Use of Transactional Risk Insurance continues to rise
According to the latest results from the Willis Towers Watson (WTW) Quarterly Deal Performance Monitor run in partnership with Cass Business School, all regions other than Europe are currently underperforming their respective indices. But the sluggish start to the year has not stopped the growing use of Transactional Risk Insurance. The number of deals implementing Transactional Risk Insurance has grown year on year globally in the past years, owing in part to greater product awareness and demand for cover in various regions along with growing interest for investment of Private Equity Funds and other strategic investors including Real Estate Funds.
Furthermore, increased appetite of insurers and competition is resulting in better tailored and more competitive terms. Beatriz Pavón, Head of Southern Europe M&A Transactional Risks Practice at WTW notes that the warranty and indemnity (W&I) insurance market has become much more flexible in providing competitive terms, tailored coverage positions and policy enhancements on cross-border deals. There is growing interest in Southern European deals and a number of leading W&I insurers are building their local teams to cater for such growing demand.
The warranty and indemnity (W&I) insurance market has become much more flexible in providing competitive terms, tailored coverage positions and policy enhancements on cross-border deals.
The rise of “W&I Stapling”
One of the current upwards trends in particular for W&I insurance is the rise of “W&I stapling”, where a buy-side W&I policy is instigated by the seller who insists on insurance to limit own exposure and provide alternative recourse. Metaphorically a W&I policy is “stapled” to the acquisition agreement (SPA). Albeit initiated by the seller, a stapled buyer side W&I policy has the same characteristics as a W&I policy initiated by the buyer –including cover for seller fraud and allowing to potentially reach a level of cover beyond that offered in the SPA on certain points.
W&I stapling: how does it work?
There are two ways that a seller can staple W&I insurance – a hard staple and a soft staple.
- A hard staple is a take it or leave it approach as the seller warranty package is only available if a buy-side W&I insurance policy is purchased. Usually, other than for limited fundamental warranties, the buyer´s sole recourse is against the W&I policy in the event of a breach of warranty.
- A soft staple permits the buyer to decide ultimately whether to contract insurance or assume residual transaction risk and usually limited seller recourse.
In a hard staple process, the seller engages WTW to procure non-binding indications of cover (NBI) from the insurance market for a buyer-side W&I policy. WTW prepares an NBI Report and advises the seller as to the selection of the insurer. A phase of pre-underwriting work is then undertaken by the selected insurer with regard to the sell-side due diligence and WTW commences the negotiation of the W&I policy tailored to the transaction. An advanced draft of the policy is made available together with the SPA to the prospective bidders.
Following confirmation from the bidders in their offers as to implementation of the W&I insurance, the engagement of WTW with the seller will cease and it will commence acting for the bidders in negotiating and finalising the policy. The successful bidder will be the insured.
One of the current upwards trends in particular for W&I insurance is the rise of “W&I stapling”, where a buy-side W&I policy is instigated by the seller who insists on insurance to limit own exposure and provide alternative recourse.
To the extent that various transaction parties are involved, both WTW and the selected insurer have internal confidentiality barriers in place to ensure that a separate dedicated team works with each bidder.
The mechanics of a soft staple are similar in that the seller initiates the process and engages WTW to obtain insurer NBI for a buy-side W&I policy and makes the WTW NBI Report available to the bidders in the data room. However, there is no further preparation, underwriting or negotiation of the policy until the successful bidder is selected. If a draft W&I policy is made available with the SPA, it is a generic one.
W&I insurance is not stated as a requirement in the SPA and the buyer ultimately has autonomy to select the insurer and decide whether to contract W&I insurance or to assume the residual transaction risk of limited recourse against the seller for a potential breach of warranty, as seller liability is usually capped to a relatively low amount. The underwriting phase commences only when the successful bidder selects an insurer.
By controlling the W&I insurance placement in both hard and soft W&I staple processes, WTW ensures an expeditious insurance placement, safeguards the equal treatment of all bidders and secures the best terms for the transaction.
By approaching the market individually, bidders may create confusion and prevent an insurer due to exclusivity from offering their terms to other bidders, possibly leading to the best terms not being secured for the deal, particularly from a seller´s perspective.
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Head of Transactional Risks – Southern Europe Mergers & Acquisitions, Transactional Risks, FINEX Global