Warranty and Indemnity insurance is the most important transaction insurance within the insurance market. It is often also called M&A insurance or transactional insurance. Find out here what exactly the benefits of W&I insurance are within an M&A process.
1. What is meant by Mergers and Acquisitions (M&A)?
Mergers and Acquisitions is a collective term in the corporate sector. This term mainly includes:
- Company acquisitions
- Transfer of operations
- Debt-financed takeovers – outsourcing/ insourcing
- Spin-offs, carve outs
- business cooperations
Especially the so called Due Diligence (DD) plays an important role during a M&A process. The task of Due Diligence is to review the risk of the transaction. It is carried out by the buyer and aims to uncover hidden opportunities and risks of the company to be taken over. Risks that cannot be assessed on the basis of DD are usually included in declarations of exemption or guarantees. The data necessary for the sale are provided by the seller. Based on the provided data the company is analyzed on strengths and weaknesses. The Due Diligence is the decisive basis for estimating the integration costs and synergies. This means that the entire company valuation (= purchase price) is based on it.
2. What is a Warranty and Indemnity insurance?
W&I insurance provides insurance cover for warranty rights that may arise in the future. Such rights can arise especially if guarantees or indemnity claims from a company purchase agreement are breached. In principle, W&I insurance serves to protect both sites, the buyer and the seller. While the seller usually has little interest in assuming a guarantee within the contract, the buyer will, however, try to obtain as many binding concessions from the seller as possible. The interests between buyer and seller are naturally opposed, so that extensive and lengthy negotiations may result. For this reason, an attempt will be made to cover those risks with appropriate insurance policies. W&I insurance acts as a bridge between seller and buyer and transfers the guarantees to the insurance industry.
In the case of W&I insurance, the policyholder can be either the seller or the buyer.
2.1 Sellers W&I insurance
If a seller decides to take a W&I insurance, the buyer asserts his claims from the sales contract „normally“ against the seller. This means that the seller remains directly responsible to the buyer. If the claims are asserted, the seller may have recourse to his W&I insurance as part of the coverage. The insurance usually also covers the defense and a possible settlement of the asserted claims.
2.2 Buyer W&I insurance
If the W&I insurance is taken by the buyer, the buyer asserts its claims against the seller up to the agreed maximum liability amount (cap). However, if the cap is exceeded, the buyer contacts the insurance company and asserts his claims against the insurance company. Then the seller is involved little or not at all during the claims settlement with the insurance company. However, recourse by the insurer may be considered if the damage is based on fraud or malice of the seller.
2.3 Scope of the insurance cover
In the case of W&I insurance, particular attention should be paid to the scope. This is because many risks are excluded from insurance cover. These include the following risks:
- certain areas of environmental guarantees (e.g. asbestos)
- known circumstances or risks that are discovered by the buyer during the due diligence or otherwise disclosed by the seller
- areas not audited during the due diligence
- certain tax issues
- future-oriented guarantees
- Guarantees with references to anti-corruption laws
3. Strengths of the W&I insurance
Taking out W&I insurance can have several advantages for both buyer and seller
- „Bridging the Gap“: Often the seller is willing to give guarantees to the buyer, but from the buyer’s point of view, the maximum liability is far too low. With appropriate W&I insurance, it is possible to increase this maximum sum by having the insurance take effect as soon as this agreed sum is reached.
- „Clean exit“ for the seller: In many situations, however, the seller is not willing or able to provide guarantees in the purchase contract. W&I insurance can provide the seller with a „clean exit“ while at the same time allowing the buyer to have adequate protection.
- Solvency of the claimant: If the seller is actually solvent when the claim is made may be uncertain for the buyer. This uncertainty exists in particular if the sale of the company has resulted from economic difficulties. The insolvency risk of established insurance companies is also present, but this should be significantly lower in comparison to the insolvency risk of the seller.
- „Sweeten the bid“: In bidding procedures, an offer that includes W&I insurance can be a strategic advantage to distinguish oneself positively from other bidders who otherwise offer the same conditions.
4. What are the disadvantages of Warranty and Indemnity insurance?
Despite the many advantages, there are also some disadvantages to taking out W&I insurance.
First, W&I insurance requires a minimum transaction size. However, premiums have fallen significantly as a result of price pressure in the market, Warranty and Indemnity insurance is not a bargain. If one translates the usually required minimum premium into a possible loss potential, this potential should be at least € 3-4 million, so that W&I insurance is economically reasonable.
As mentioned above, not every risk is insurable with the help of a W&I insurance. Essentially, only those issues can be insured that have already been examined during the due diligence process. The insurance only covers such guarantee areas if sufficient DD has taken place for them. For this purpose, all reports must be submitted to the insurance company. Because of this, the W&I insurance is not a substitute for a careful and comprehensive DD. On the contrary: a thorough DD is expected by the insurance company.
Do you have any questions or would you also like some advice? The experts at STC will be happy to advise you – just fill out our contact form.