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Reps and warranties coverage takes off in hot M&A market

Lori Seidenberg, Jodi Rosensaft, Anna Geml and Toria Lessman

More companies are buying representations and warranties insurance to cover potential liabilities arising from mergers and acquisitions, a panel of transactional risk experts said.

The coverage, which includes more upfront costs than traditional property/casualty insurance lines, has taken hold over the past several years as corporate M&A deals have accelerated, they said.

They were speaking during a session Tuesday at Riskworld, the Risk & Insurance Management Society Inc.’s annual conference in San Francisco.

Reps and warranties insurance is used to cover potential misrepresentations in sales contracts in about 85% of middle-market M&A transactions, said Anna Geml, a Chicago-based partner at Kirkland & Ellis LLP.

The “sweet spot” for reps and warranties is for deals valued between $50 million and $2 billion, because minimum premium requirements can be too much for smaller deals and percentage retention requirements limit the attraction of the coverage on larger deals, she said.

Marsh LLC placed reps and warranties policies on 999 deals in North America last year, which was a busy year for M&A deals, said Jodi Rosensaft, a New York-based managing director in the brokerage’s transactional risk practice.

The buyers of the policies were fairly evenly divided between private equity firms and corporate buyers, she said.

The attraction of the coverage is that it gives sellers a clean exit after a deal, and for buyers it means that they don’t have to pursue the seller if something goes wrong, Ms. Rosensaft said.

Without reps and warranties coverage, deals often stipulate that 10% of the purchase price is held in escrow for a year to provide indemnity for the buyer, she said.

“Our deal teams really want a clean exit, even with sellers they’ve known historically,” said Lori Seidenberg, New York-based global director, real assets insurance risk management, at Blackrock Inc. “They want to do the deal; they want to walk away from the deal.”

The coverage, though, does have costs that are not associated with traditional property/casualty insurance, she said.

Because the underwriting process is complex, insurers require the payment of an underwriting fee before binding and a breakup fee is charged if the underlying deal is not completed, Ms. Seidenberg said.

Pricing for the coverage peaked in the fourth quarter of 2021, as M&A deals accelerated, said Toria Lessman, Chicago-based senior vice president, transactional liability, at QBE North America.

“In the first quarter of 2022, we’ve seen the volume coming down. Deals are still getting done, but it is less than we were seeing previously, and pricing has come down. I think it is still a very healthy rate,” she said.

The total cost of coverage — including the premium, a $40,000 to $50,000 underwriting fee, surplus lines premium tax and broker compensation not included in the commission — is about 4% to 5% of the limit purchased, Ms. Rosensaft said.