Transactional Insurance Products Help Close More Deals

Have you ever thought of using insurance to gain a competitive advantage to close more deals?  If not, perhaps it’s time to explore the concept.  From early stage ventures to distressed buyouts, a common thread to all deals is risk.  Risk is present in all M&A transactions. How one chooses to address the risk in a transaction can greatly affect the outcome.  If a buyer or seller is able to transfer risks outside the scope of a deal, they can negotiate their position with greater certainty and thus create a competitive advantage over other parties. 

Insurance is a mechanism designed to transfer risk from one party to another and can be applied to most M&A scenarios.  For example, if a certain liability is disclosed in the confidential memorandum or uncovered in the due diligence process, a buyer can negotiate a lower purchase price as a result of this liability. This same buyer can arrange to transfer this liability post closing using an insurance product.  Such a strategy can improve the odds of positive returns for the transaction.  A sell-side example would essentially work in a similar fashion with the seller negotiating a higher selling price as a result of the decreased exposure to risk.  In both of these scenarios insurance isolates the risk, provides greater certainty to both parties and increases the chances of closing the deal.

Reps & Warranties Insurance Minimizes Uncertainty

Perhaps the most common insurance product used in deals is Representation and Warranties insurance.  Over the past decade, Reps and Warranties policies were most typically employed by sellers as a way to supplement the indemnification provisions of the Purchase & Sale Agreement. These policies provide sellers with enhanced protection in the event of a buyer’s financial loss for a breach of reps and warranties.  The purchase of a Reps and Warranties policy may entice buyers to forgo the customary escrow account that is established in the event of a breach.  Without the escrow account, the seller receives more of the sale proceeds upfront and can make a more timely and clean exit.

A Reps and Warranty policy can also protect buyers in the event a seller is not able to provide full indemnification due to insolvency or other issues.  Perhaps the seller will not accept an escrow greater than two years, but the buyer could secure a three to five year policy providing extended indemnification. In the event of a financial loss due to a breach, the buyer would only need to make a claim against the insurance policy to provide indemnification. 

Premiums Are Declining

Historically, the cost of Reps and Warranties insurance coverage ran between three-and-a-half percent and six percent of the policy limit purchased.  Reps and Warranties rates have dropped to between two percent and five percent. However, insurers are invoking minimum premiums of $100,000 or more.  Policies purchased by sellers tend to be less expensive than policies purchased by buyers because sellers are typically willing to provide greater disclosure to the underwriters in order to secure coverage. 

Despite the declining cost, Reps and Warranties insurance still is not commonly used in deals.  The advantages available to both buyers and sellers abound. Dealmakers should consider the opportunities available to differentiate themselves from competitors, develop greater certainty in their transactions and provide creative solutions when exploring deals in this challenging economic environment.

Reps & Warranties Coverage in a Nutshell

Deploys insurance capital to respond to legal exposures that may prevent consummation of a business transaction
Programs can be designed to address both known and unknown exposures
Removes doubt and provides piece of mind
Underwriting process moves quickly to conform to transaction timeline
Cost: 3% to 15% of the limit (varies by complexity of the deal and product involved)
Deductibles: negotiable, but typically a percentage of the deal size
Policy Duration: negotiable, but at a minimum will track the Agreement
Due Diligence Fee: an upfront fee is typically charged, with the amount varying by product and complexity