declining in the last few years (reaching as low as 2.5% and infrequently exceeding 3.5%), a more common range initially quoted recently has been around 3-4.5% depending on the industry, and sometimes exceeding 5%. Carriers cite their claims experience and deal volume for reasons for the pricing increase.
The retention for the policy has not changed. A typical retention is 1% of the enterprise value (EV) initially, dropping down to 0.5% (usually on the first anniversary of the closing). As before, the initial retention for larger deals (close to or above $500 million) is often 0.75% of the EV. For smaller deals, minimum retention may apply (around $200,000, depending on the insurer and the type of transaction).
Term Sheets and Policies
The number and types of proposed coverage limitations in quotes have become more extensive and technical, including comments on the representations, interplay with other insurance, and cap on multiple damages (for some insurers). This trend has accentuated the need for experienced R&W insurance coverage counsel to be involved early and negotiate the terms at the quote stage because it would become difficult to do so later in the process.
Brokers and Underwriters
Broker landscape has changed significantly over the past year, both institutionally and individually. Clients should understand the particular broker’s experience, services and fees that may apply at the outset. As for the insurers, since 2020, the number of market participants has increased (2 entries, 1 exit). The movement of underwriters within the industry has had an impact on some insurers’ bandwidth and capacity to underwrite certain types of deals.
Carriers continue to process and pay claims, while large claims that exceed the retention are relatively infrequent. To date, litigation over R&W insurance claims in the U.S. is limited to a handful of cases and not necessarily indicative of any non-performance under the policy. As with other lines of insurance, a claim process typically involves fairly extensive information requests from the insurer (which can be discussed and tailored) and, sometimes, a damages expert for complex claims. Once a breach and loss are demonstrated, we have been able to leverage our knowledge of how the policy was underwritten and relationships with insurers and brokers to help clients achieve an acceptable resolution.If you have any questions regarding R&W insurance, please reach out to Ai Tajima and Cecelia Lockner.