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CMS: The rise of warranty and indemnity insurance

Frank Fowlie, partner at CMS.
Frank Fowlie, partner at CMS.

M&A deals almost always include warranties – promises by the seller to the buyer about certain matters in relation to the company they are selling.

Sellers have never liked giving warranties to buyers. More than 20 years ago, the insurance industry sought to devise a solution for sellers such that they could insure that liability. The process was seen as slow, cumbersome and expensive, and rarely succeeded in limiting sellers’ liability or providing the assurance buyers were looking for.

But in the past few years, warranty and indemnity (W&I) insurance has seen significant change and risen hugely in popularity. It is now used in a wide variety of deals and has played a significant part in allowing many deals to be completed.

Our CMS M&A Deal Study found its use more than doubled between 2011 and 2017, and the figure is expected to have risen again last year.

Whether W&I insurance is used in a deal is usually confidential, but a number of transactions in the Aberdeen and oilfield services market during the past year included the provision of insurance to allow the deal to be done.

W&I policies are now usually taken out by the buyer. The policy provides that if the buyer has a claim and –subject to the limitations, deductibles and exclusions that apply in the usual way under an insurance policy – the insurer (and not the seller) will pay the loss to the buyer.

Research has shown W&I insurers pay out more often than sellers when a buyer makes a claim.

So, in which deals do we see W&I being used most often?

Often it is when the seller is a financial or strategic seller, such as private equity. Management teams who are willing to give warranties may have only a small stake in the company, while those owning the rest can be either unwilling or unable to do so.

Buyers are likely to be concerned about this large gap and often wish to have cover against the warranties they have been given – up to 100% of the price they have paid.

W&I has been successfully used to fill the gap. Premiums are usually relatively modest against the price paid – around 1% – but each insurer has a minimum premium and, therefore, W&I is more often used in larger deals.

Insurance brokers have continued to innovate and W&I has now been used to almost limit the sellers’ liability completely.

In deals involving the sale of firms owning properties or renewable projects, such as wind farms, the seller’s liability can be limited to £1, with the buyer otherwise relying exclusively on the insurer for any claim under the warranties.

This concept has now been brought into insuring deals for the sale of trading businesses such as oilfield service companies, where insurers are willing to cap the seller’s liability to under 1% of the price paid.

The process for putting W&I in place has also significantly improved and insurers can usually put a policy in place within two weeks of being instructed.

W&I has become a slick and cost effective way to get deals done and its rise in popularity is set to continue in 2019.

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