United States: Insuring The Deal: Key Trends And Terms In Representation And Warranty Insurance

Last Updated: September 25 2018
Article by John J. McDonald and Christian Chad Warpula

As regular participants in mergers and acquisitions (M&A) transactions know, representation and warranty (R&W) insurance has grown from an obscure product rarely seen in M&A transactions just a few years ago to a pervasive element in many (if not most) M&A transactions today. That is particularly the case in M&A transactions involving private equity sponsors.

However, the use of R&W insurance by strategic buyers and sellers of companies is rapidly becoming more pervasive as buyers, sellers and other deal participants grow more comfortable with the product. The volume of R&W-insured M&A transactions has increased exponentially over the last few years, rising to over 2,000 policies placed in 2017 in the U.S. alone. As this process has continued, some key trends and terms in R&W insurance have emerged, which are summarized below. Private equity firms and strategic buyers and sellers of companies, as well as their attorneys, investment bankers and other advisors, need to be aware of these trends and terms as they can have a major impact on their M&A transactions.


By way of background, R&W insurance is an insurance policy obtained in connection with M&A transactions, typically by the buyer. In a usual, non-insured M&A transaction, the seller has the sole responsibility for indemnifying the buyer for losses resulting from breaches of the seller's representations and warranties in the purchase agreement (typically relating to undisclosed or inaccurately disclosed issues with the target company), subject to highly negotiated caps, thresholds and baskets. In an R&W-insured M&A transaction, the buyer instead obtains recovery for some or all of such losses from the R&W insurance policy, up to the policy's coverage limit and subject to certain negotiated exclusions in the policy.

Clean Exit

R&W insurance is attractive to sellers of companies because it substantially reduces or eliminates completely the possibility that they will be required to return sale proceeds to the buyer, either directly or through release of sale proceeds placed into escrow. That is particularly attractive to private equity sellers of companies, as they want to return capital to their limited partner investors as quickly as possible after closing of the sale to maximize their fund's internal rate of return from the investment and their carried interest compensation. This clean exit from their investment is the primary reason that private equity sellers often insist on insured sell-side transactions.

Competitive Advantage

R&W insurance is also attractive to buyers in competitive auction processes because it can improve the competitiveness of their bids by increasing the amount of sale proceeds that the seller receives at closing, as compared to non-R&W insured transactions in which the customary 10-20% of transaction proceeds are placed into escrow for 12-18 months after closing to act as a source of recovery for the buyer relating to undisclosed issues.

Broker-Driven Process

With the influx of carriers into the R&W insurance market, the buyer typically engages an insurance broker to obtain competitive quotes from several carriers, from which the buyer is able to select one to proceed. As discussed below, this competitive process has greatly reduced premiums and retentions for R&W insurance policies and helped narrow exclusions from coverage. The broker will typically schedule and moderate the "underwriting call" (discussed below), act as the intermediary for follow-up questions, and assist the buyer with negotiation of exclusions and other terms and conditions of the R&W insurance policy. It is highly recommended that buyers engage their broker as early as possible in the potential process, including prior to preparing or submitting an indication of interest or letter of intent.

Some Key Metrics

Coverage Limit: Coverage limits under R&W insurance policies vary, but are typically 10% of the transaction value.

Premiums: Premiums are decreasing with increased competition among carriers and are typically from 3-4% of the coverage limit of the policy. Premium costs are usually borne by the buyer, although the parties sometimes split the cost of the premium, particularly in "no seller recourse" policies as discussed below.

Retentions: R&W insurance policies also include a retention (i.e., deductible or basket) for which one or both of the parties remain liable before the policy provides coverage. Competition among carriers has put downward pressure on retention amounts, which are now typically 1-2% of transaction value, with retentions toward the higher end of that range more common in smaller transactions. A common structure is for the seller and the buyer to split the retention, with the seller's portion funded through a small escrow under the purchase agreement. Retentions typically step down to half of their original amount 12-18 months after closing. Increasingly common are R&W insurance policies in which there is "no recourse" against the seller, in which the buyer absorbs losses for the full retention amount and the R&W insurance policy covers any losses in excess of that amount, up to the coverage limit. However, no seller recourse policies are typically only available for larger M&A transactions with enterprise values in excess of $150 million in which there are correspondingly more substantial retentions and more professionalized target company management teams. Premiums in no seller recourse policies are typically higher to reflect the additional risk to the carrier from the seller not having "skin in the game," although the spread between the two types of policies has been shrinking with increased competition among carriers.

Term: A common formulation is a six-year coverage period for fundamental and tax representations and three years for all other representations and warranties, but longer or shorter coverage periods are available. Unlike traditional non-insured M&A transactions in which the buyer and seller negotiate the survival periods of the representations and warranties, the term of the R&W insurance policy is typically negotiated only by the buyer and the carrier.

Due Diligence

The carrier typically receives a fixed underwriting fee of $20,000 - $50,000 from the buyer, which is paid at the start of the process and is used by the carrier to pay its legal counsel assisting with due diligence in connection with underwriting of the policy. Since carriers usually piggyback onto the due diligence performed by buyers on target companies, rather than performing their own "ground up" due diligence processes, carriers often require buyers to obtain a full suite of third-party due diligence reports, including legal, tax, quality of earnings, employee benefits, insurance, IP/IT and environmental. Buyers are then required to provide these reports to the carriers and their counsel, along with drafts of the purchase agreement and disclosure schedules and access to the virtual data room for the project.

Fast-Track Process

Obtaining R&W insurance can occur quite quickly – often no more than a few weeks from beginning to end – but deal parties are well advised to plan ahead and contact the broker or carrier as soon as possible in the M&A transaction process. The carrier will typically provide a "non-binding indication letter" (NBIL) outlining the terms of the R&W insurance policy. A few days to a week after the buyer due diligence reports, the draft purchase agreement and disclosure schedules, and access to the virtual data room are provided to the carrier, the "underwriting call" is typically scheduled by the broker and the carrier. During the underwriting call, the carrier and its legal counsel will inquire about the buyer's due diligence process on the target company with the buyer, its legal counsel and its other advisors.

Underwriting calls usually last several hours, and, once they end, the carrier typically provides a list of follow-up questions to the broker, to which the buyer and its counsel will provide answers over the next couple of days. The exclusions and other terms and conditions of the R&W insurance policy will then be negotiated by the parties, the buyer will pay the premium for the policy to the carrier, and the policy will be "bound." Most policies are bound at signing of the purchase agreement rather than subsequently at closing.


Because insurance is intended to help mitigate risk by covering issues not known by the buyer when the policy is obtained, R&W insurance policies typically exclude from coverage any issue of which a defined group of buyer "knowledge parties" is aware. "Known issues" excluded from coverage under the policy will include those referenced in the due diligence reports obtained by the buyer from its legal counsel and other advisors, as well as other issues the buyer learned about during its due diligence process. Although, in theory, this means that buyers could have an incentive to limit their due diligence on the target company in order to remain intentionally blind to issues and try to minimize the "known issues" excluded from the policy, in practice, sophisticated buyers realize that doing so would be foolish, as they will ultimately own the target company and need to fully understand its business in order to successfully operate it and satisfy their obligations to their boards or investors. Doing so would also be impracticable, as the carrier will require that the buyer have conducted full and thorough due diligence as a condition to binding the policy and will exclude areas that it feels have been subject to insufficient diligence by the buyer.

The policy will typically also include a list of matters that are expressly excluded from coverage. In addition to matters specific to the particular target company, there are also typically "standard" exclusions such as covenant breaches, interim breaches of representations and warranties (those occurring between signing of the purchase agreement and closing of the transaction) and issues addressed by purchase price adjustments, as well as exclusions for areas determined by the carrier to present an unreasonable risk as a matter of policy, such as asbestos claims, pension plan liabilities, Medicare/Medicaid reimbursement liabilities, wage and hour claims, net operating loss usability and S-corporation qualification.

Increased competition among carriers has reduced the number of exclusions from coverage under R&W insurance policies and narrowed the scope of exclusions in which they address specific issues, rather than having broad exclusion categories. Brokers often place substantial pressure on carriers to reduce both the number and scope of the exclusions to their policies, and negotiation of exclusion language in R&W insurance policies by buyers (aided by their brokers) and carriers is commonplace. Issues excluded from coverage under the policy will either be the subject of the special indemnities from the seller in the purchase agreement or be borne by the buyer, depending on the relative negotiating leverages of the parties.


The emerging trends and terms in R&W insurance discussed in this article have important ramifications for buyers and sellers of companies utilizing R&W insurance policies and the carriers insuring their deals, which will continue to play out over the coming years. Practitioners, advisors, bankers, buyers and sellers should become familiar with the customs and intricacies of R&W insurance as the policies are becoming increasingly more pervasive, and almost commonplace, in all types of M&A transactions.

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