Demand for Transactional Risk Insurance (Reps & Warranties Insurance) is high & moving higher. There is a significant emerging trend in the use of M&A warranties insurance in mergers and acquisitions of privately held companies.  

The Benefit of Getting Insurance Coverage

The key benefit of reps and warranties insurance policies is that they provide a viable alternative to escrow funds or similar indemnity requirements, which are used to protect buyers in the event of a breach of any of the representations and warranties contained in transaction documents.

Both strategic acquirers and private equity buyers have gotten increasingly comfortable in using such insurance for their acquisitions, providing meaningful benefits to both the buyer and seller in an acquisition.

Here are 8 things to know about general reps and warranties insurance.

#1 Representations and warranties insurance is an insurance policy used in mergers and acquisitions

As a result, the insurance protects against losses arising due to the seller’s breach of certain of its representations in the acquisition agreement. While it’s best to engage your insurance representative early in the process, an ideal time frame would be two to three weeks prior to the signing date.  If the deal has already been signed, coverage can still be secured prior to closing – although there’s less room for negotiation on the terms of the policy at that point. 

#2 24 insurance companies actively quote Reps & Warranties Insurance

Competition is aggressive for attractive deals resulting in coverage and price improvements. With the increased demand in coverage, more and more insurance companies are competing in the space.

#3 Pricing

Rates continue to soften as we look at the pricing in the general reps and warranties insurance world.  Current rates at the primary layer are trending at 2.75% – 3.25% of the indemnity limit. This is down from 4%-6% just 24 months ago, depending on the size of the transaction. It’s important to note that excess layer pricing bottoms out at around 1% of the indemnity limit.

#4 Standard Retentions

Retentions and deductibles have also decreased 25-50% to about 0.5% – 1.0% of deal value, down from 1.5%-2% a few years ago. They are 1% of the enterprise value of the transaction, but they drop to 0.5% after 12-15 months. Just as the deal market has remained strong for several years and healthy valuations persist, the market for representations and warranties insurance has expanded rapidly. 

#5 Standard Policy Terms

Standard policy terms are three years for general reps and 6 years for fundamental reps. However, it’s possible to extend the coverage period for the general reps.

#6 Recent Developments in Coverage

Overall general reps and warranties insurance coverage terms and conditions have become broader in recent years. Insurance companies are now willing to cover liabilities that, not too long ago, they were quick to exclude such as tax liabilities, intellectual property infringements, product recall, product liability, environmental risks, and regulatory risks. There is also coverage for pre-closing tax returns, for example, Research and Development credits, accelerated depreciation schedules, Pre ASC 606 revenue recognition, etc. 

#7 Underwriting Information Required

Initial Pricing/Coverage Indications (2-4 days) – we will execute an NDA with your firm, and then secure joinders to that NDA from all interested insurers.  Once we are all under NDA, we will need to provide the following items:

• Most recent versions of the Purchase Sale Agreement

• Most recent audited or reviewed financials if audited financials are not available

• In the absence of audited or reviewed financials, underwriters would require a 3^rd party Quality of Earnings (QofE) analysis for the target if financial reps are to be covered

• Copy of the Confidential Information Memorandum or slide deck outlining details of the entity

• Copies of the draft disclosure schedules, if available

#8 Full Underwriting Process

The full underwriting process for general reps and warranties insurance is 1-2 weeks but can be longer if necessary. Once indications are reviewed and vetted, there are a few things that will be done:

• Select the insurer, pay the required, non-refundable “underwriting” fee

• Provide access to data room with due diligence reports and supporting material

• Update terms of all deal documents

In conclusion, general reps and warranties insurance lowers your risk and minimizes uncertainty. It can be a complex and detailed process. It’s imperative you have a skilled broker guiding you through the process of placing this specialized type of coverage. Diversified is happy to answer any questions you may have. Go HERE for more information.