Warranty & indemnity insurance (W&I insurance) is an instrument increasingly used in the Dutch merger and acquisition market.
In 2023, only 4% of transactions of less than €25 million in Europe used W&I insurance (compared to 42.5% for larger transactions). Nevertheless, there are recent developments that make S&I insurance interesting for smaller transactions.
In this expert contribution, we successively explain (i) what W&I insurance is, (ii) the reasons for using W&I insurance and (iii) why W&I insurance is becoming interesting for smaller transactions as well.
What is S&I insurance?
W&I insurance is a specialized insurance used in mergers and acquisitions to protect buyers and sellers against breaches of warranties and (tax) indemnities in the purchase agreement.
There are two types of policies: seller policies protect the seller against buyer claims. Buyer policies protect the buyer against financial losses resulting from breaches of warranties and indemnities in the purchase agreement. Most S&I insurance policies are buyer's policies (96% in Europe).
We use the following assessment criteria for W&I insurance:
- (i) Policy limits (the maximum payout under a policy, usually as a percentage of the transaction value)
- (ii) excess risk (is paid by the insured - i.e. usually the buyer! - paid before coverage takes effect and is sometimes shared between buyer and seller)
- (iii) Coverage period (preferably corresponding to warranty periods).
- (iv) (standard) exclusions (e.g. issues uncovered during due diligence, fraud, and forward-looking statements)
- (v) the underwriting process (thorough review of transaction documentation, due diligence reports and warranty appendix, by insurer).
Main reasons for W&I insurance
W&I insurance offers undeniable advantages in mergers and acquisitions. For buyers, it sits in competitive bidding and protection against unknown risks and warranty breaches, which increases confidence in the deal and potentially allows for more favorable financing terms.
Different types of sellers have their own reasons for taking out W&I insurance. The insurance limits seller's liability by transferring the risk of warranty breach to the insurer, allowing the transaction to close more quickly with fewer security requirements on the part of the buyer.
It helps mitigate risks by transferring financial losses resulting from breaches of warranties to the insurer. For a seller, this enables a "clean exit," which may be relevant for sellers for whom continuing to bear risk may be a reason to abandon a transaction. Further, insurance can be used where preservation of the buyer-seller relationship in the future is desirable.
W&I insurance is thus a good way to facilitate negotiations by limiting discussions about disputed warranty clauses.
Time and money no longer work against S&I insurance: timelines for taking out S&I insurance have become increasingly shorter in recent years: within two weeks is common and under circumstances faster is even possible. Costs have dropped dramatically since the early days of this type of insurance, making this tool within reach of the SME vendor as well.
Under current market conditions, transactions around €10 million are insurable for an entry fee starting at €50k (including premiums, including underwriter fee and insurance taxes).
Integration of W&I in acquisition process
To use W&I insurance successfully in an acquisition, it is essential to discuss the possibilities at an early stage so that the acquisition process is designed accordingly. For example, proper agreements should be made about due diligence to promote smooth cooperation, reduce the likelihood of disputes and avoid indemnities in the acquisition contract as much as possible.
In addition, the use of W&I insurance can be used as a negotiation tool. A strategic use of W&I insurance can thus optimize the acquisition process.
