Reps and Warranties insurance has gone from being an occasionally used, slightly mysterious product, to an everyday component of many mergers and acquisitions. Despite this uptick, a lot of people involved in a transaction may still be using it for the first time. Even advisors who have heard of it may not be involved in the details of a placement.
Reps and Warranties insurance has gone from being an occasionally used, slightly mysterious product, to an everyday component of many mergers and acquisitions. Despite this uptick, a lot of people involved in a transaction may still be using it for the first time. Even advisors who have heard of it may not be involved in the details of a placement. The following are questions I am most commonly asked about reps and warranties.
1. How much does it cost?
There are two numbers to think about with regards to reps and warranties, and indeed, any insurance policy. The deductible/retention, and the premium.
Deductible/Retention
This is the amount of “loss” someone has to suffer before the insurance begins to pay out. In reps and warranties insurance, the deductible is expressed as a percentage of the overall transaction size. Currently minimum deductibles are at 1%. So in a $100 million transaction, the minimum deductible is 1%. This amount can be borne by either the buyer or the seller or a combination of the two.
Premium
This is also expressed as a percentage. This time it is a limit of the coverage bought. IT HAS NO RELATIONSHIP TO TRANSACTION SIZE. Sorry to shout, but it’s one of the most common causes of confusion for people new to the product. Premiums are currently 2.5%-4%. Therefore, $10 million of cover would cost $250-$400,000 for six years of cover.
2. Who pays the premium?
There is no specific requirement for this. There is no relationship between who pays the premium and who the insured is. This is a matter for negotiation between the buyer and the seller.
3. What’s the smallest amount we can buy?
Minimum premiums are currently running about $150,000, so unless someone is looking for at least $3 million of coverage, it doesn’t make sense.
This question is often expressed as, “What’s the minimum size of a transaction we can cover?” As I stated above, the limit is NOT linked to the transaction size. Therefore, the smallest amount you can buy is a function of how much coverage makes sense for minimum premiums, and is not a function of overall transaction size.
As a rule of thumb, we are generally seeing average limits being set between 10%-12% of the transaction size.
4. How long does it take?
Unfortunately, the answer to this one can be frustrating because essentially, “it depends.” There are two phases to the underwriting process:
Phase 1 – We can start this with just a copy of the current draft of the transaction agreement and target financials. We start by sending a submission out to market. Then, about one week later we can produce a report showing the underwriter’s initial thoughts and competing bids.
Phase 2 – This happens concurrently with the deal; however, depending on what stage the deal is in, the underwriting process can take another seven to ten days. As this part of the process takes as long as it takes the deal and diligence to solidify, we end up with the “it depends” answer.
5. Does a shorter time period, or only covering some warranties, affect the premium?
No, shorter periods of cover do not really affect premium. Most claims are brought in the first 18 months, so the difference in price between two years of coverage and four years is minimal.
Fewer warranties may make the process smoother but won’t affect the price unless we are talking about only covering fundamental warranties.
6. What are the exclusions?
- Forward-looking warranties (you can sell “x” units at “x” price in the next year)
- Availability of net operating losses
- Wage and hour claims
- Underfunding of pensions
- All other exclusions will be dependent on the deal terms and conditions and the quality of the due diligence.
7. Are there claims and do they get paid?
Yes, we’ve looked at recent claims data in a previous blog post. You can take a look at that post for interesting information on claims trends and severity.
Hopefully that has answered some questions and given you a flavor of the kinds of concerns people have with this coverage. However, if there is a question I haven’t covered I would love to hear from you. Feel free to reach out at emaier@woodruffsawyer.com.
FAQs
Who Pays For Rep And Warranty Insurance? It is the Buyer in an M&A transaction who pays for the rep and warranty insurance premium most of the time. However, there are various instances when the premium is either shared between Buyer and Seller, or when the Seller picks up the bill.
What is covered by reps and warranties insurance? ›
R&W insurance generally provides coverage for all representations and warranties of a target company or seller(s) contained in an M&A purchase agreement. The policy protects an insured against financial loss — including defense costs — resulting from breaches of such representations and warranties.
What are the basics of reps and warranties? ›
Representations and warranties (reps and warrants from now on) are contractual tools which allocate the risks of unknown conditions and circ*mstances to the seller. They are past and present (and future) statements of fact made by the seller about the conditions and circ*mstances of the business.
How much does representation and warranty insurance cost? ›
RWI deductible typically ranges from ~1%–2% of the transaction value (downward trend over the last 1–2 years), often dropping to a lower level 12–18 months after closing. Underlying transaction sizes typically range from ~$30M to well over $1B, although larger and smaller transactions may qualify.
What is the standard reps and warranties clause? ›
Standard representations and warranties commonly relate to: ∎ The party itself. contract. In a commercial contract, transaction- specific representations and warranties typically relate to the nature, type, quality, and condition of the goods, assets, or services central to the subject matter of the agreement.
What happens if you breach a rep and warranty? ›
Based on the representations and warranties at issue, parties may seek a variety of different damages, including various direct costs incurred as a result of the breach, lost profits, or the amount allegedly overpaid for a business.
What is the limit on reps and warranties insurance? ›
A key point of negotiation of R&W Insurance is the amount of the limits and retentions. Limits are often set at 10% of enterprise value, with retentions typically 1-3% of enterprise value. Premiums generally range from 2% - 4% of limits.
Who buys RWI? ›
An RWI policy can be either “buy-side” or “sell-side.” When the buyer is the insured (a buy-side RWI policy), RWI can reduce or eliminate the need for a holdback or escrow because the buyer can pursue the insurance policy instead of pursuing the sellers; although, it should be noted that the sellers may remain liable ...
What is the reps and warranties cap? ›
This cap (the “General Cap”) is most commonly set at 10% of the total Purchase Price, although this may be higher or lower for certain deals. The cap on Fundamental Representations and Warranties is often set at up to 100% of the Purchase Price or even uncapped, and fraud claims are typically uncapped.
What are the 2 basic types of warranties? ›
The two main types are express and implied warranties. An express warranty is clearly stated either verbally or in writing. An implied warranty automatically covers most consumer goods but only provides a base level of consumer protection.
Such indemnity holdbacks come in all shapes and sizes, but the general mechanism is that a seller agrees to indemnify (or make whole) the buyer post-closing if certain things occur, most often if it turns out that the seller breached a representation or warranty or a covenant in the purchase agreement.
How long should reps and warranties last? ›
A statute of limitations operates to limit the time during which a claim may be brought against a party. If a purchase agreement is silent as to survival, reps and warranties survive until the applicable jurisdiction's statute of limitations for claims for breach of contract lapses.
Who typically pays for reps and warranties insurance? ›
Typically, buyers pay for the reps and warranties insurance because there are so many unknowns from their perspective, and they want protection. However, there are very rare instances where sellers pay for the insurance.
Who typically pays for RWI? ›
Failing that, the seller will seek an arrangement under which RWI is the buyer's main recourse, although there could also be some liability for indemnification, such as claims below the policy retention or above its coverage limit. Ideally the sellers will want the buyer to bear the policy retention and premium cost.
What are damages for breach of representations and warranties? ›
Here the measure of damages for a breach of warranty is calculated by taking the market value of the target company had the warranty been true and deducting the actual market value of the target company. This is often referred to as the difference between the value of the business "as warranted" and "as was".
Who usually pays for W&I insurance? ›
W&I policies can be taken out by the buyer and/or seller on a deal. ∎ In a buyer side policy, the insurance is taken out by the buyer so that it can claim directly against the insurer for loss flowing from a breach of warranty by the seller.
How much does RWI cost? ›
The coverage amount for RWI usually will be at least $5 million (lower limits are available, but will generally cost almost as much as a $5 million policy). For most deals, the premium cost will be somewhere between 2.5% and 3% of the coverage amount.
What are the benefits of R&W insurance? ›
R&W Policy Highlights
- Available for both buyers and sellers in a transaction.
- Facilitates mergers and acquisitions by protecting deal participants from unintentional and unknown risks.
- Offers additional protection to the buyer beyond the negotiated indemnity cap and survival limitations in a purchase agreement.
4 In the case of rep and warranty (R&W) insurance, treatment will often be tax neutral, because the insured will frequently be permitted a deduction for the loss triggering payout under the R&W policy.
