Warranty and indemnity (W&I) insurance has come to the fore over the past decade, according to Luke Thorngate-Davies, a managing associate in the corporate team at law firm TLT. “It did exist before then,” he says, “but there’s been an increase in the use and understanding of it, and clients now come into transactions asking about it.

“Historically, it was used to plug the gap on private equity exits,” he explains. “If, for example, a private equity firm owned 40% of the shares in a company, then the buyer will pay 100% of the purchase price but only get 60% warranty coverage because it would only be able to make a warranty claim against the non-private equity shareholders. And while it is still predominantly used in private equity backed transactions, there is growing appetite for sellers to explore the benefits of W&I on traditional trade sales.”

“It’s always been attractive to PE firms,” says Simon Radcliffe, head of GTS claims at insurers Liberty Global Transaction Services (GTS). “The basic principle is that if the buyer has a claim and it has a W&I policy, then instead of claiming against the seller, if it finds that there’s been a breach of warranty, it makes a claim under the policy. For the seller, the big advantage of this is that it provides a clean exit.” 

He adds: “If there wasn’t a W&I policy in place, then the buyer’s sole recourse would be against the seller and the seller would obviously have to put money in escrow in case there was a claim down the line. But with insurance, the buyer’s recourse isn’t against the seller, it’s against the insurer. The seller is free to take the money and reinvest it, distribute it to investors. 

Seller’s advantage

“That’s the big advantage from a seller’s perspective. How we’ve seen the product develop is that now, at auction processes in particular, sellers are saying to buyers that it’s going to be a requirement that you take out a W&I policy if you’re successful in the auction. And buyers are obviously willing to do that because, for one thing, they have to and, second, if other bidders aren’t prepared to do it, then it differentiates them in a good way.”

And in the event of a warranty claim the buyer isn’t potentially having to claim against management co-investors and therefore destroying relationships, but can instead claim against the insurer. “The buyer would rather just go straight to its own policy,” says Thorngate-Davies, “so even if the sellers want it in place – and maybe they’re the ones who’ve initiated the conversation – predominantly it’s a buy-side policy and the buyer deals with it.”

Conversations about W&I insurance usually happen at the beginning of the deal process, he says, for example “on an auction process the sellers often work with a broker to prepare a non-binding indicative set of W&I terms, which are presented in the data room.” Once exclusivity has been agreed, the broker will then “go to the buy side and help the buyer with the policy”.

A typical W&I insurance premium for an EMEA region operational deal has historically been in the 1%-1.25% range, although rates have dipped below this in the last few years due to increased competition among insurers. More brokers are appearing on the market, adds Thorngate-Davies, which has in some instances driven premiums down, with premiums varying according to sector: “The premiums tend to be a bit more expensive because of the complicated nature of the business in an area like financial services or digital. If it’s more of a bricks-and-mortar type of business, then the policy is likely to be a bit cheaper because, usually, what’s being underwritten is less complex.”

Radcliffe says that pricing has “really dropped down” in the past 18 months and, as well as extra competition, that discount could be a function of there being fewer deals around. “Lots of insurers have been chasing the same deals, but activity is going up again. Everyone agrees that the pricing over the past year isn’t sustainable and that’s one of the reasons why it’s beginning to tick up again.”

Busier deal periods can also mean that there is an increased number of notifications. Radcliffe says: “When deal teams were incredibly busy and law firms that were doing the diligence were also busy, things probably weren’t looked at in the same forensic detail. Deals were done under very compressed timelines and I think that has filtered through an increase in W&I claims frequency for that period, but we have seen it drop down a bit since.”

US investors

Another dynamic is an increase in overseas corporate buyers looking to insurance on UK transactions. Rob Dando, who leads the transaction services team at MHA, says: “I thought it was less prevalent in the US, but in the past six months I’ve worked with four US inbounds into the UK where they’ve taken out W&I insurance. One reason for this could be that three of the four were PE sellers, the processes were competitive and the level of warranty protection being offered or provided was not sufficient for our clients’ needs. That’s why our clients wanted to get an extra level of comfort.”

But generally, he says: “W&I is used more frequently in competitive auctions; private equity transactions; cross-border deals as buyers understand foreign jurisdictions less than their own; larger cap and mid-cap deals; and deals with unknown sellers. It is used less frequently when strategic buyers with extensive diligence capabilities may rely more on their own investigations rather than purchasing W&I insurance. And in situations where the buyer knows the seller and has confidence in them, the perceived need for W&I decreases. The cost of W&I insurance tends to be prohibitive in smaller-cap transactions. And low-risk sectors or industries with straightforward assets will typically not use W&I insurance.”

In conclusion, he adds: “W&I insurance is more prevalent in high-value, competitive and cross-border M&A deals where risk management and deal certainty are priorities. Its usage is less common in smaller, low-risk or relationship-driven transactions due to cost or perceived necessity. The choice to use W&I insurance depends on deal dynamics, sector-specific risks and the preferences of the parties involved.”

Sellers also like the idea of a pound cap, says Thorngate-Davies, referring to a term where seller liability is capped at £1. “I can’t say that I’ve ever seen a claim on a policy,” he says. “That’s not to say it hasn’t happened. I know with a lot of the literature the brokers send us, we are given stats of the claims that have been made, but like any kind of insurance policy, they’re all buy-side, so if acting for the sellers, we’re probably not going to see it anyway. But even if we’re buy-side, they’re probably going to go straight to the insurer.”

Liberty GTS’s 2024 briefing does detail $340m of claims, with tax-related issues making up a large proportion of notifications. But Radcliffe says that financial statement and material contract claims account for the biggest losses “because they’re the ones that most impact value. We’ve stepped up and paid some very big claims.”