Warranty and indemnity insurance (W&I Insurance) continues to be an increasingly common instrument used by merger parties to manage deal risk in Australian M&A transactions.

In broad terms, W&I Insurance involves the underwriter indemnifying the insured for any loss arising out of a breach of warranty or a claim under the tax indemnity in the relevant sale and purchase agreement. The insured can either be the buyer (a "buyer-side" policy) or the seller (a "seller-side" policy) but will most often be the buyer. Both policies will also cover reasonable legal costs incurred by the insured in defending certain claims.

We expect that buyer-side policies will continue to dominate whilst M&A parties are willing to structure the transaction and policy to ensure that there is little or minimal residual liability for the sellers. Under a buyer-side policy, the insurer waives its right to subrogate against a seller other than in the case of a seller's fraud and an insured buyer will also typically agree not to make a claim against the seller for an insured matter.

While the market for W&I Insurance has evolved rapidly over the last 5 years, there is still a great deal of expertise required to underwrite this product. Underwriting teams are inevitably advised by experienced M&A practitioners from leading law firms to familiarise underwriters with the process and structure of an M&A transaction to properly assess risk.

Policy documentation is also becoming more standardised but is still evolving gradually to reflect changing M&A trends and risk appetites in the market. Each policy also has to be tailored to reflect the particular terms of each transaction and there is always scope for some negotiation of policy terms with insurers depending on the needs of the insured.

Whilst other forms of transaction liability insurance (eg. environmental liability insurance, litigation insurance, tax liability insurance, contingent risk insurance and prospectus liability insurance) are available, they are usually separate and distinct from the cover available under a W&I Insurance policy and have not gained as much traction in Australia as the W&I Insurance product.

Australia is seen globally as an attractive growth proposition for the transaction liability insurance market, particularly because of its relatively high M&A deal flow (by number and value), continued strong economic growth, low geo-political risk and its robust legal system. This, combined with strong market penetration, awareness and acceptance of the W&I Insurance, has led to the Australian market for this product being roughly similar in size to the UK market, and has meant that the Australian market has become a focus for brokers and insurers/underwriters specialising in these transaction risk insurance products.

As a result, we have seen a marked increase in the number of international brokers and insurers/underwriters seeking to participate in W&I Insurance deals in Australia in the last 12 months. Given the up-take of the product in Australia, many international brokers and insurers/underwriters have also decided to send experienced team members to Australia to establish a physical presence to enable them to more properly service the Australian M&A market.

The market for W&I Insurance in Australia continues to remain competitive, particularly as a result of the increased competition between brokers and insurers/underwriters. The effect of this has been that:

  • premium costs have decreased significantly over the last 5 years, presenting an even better value proposition for a potential insured; and
  • insurers/underwriters have been willing to offer greater flexibility in the policy wording and insurance coverage being provided (eg. full or partial tipping retention structures, cover for specific indemnities or specific known issues and more limited exclusions from policy coverage).

While competition is still increasing, we expect that there is very little room for further depreciation in premium costs and we think that the increased competition is instead likely to drive further product innovation.

Based on our experience, we expect the use of W&I Insurance to increase further as the product continues to become more widely known and accepted beyond the private equity industry which was, and still is, the biggest buyer of the product. In particular, we are seeing strong growth in take-up of the product by corporates, particularly those involved in cross-border transactions.

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