While representation and warranty (R&W) insurance continues to be used across a broad range of M&A transactions, its use has cooled as dealmakers navigate challenging market conditions. Even for deals that are getting done, a smaller percentage of private deals have included R&W insurance than in recent, more robust M&A markets. The American Bar Association’s Private Target Mergers & Acquisitions Deal Points Study estimates that 55% of private transactions used R&W insurance in 2023, a fall from the record 65% set in 2021. As transaction values and deal flow have moderated, R&W policy purchasers generally have been able to obtain more R&W insurance quotes: For example, a $100 million enterprise value transaction in Q4 2021 may have received one or two R&W insurance quotes, while a $50 million transaction in Q3 2023 often resulted in more than 20 R&W insurance quotes.
As a result of the competition among insurers, we have seen increasingly favorable rates and policy terms for policy purchasers in 2023 and continuing into 2024, as well as carrier expansion into alternative transaction structures and historically harder to underwrite areas, such as healthcare and financial services. In addition, while traditionally driven by cost, carrier choice in the current market is increasingly driven by reputation and experience, because costs and policy exclusions decreased. Policy purchasers also are paying close attention to common claims and payouts when considering coverage options.
In this post, we dive into the current R&W insurance market and discuss common approaches to pricing, coverage, exclusions, structures, and claims.
Pricing
Policy limits
The coverage limit under R&W insurance policies is usually around 10% of the enterprise value of the transaction, with a floor of about $5 million of coverage, making R&W insurance a less attractive option for smaller or lower mid-market deals with enterprise values below $20 million. This was especially prevalent in 2021, with many underwriters not insuring transactions with enterprise values below $200 million as a way to manage unprecedented deal volume. In some instances, policy purchasers for smaller or lower mid-market deals were required to purchase more than 10% of enterprise value to obtain coverage and access the R&W insurance market. As deal flow has dwindled, competition has increased among carriers, and minimum floors largely have fallen away. It is now much easier to get limits as low as $3 million with premium and retention rates that are comparable to larger transactions.
Premiums
Policy premiums hit a highwater mark in Q1 2022, averaging about 5% to 6% of the policy limit. As transactional work has slowed across the board, premiums have stabilized at prepandemic levels, generally averaging between 2.5% and 3.5% of the policy limit.
Retention
The standard retention (i.e., the deductible that is applied before claims can be recovered under an insurance policy) remained steady through 2020 and 2021 at an average of 1% of enterprise value for deals valued between $50 million and $250 million and 0.75% of enterprise value for larger transactions. In current market conditions, underwriters increasingly are offering initial retention below 1% and as low as 0.5% to 0.25% for large transactions – and may be more inclined to offer additional sweeteners to underwrite the deal. Often, the cost of the retention is split 50/50 between the buyer and the seller, with the definitive agreement providing for a seller indemnification escrow and a buyer deductible each equaling 50% of the retention.
Alternatively, transactions can be structed as walk-away deals or no-seller-indemnity deals with the buyer bearing the full economic impact of the retention. No-seller-indemnity deals represented 36% of insured transactions in 2023, a decrease from 51% in 2022 and representing a change from a seller-friendly market. While the no-seller-indemnity structure initially resulted in higher R&W premiums due to its apparent risk and a perceived lack of “skin in the game” from sellers, since 2020, the difference in premiums between no-seller-indemnity and limited-seller-indemnity transactions has been reduced considerably. We can expect this insurance trend to continue as no-seller-indemnity transactions become more common, and there is no evidence that no-seller-indemnity deals cause an increase in claims or payouts. We do not believe the insurance pricing trend will necessarily influence whether a seller is offered a no-indemnity deal because buyers may want sellers to have skin in the game in the form of a share of retention.
Policy coverage and exclusions
With more carriers vying for smaller market share over the past year, coverage under R&W insurance policies has become broader with more favorable terms. Policies generally include fewer specific exclusions and fewer deemed changes to the representations and warranties in the definitive agreement. In the past, underwriters have tended to reduce the scope of certain representations that most often lead to losses or claims (i.e., representations with respect to financial statements, accounts receivable, customer and supplier relationships, forward-looking statements, and statements related to adequacy or sufficiency of assets). As competition continues to increase among carriers, these types of reductions in scope have become less common, and buyers are able to negotiate to reduce or eliminate many of these deemed deletions.
Additionally, we’re frequently seeing carriers cover cybersecurity and data privacy representations without a corresponding exclusion for coverage in excess of underlying cyber policies.
Additional industries and alternative transaction structures
In an effort to increase their market share, carriers are showing interest in industries that were traditionally challenging to underwrite, like healthcare and financial services. We expect this trend to continue as underwriters continue to gain experience and comfort in these areas, and R&W insurance products become more specialized.
We also are seeing carriers increasingly willing to underwrite alternative transaction structures, such as minority investments, carve out transactions, mergers of equals, restructurings and secondary transactions led by a general partner (GP), and limited partner transfers. The volume for R&W coverage for GP-led secondaries has increased significantly over the past two years, which we expect to continue as the broader economy still faces headwinds and private equity firms seek alternatives to M&A.
Claims
While the pricing and coverage terms of R&W insurance have changed in response to the competitive market, there remains consistency in the frequency and type of claims made under R&W insurance policies. Carriers are fielding claims in approximately one in six issued policies, which represents a slight decrease from prior periods. The overall number of claims has increased because of the M&A boom in 2020 and 2021. Breach of representations and warranties related to financial statements remains far and away the most common claim under R&W insurance policies, followed by material contracts and compliance with laws. Notably, breaches of representations and warranties related to intellectual property represent a smaller portion of claims by number, but a larger percentage of claim liability by value, indicating that intellectual property claims have a higher payout per claim.
In market reports, carriers indicated that they are seeing an increase in claims for smaller M&A transactions and M&A transactions in emerging markets. This claim activity may reflect the lack of highly scrutinized financial statements in these deals. As carriers increase coverage options in this competitive market, we expect this trend to continue.
Looking ahead
As deal flow increases, policy coverage and exclusion terms may start to swing back to more underwriter-favorable terms. Anecdotally, underwriters have received an increased number of submissions in 2024, but not all transactions are signing or closing. In other words, there is a lot of talk but little action. However, we suspect that increased carrier capacity, the entry of new market players, and increased specialization of carriers will likely lead to sustained interest of insures to underwrite deals across a wide variety of industries and the continued use of alternative structures as we move through 2024. If R&W premiums remain reasonable, we expect parties to continue to deploy R&W insurance in a significant percentage of private M&A transactions.
