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January 12, 2023

Reps and Warranties Insurance from a Business Perspective

Today, there are more than 20 reps and warranty insurance companies. And unlike before, they are now willing to cover the entire suite of reps and warranties to replace the indemnification provisions in a traditional purchase agreement. So are they worth it? Should buyers consider reps and warranty insurance on all their deals? In this article, Gitanjali Pundir, Vice President, Global Corporate Development and M&A at Visa, discusses reps and warranties insurance from a business perspective.

"Reps and warranties insurance preserves the deal value by shifting the risk of loss to ensure a fixed cost." - Gitanjali Pundir

How reps and warranties insurance work

Reps and warranties are sellers' declarations about the business' condition often found in the purchase agreement. The buyer relies on them to be accurate and could seek compensation for any harm or loss resulting from breaches. Reps and warranty insurance shift these risks to the insurer, benefiting both parties.  

However, reps and warranty insurance do not cover anything known to the buyer, uncovered in the diligence process, and included on the disclosure schedules. It also applies to discoveries made between signing and closing. 

The anti-sandbagging provision states that if the buyer discovered a breach after signing and proceeded with closing, the buyer cannot claim that breach to the insurer. 

Depending on the status of the deal documents, the depth of due diligence, and the negotiations with sellers, the underwriting procedure for reps and warranties insurance takes one to two weeks.

Benefits of reps and warranty insurance to buyers

According to Gitanjali, buyers should always consider purchasing reps and warranties insurance on their deals. Not only does it serve as a helpline for sellers, but it also benefits buyers in many ways.

  1. More extended protection - Buyers will get a survival period of 3 years for general reps instead of 12 to 24 months and up to 6 years for fundamental reps.
  2. Enhanced protection - Buyers can get stronger coverage for definitions in the purchase agreement. Also, consequential or multiplied damages are covered by insurance.
  3. Double materiality scrape - With insurance, buyers can remove materiality restrictions, which are heavily negotiated or may not be included in the purchase agreement. 
  4. Better offers for auctions - Buyers can make their bid more attractive in an auction process because the seller receives a larger portion of the purchase price upfront with insurance, removing holdbacks and escrows. 
  5. Preserves relationships post-close - The seller works for the buyer to run the business on some deals. Having an insurer shoulder the risks will ensure that the buyer doesn't have to go after the seller for breaches. 
  6. Better claims - Buyers will have reduced credit risk for future claims. Also, it's a much more sophisticated process to deal with an insurer rather than a small seller. 
  7. Speeds up negotiations - Insurance reduces the friction between buyers and sellers and simplifies and speeds up the negotiations.
  8. Can provide recourse in a public deal – Reps and warranties typically don't survive in public deals. 

Cost of reps and warranty insurance

The insurance cost is approximately 2.5% to 3% of the coverage the buyer wants to purchase. Aside from the premium, the buyer will also have to pay diligence costs, taxes, and broker fees, increasing the total cost to 3.5%. Buyers will be responsible for paying for it in an auction process, while it could be up for discussion in a bilateral process.

In addition to the premium, there is also retention, which is essentially a deductible amount. Retention is the sum the insured must pay out of pocket before the insurance policy begins to pay on a claim. The retention cost is roughly 1% of the purchase price, but bigger acquisitions with a price tag of more than $1 billion could be as low as 0.75%, with a decline to 0.5% after a year. 

In some deals, buyers and sellers split the retention cost, and the buyer's retention gets exhausted before the seller's.  

Lastly, insurers have a minimum premium requirement of at least $150,000 to $200,000. For smaller deals, insurance might not make sense because of this requirement.  

The price of rep and warranty insurance is almost the same across the board. It is why selecting insurers all comes down to exclusions. Buyers must pick insurers that offer minimal exclusions to get maximum protection.

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