Warranty and indemnity (W&I) insur-ance originated in the 1980s and was at that stage purely used by sellers as a pro-tection policy where they had given war-ranties. It was not until the mid to late 1990s that W&I insurance started to get used in situations where sellers were un-willing or unable to provide prospective buyers with the level of warranty com-fort that buyers were seeking for poten-tial breaches of warranty in a merger or acquisition (M&A).
Buyers used to complain that W&I in-surance was too expensive and cumber-some to arrange compared with more traditional deal security measures such as escrows and deferred consideration arrangements. But in recent years, W&I insurance has undergone a number of material changes which address many of those complaints. W&I insurance pricing has fallen significantly since 2007. Brokers and underwriters have recruited experienced M&A profes-sionals, which has enabled W&I insur-ance to become more adaptable to deal requirements and, as a process, more compatible with overall deal timetables. As a result, many buyers are now more inclined to view W&I insurance as a credible deal protection measure. There have been other interesting devel-opments. As the W&I insurance prod-uct has expanded globally, three core
markets have established themselves as the centres for the brokerage and un-derwriting of transaction risk policies: London, Sydney and New York. Poli-cies provided in these markets have sub-tle differences that, on occasion, merge
into other markets and affect market practice there. There has also been an increase in the use of bespoke policies, reflecting the general acceptance by parties of the use of W&I insurance in transactions.
Warranty and indemnity
insurance
A global reach
Jannan Crozier and David Allen of Baker & McKenzie LLP and Brian
Hendry of Willis Limited consider recent trends in global W&I insurance.
This article looks at:
• The main types of W&I insurance available and the growing trend for use of W&I insurance in transac-tions.
• The key insurance markets for W&I insurance.
• The practicalities of obtaining W&I insurance.
• The rise of bespoke policies for dif-ferent transaction risks.
• The anecdotal evidence of claims. POLICIES AND M&A
There are two main types of W&I insur-ance policy used in M&A transactions: • Buy-side policy. The buyer is
insured for any losses it suffers as a result of a breach of a warranty (subject to the agreed limitations and policy limit) given in the trans-action documents, plus any associ-ated defence costs.
• Sell-side policy. The party providing the warranties is insured for any loss-es it suffers as a rloss-esult of the buyer bringing a valid claim against it for a breach of warranty (subject to the agreed limitations and policy limit)
under the transaction documents, plus any associated defence costs. (For more information, see feature
ar-ticle “Covering the risks: warranty and indemnity insurance”, www.practical-law.com/5-382-3120.)
Traditionally, the W&I market was built on sell-side policies. However, sell-side policies have become less popular as the party giving the warran-ties remains contractually liable in the first instance to a claim by the buyer for breach of warranty and effectively remains on risk if, for some reason, the policy does not provide coverage for the relevant breach.
This article therefore mainly focuses on points concerning a buy-side policy. Increased use in transactions
Over the past three years, the use of transaction insurance has increased on average by about 20% year on year globally. We estimate that in 2012 there have been approximately 650 W&I in-surance policies placed globally, with the key markets remaining as the UK, US and Australia. However, there has been a steady increase in the numbers of policies bought in continental Europe and Asia and the interest levels continue to grow (see box “Geographical spread
of policies”).
While W&I insurance has been em-braced by the private equity commu-nity, it is increasingly being taken up by companies: recent Willis statistics show that over 50% of insured parties are now companies.
The average level of warranty protec-tion coverage secured over the last two years has ranged between 10-30% of the total deal value of the target pur-chased (that is, the enterprise value) (see boxes “W&I placements” and
“Average premium”).
KEY MARKETS
The number of insurance companies that offer W&I insurance globally is limited and the major players have un-derwriting teams in two or more of the three key markets.
Status of key markets
The status of W&I insurance in the key markets is as follows:
• There are currently two W&I insurers based in Australia; fur-ther capacity from ofur-ther insurers is accessed from the London or New York markets. The market focus is on Australian and New Zealand domestic transactions but also extends to certain Asia-Pacific transactions. For Australian/New Zealand transactions, policy terms
Geographical spread of policies
(by percentage)Europe (including CEE) UK US and South America Elsewhere (Australia/New Zealand, Asia & Africa)
2010 2011 2012
30 20 25 20 24 20
have tended to be more favourable towards the insured party (referred to in this article as “the insured”). • The London market is now the
big-gest and most established market for W&I insurance with the abil-ity to provide over £300 million of coverage per policy. Most insur-ers have a global authority (subject to local insurance regulation) and will look at risks anywhere in the world regardless of location with the exception of the US where New York is the main market centre. • The New York market has focused
on North American transactions and has been slower to expand due to a combination of factors. Premium rates have been much higher in the US than other markets due in part to the US’s reputation for being highly litigious. In addition, US transac-tions have tended to include very broad representations and warran-ties on an indemnity basis, with no general disclosure provisions and less extensive limitation provisions for claims than other jurisdictions. So the perceived risk profile is high-er. The New York market is now starting to grow as the popularity of the product increases and competi-tion among insurers drives down premiums.
The terms of W&I insurance vary de-pending on numerous factors including the insurance market which is under-writing the deal. That market may not necessarily be in the same jurisdiction as the target’s jurisdiction, although typi-cally it is the same.
Pricing terms
There are a number of elements to the pricing of W&I insurance:
• Premium. The amount payable to the insurer for the policy, generally calculated as a percentage of the amount insured.
• Retention. Sometimes called the ex-cess or deductible, the retention is the amount for which the insured
is on risk before the policy will re-spond to cover a liability.
• Broker income.
• Insurer due diligence costs. The in-surer may waive these fees if the policy is successfully purchased and placed.
• Insurance premium tax. In some in-stances, for a UK insured, this is 6% of the premium; for a Dutch insured, this is 21%; for other ju-risdictions, tax may apply to the premium but it may be known by another name (for example, in Aus-tralia it is referred to as GST and Stamp Duty and in many US states, it is referred to as surplus lines tax and, potentially, a stamping fee). The scope of the insurance cover and the policy exclusions will invariably affect the premium for a policy.
London market premiums. The London market is currently seeing premiums within a range of 0.9-1.6% of the policy limit insured for retentions of 1% of the deal enterprise value. In some deals, it
has been possible to bring the retention level below 1%, even to zero, but this in-evitably raises the premium, reflecting the increased risk profile for the insurers. On a buy-side policy, the retention is re-ally an issue for the insured (that is, the buyer). It can choose whether to self-insure that amount or to push for the seller’s liability under the warranties to cover the retention as well.
Underwriters have typically insisted that the warrantors must have some li-ability under the warranties to ensure that there is an incentive to run a proper disclosure exercise (different underwrit-ers have different views on what con-stitutes “sufficient liability”). For ex-ample, in many transactions, the seller retains liability under the warranties for 1% of the deal enterprise value.
Australian market premiums. Aus-tralian market premiums are around 1-1.4% of the policy limit insured for retentions of 1% of the deal enterprise value.
The process in Australia has evolved to allow a seller to have zero liability
W&I placements
Total Buyer side Seller side Tax Other
Willis Limited
2010 2011 2012
0
20
40
60
80
under the transaction documents. The seller will therefore have no liability on a breach of warranty claim (save in the event of fraud), and the buyer will effec-tively self-insure the risk of the retention amount under the policy.
Buyers and their advisers have been able to get underwriters comfortable with this position on the basis that it will not affect the depth or quality of the sell-side disclosure exercise, and, indeed, this can only be achieved where the sell-side disclosure exercise appears to have been professionally and thoroughly done. Buyers have been willing to accom-modate this also on the basis that their sole recourse, absent fraud, is under the policy.
New York market premiums. US mar-ket premiums are usually not less than 2-3% of the policy limit insured for re-tentions of between 1.5-2.5% of deal enterprise value. Premium rates are gen-erally higher for the reasons mentioned above.
Scope of coverage
The precise terms of a policy are a mat-ter for negotiation between the insured and the insurer and will be tailored for
each transaction. However, the starting point is for coverage under the policy to match the scope of the warranties and the tax indemnity in the transaction documents. For example, where the transaction documents provide for loss for breach of the warranties to be on an indemnity basis rather than contractual damages, the policy will match this. The policy will invariably include a schedule that lists each warranty given under the transaction documents and sets out whether, for the purpose of the policy, the warranty is covered, not cov-ered or covcov-ered with a modification. A modification means that the insurer will amend the wording of the warranty to reflect a warranty for which it is pre-pared to provide cover.
A standard policy generally covers: • Loss incurred by the insured arising
from a breach of the warranties. • A claim under the general
indem-nity for tax.
• Reasonable costs incurred in the in-vestigation or settlement of a third party claim.
Coverage differs between the key mar-kets in a number of ways, including, for example, the use of tipping retentions and the coverage that can be achieved between signing and completion. Tipping retention. The tipping reten-tion is a reasonably well-established policy feature in the Australian market. Once the retention has been eroded, the W&I insurance will “tip” to cover some or all of the retention (see box
“Austral-ian model for tipping retention”).
The concept of a tipping retention has been available in the London market but normally attaching above a policy excess of 2%+ of enterprise value or greater. Given that it has been possi-ble on some deals to bring the retention claim to zero, it seems a natural develop-ment for this trend to migrate into the London market.
The concept does not yet seem to have been taken up by the New York market, but given that it is available in the other major insurance markets, the New York market may need to adapt in order to re-main competitive.
Coverage between signing and closing W&I insurance has traditionally ap-proached the issue of repetition of war-ranties on the basis that:
• If a breach of the signing warranties comes to light after signing which was not known on signing, then it will be covered.
• If a breach of the repeated warran-ties comes to light after signing but before completion, the insured will not be covered. Subject to the length of time between signing and clos-ing, insurers may wish to see a new disclosure letter applicable to the closing warranties and, at the very least, will want a no claims declara-tion against the closing warranties (that is, the buyer’s deal team con-firms that they are not aware of any matter that could give rise to a claim under the warranties at the date of declaration). In such situations, the buyer’s only protection is to
negoti-Average premium
(% of amount insured)Buyer side Seller side Tax
Willis Limited
2010 2011 2012
0
2
4
6
ate with the seller up front in the acquisition agreement an ability to terminate the transaction or (less likely given that W&I insurance is being used) for the seller to under-write or share in those risks. This has tended not to be a big issue in deals where W&I insurance is used and there is a private equity seller us-ing a locked-box structure as the busi-ness warranties typically will not be repeated on closing. (This is because the buyer will bear the risk and reward of the target business from the effective date.)
Australian approach. The Australian market has departed from this position, and coverage has been provided for new breaches that have occurred in a desig-nated period between signing and clos-ing. The key factors relevant to the pro-vision of such coverage are:
• The time period during which the new breach occurs must be limited. Typically, the time period has been in the range of 30 to 45 days, but in some cases that has extended to 45 business days or even 90 days. One structure that has been used is for the coverage period to be for 90 days, but if a claim is made during that period then claims coverage for additional new claims ends on the 45th business day after signing. • The existence of buyer termination
rights for a material adverse event, and a requirement in the policy for the buyer to exercise that right. • A lower policy sub-limit or a higher
retention for any such breach. • An additional amount of premium
to cover these types of breaches. However, in the last 12 months, the Australian market has waivered on this issue, and there have been mixed reac-tions from underwriters on providing coverage for new breaches.
Third party claims. The London and New York markets have tended to take
the more traditional approach (see
above). One exception to this is third
party claims.
It has sometimes been possible to get cover for third party claims that occur between signing and completion (where the period between signing and
comple-tion has been a relatively short and fixed period) and for these to be carved out of the completion no claims declaration. As this is something that is outside of the control of either a seller or buyer, the underwriters are more prepared to con-sider providing cover on a case-by-case basis to cover this risk.
Australian model for tipping retention
In Australia, the level of tipping has been 50%-100% of the retention. This means that, for example, where a policy includes a 50% tipping retention and a retention amount of AUS$1 million, if losses exceed this retention, the policy will pay out AUS$500,000. A tipping retention of 100% works on the same basis, but would cover the whole AUS$1 million.
The cost of a tipping retention clearly affects the premium, and the overall materi-ality will depend on the transaction. As with all pricing issues, it is a matter for negotiation and the broker will play an instrumental role in steering the pricing discussions by reference to what has been achieved in the market on past transac-tions.
Typically, the underwriter will charge an additional premium for the incremental amount of the retention on risk (but see below regarding impact also on follow-on insurers). For example, on the above example, the additional premium would be charged on AUS$500,000 (with a 50% tip) or AUS$1 million (on a 100% tip).
In considering the economics, the following key factors should be borne in mind:
Size matters. In some deals, an additional premium of 10-20% on the incremental amount of coverage has been charged. On smaller deals, that additional sum can make the overall cost of the policy uneconomical: if only AUS$10 million of cover-age was being arranged at a 1% premium, the tipping retention could push the blended premium to 1.5-2% (for a 50% tip) or 2-3% (for a 100% tip).
But on larger deals, where, say, AUS$100 million of coverage is being arranged at a 1% premium, the blended impact of the incremental cost may only push the overall blended premium to 1.05-1.1% (for a 50% tip) or 1.1-1.2% (for a 100% tip).
Impact on excess underwriters. Where the insurance has been arranged in layers with a primary underwriter and one or more follow-on underwriters providing ex-cess-only coverage, the insured will argue that only the primary underwriter should be able to charge an additional premium because only it is at risk if the retention tips. However, the follow-on markets may also try to push for an additional pre-mium on the basis that their insurance is at risk sooner.
If the primary insurer provides AUS$30 million of coverage and there was an AUS$5 million deductible then that primary layer would ordinarily extend to pro-vide claims coverage for loss from AUS$5 million to AUS$35 million, and above that the follow-on insurance applies thereafter. If the primary insurers agree to a full-tipping retention then the insured’s coverage would extend from AUS$0 mil-lion to AUS$30 milmil-lion, meaning that the follow-on insurer’s insurance starts at AUS$30 million rather than AUS$35 million, which places the follow-on insurers at greater risk of a claim. The broker plays a key role in those pricing discussions.
Policy exclusions
A standard policy will sit behind the warranties on a back-to-back basis but will also customarily exclude the insur-er’s liability for losses arising out of the following:
• Matters of which the insured had ac-tual knowledge before the effective date of the policy. In order to limit its scope, this exclusion is often re-stricted to the actual knowledge of specified members of the insured’s transaction team (this is limited to the internal deal team of the insured and does not include advisers). • Fraud and deliberate
non-disclo-sure on the part of the innon-disclo-sured. • Amendment of the transaction
doc-uments without the prior written approval of the insurer.
• Fines and penalties, in respect of which the insurer is not permitted by law to underwrite.
• Any pension arrangement under-funding.
• Tax avoidance.
• Purchase price adjustments and locked-box leakage covenants. • Forward-looking warranties (for
example, a warranty relating to the target’s ability to collect debts after completion of the transaction or fi-nancial projections).
One of the more creative aspects of W&I insurance is the ability to include en-hanced protections in the policy to im-prove the position that otherwise would have been achieved in the transaction documents. For example, where warran-ties have been provided subject to seller’s awareness, it is possible (in the right cir-cumstances) to remove the knowledge qualifiers for certain of the warranties so that the warranties are treated as being given absolutely in the policy.
The insurer will typically only remove the knowledge qualifier for
warran-ties which are not usually qualified by awareness (for example, an audited ac-counts warranty would ordinarily not be qualified by awareness in an M&A deal between two companies), but it will not, for example, remove the knowledge qualifier for speculative warranties, such as whether litigation is expected to be threatened.
ARRANGING A POLICY
The process for arranging W&I insur-ance has significantly improved in re-cent years and dovetails well with the transaction timetable. Before an insurer is prepared to offer cover on a binding basis, it will need to have a good ap-preciation of the transaction and to feel confident that adequate disclosure and due diligence have been undertaken by the parties.
Key steps
To arrange the placement of a standard buy-side policy, the following steps will typically need to take place:
Review the feasibility study. The buyer will engage a broker and provide the broker with a basic overview of the transaction, including details of the tar-get, jurisdiction of the target business, likely deal value and potential policy amount. At this stage, the buyer does not need to provide any documents to the broker.
The broker, using its market experience and without going out to the insurance market, will provide the buyer with a feasibility study which will include an indication of possible pricing and guid-ance on the likely reaction of the insur-ance market to the request for W&I in-surance.
Approach the insurers. If the buyer re-mains interested in obtaining a policy following the feasibility study, the bro-ker will approach the applicable insur-ance market to secure non-binding in-dicative terms based on a preliminary set of business warranties.
The buyer will be required to provide the insurers with an overview of the tar-get business (for example, a copy of an
information memorandum), the last set of (audited) accounts, the data room in-dex and a set of warranties. The insur-ers will sign a customary confidentiality agreement.
The seller’s preliminary warranties will ideally be marked up by the buyer to show the differences between the seller’s and buyer’s proposed set of warranties, but, if this is not available, educated assumptions can be made on where the warranty language may move. The idea is to present the insur-ance market with the best position on the warranties from a buyer’s perspec-tive in order to obtain the most realistic pricing and determine whether the in-surance market will provide coverage for those warranties.
Review indicative report. The non-binding indicative terms from the in-surance market will be provided to the broker and will include an indication of cost and the basic terms of the policy, including the amount the insurer is pre-pared to go on risk for, the retention and key exclusions from the coverage the insurer is prepared to offer. The broker will then compile the numerous non-binding indications into an indica-tive report.
The indicative report sets out details of each insurer’s terms in a format which is easily comparable. If the level of cover required by a buyer is likely to exceed the amount of coverage that any one in-surer would be prepared to accept, it will be necessary to arrange a programme of insurance using a syndicate of insurers. If this is the case, the broker will present a number of options for how the buyer might wish to form the programme in-surance (that is, which insurers will take the primary layer, first excess, second excess and so on; the excess layers are known as “follow-on markets”) based on the best combinations of premium rates offered by the insurers.
Insurers’ due diligence review. Follow-ing the review of the indicative report, the buyer will select a preferred insurer who will then conduct a non-intrusive due diligence review.
The insurer’s due diligence exercise is not intended to duplicate the main due diligence process or the transac-tion disclosure exercise, but rather to gain an overview of the deal and, if necessary, review specific issues. The insurer will review the transaction documents containing the warranties, the disclosure letter and any due dili-gence reports prepared by the buyer’s advisers (including legal, financial and environmental), and any vendor due diligence reports; in each case, this will be done on a non-reliance basis. The insurer will also require access to the data room.
At this stage, the buyer is likely to need to commit to covering the insurers’ due diligence costs to enable the prospec-tive insurer to conduct its review of any relevant documents either using inter-nal or exterinter-nal advisers. If the buyer
concludes the policy with the insurer, the insurer will typically write off these costs.
If a programme of insurance is required, the primary insurer selected by the buyer to proceed to the first part of the formal underwriting stage will produce a report which will then be made available to the other insurers who will piggyback off the work done by the primary insurer rather than conducting their own due diligence.
Consider the offer. If, following its dili-gence, the insurer is satisfied with its findings and the overall due diligence process that has been undertaken by the buyer, it will offer a quotation on formal terms. This will include a formal offer on price and insurance coverage terms. The insurer will also provide the buyer with a draft policy.
If a programme of insurance is being put in place, the follow-on markets will provide their formal offers on price, but will typically accept the same coverage and policy terms as set by the primary insurer.
Negotiate policy terms. If the buyer is satisfied with the formal offers, the in-surer and the buyer (assisted by its bro-ker and lawyers) will proceed to negoti-ate the policy terms. Any updnegoti-ates to the transaction documents or due diligence reports will need to be made available to the insurer.
Participate in underwriters’ call. Before the signing of the transaction docu-ments, the insurer will require the buyer to provide final versions of the transac-tion documents, the disclosure letter and due diligence reports. The insurer will also hold an underwriters’ call with
Phase 2
• Due diligence/ Second round bids.
• Information memorandum. • (Audited) accounts. • Data room index. • Draft share purchase
agreement (SPA).
• Broker makes submission to insurer and will obtain indicative report (costs and terms). • Insurer will sign
confidentiality agreements. • 5 - 8 days. • 6 - 11 days. Phase 3 • Exclusivity/negotiation of transaction documents. • Updated SPA. • Disclosure letter. • Due diligence reports:
tax, environmental, legal and any specialist reports (non-reliance basis).
• Access to data room.
• Insurers review documents.
• Commitment to insurer fees.
• Insurer offers quotation on formal terms.
• 7 - 10 days.
• 13 - 21 days.
Phase 4
• Signing/completion.
• Final SPA and disclosure letter.
• Final due diligence reports. • Underwriting call (insurer
holds this with legal advisers and insured's deal team: approximately one hour). • No claims declaration signed. • Finalisation of policy. • Binding policy. • Payment of premium. • 3 - 5 days. • 16 - 26 days. Deal status Information required by broker/insurer Insurance stage Time required Total time required
W&I insurance process
Phase 1
• Indicative offers/ bidding or heads of agreement.
• Deal size, industry sector, jurisdiction. • No documentation required by broker. • Broker provides feasibility/ conceptual study giving opinion- based pricing and guidance.
• 1 - 3 days.
the buyer (including its deal team) and its advisers.
On the call, the insurer will ask the buyer and its advisers to talk it through the ra-tionale for the deal, the due diligence process undertaken, the deal process, negotiations with the sellers and any specific issues regarding the target busi-ness that the insurer was not able to un-derstand in sufficient detail as part of its own due diligence process. The purpose of the call is to help the insurer be satis-fied that a due and proper process has been undertaken by the buyer and that the deal is an arm’s length transaction with the seller. The call generally lasts one hour.
Sign the policy. On the transaction sign-ing date, the policy will be finalised and signed. The buyer will also be required to make a no claims declaration to the insurer.
Timing
The timing for each of the steps can vary considerably depending on the type of transaction and the transaction time-table, along with the complexity of the policy and the programme of insurance that the buyer is trying to obtain. Generally, for arranging the placement of a standard W&I insurance policy, the feasibility phase will take between one and three days, the compiling of an indicative report can take between five and eight days, the insurers’ due diligence review and formal offer takes around two weeks, and the finalisation and inception of the policy can take five days (see box “W&I insurance
proc-ess”).
In total, the process can take between two and a half and three and a half weeks. The market will react to the needs of the deal, however, and can move much faster if required.
New approach by sellers
Some sellers have been arranging W&I insurance in a similar way to stapled fi-nancing over the last two years, particu-larly in auction deals where the seller wants to sign a transaction quickly once
the winning bidder has been selected. (Stapled finance is essentially pre-ar-ranged finance arpre-ar-ranged by the seller’s advisers and made available to potential buyers of a target company to enable the purchase to be made by the eventual buyer.)
In this process, the sellers engage a bro-ker who will approach the insurance market to obtain terms for a buy-side insurance policy. At this initial stage, the insurers will usually see the sellers’ draft of the acquisition agreement, an information memorandum, the latest audited accounts plus an overview of the sale process that is being undertaken and the likely timetable.
Following a review of the documents and making educated assumptions as to how the acquisition agreement may be negotiated, the insurance market will provide indicative terms to the sellers. As the sale process develops, further in-formation is shared with all or selected underwriters (such as access given to the
data room), their terms are refined and, in many instances, the policy is substan-tially negotiated by the seller.
At a point that makes sense within the context of the specific transaction, the policy terms are shared with the bidder(s) and the bidder(s) are put in touch with the selected insurer(s). At the appropriate time, the bidder/buyer is put in control of the insurance proc-ess (including the assignment of the bro-ker’s engagement letter to the buyer), further information that is in the control of the bidder is provided to the insurer and the policy is negotiated towards a fi-nal agreed form.
If the buyer requires additional cover be-yond the scope that the seller had estab-lished, this can be built into the policy and, when the acquisition agreement is in an agreed form and due to be signed, the policy will also be executed.
The key question which the market has not settled is precisely when control of the process should be handed over to the
Related information
Links from www.practicallaw.comThis article is at www.practicallaw.com/7-534-6007
Topics
Acquisition Finance www.practicallaw.com/7-201-4068
Asset Acquisitions www.practicallaw.com/5-103-1079
Insurance www.practicallaw.com/2-103-1132
Legal Risk and Compliance www.practicallaw.com/8-103-1332
Owner-managed Businesses www.practicallaw.com/7-376-4394
Private equity and venture capital www.practicallaw.com/0-103-1350
Share Acquisitions: Private www.practicallaw.com/1-103-1081
Practice notes
Disclosure: acquisitions www.practicallaw.com/5-107-4667
Warranties and indemnities: acquisitions www.practicallaw.com/2-107-3754
Previous articles
Warranties, indemnities and disclosure: comparing US and UK law and
practice (2012) www.practicallaw.com/0-521-8386
Covering the risks: warranty and
indemnity insurance (2008) www.practicallaw.com/5-382-3120
buyer by the seller. Some firms are of the view that control should only be ceded at the 11th hour before signing. Clearly, this in part is dictated by the competi-tiveness of the sales process and the par-ties’ bargaining powers.
BESPOKE POLICIES
W&I insurance is designed to address unknown risks. Bespoke policies are designed to cover known risks that have been excluded in standard W&I insur-ance.
If there are specific known issues high-lighted in the due diligence exercise, these would not typically be included within the cover offered as it is expected that the parties would deal with these risks at the negotiation table. If issues have a high cost if they occur, but a low probability of coming to fruition, and good analysis is available for insurers to assess the extent of the exposure, then cover may be available.
If cover is made available, the parties to the transaction will have their own preferences as to whether cover is in-corporated within the scope of a W&I insurance policy or separately via a
contingent liability cover. Cover would normally be taken outside the scope of a W&I policy if the policy wording (such as conduct provisions and representa-tions) needed for the bespoke risk had features that would not be dealt with ap-propriately in a W&I policy form. The most common example of a be-spoke policy is a tax liability policy de-signed to underwrite a specific identified tax issue. As the risk has been specifi-cally identified, the level of due diligence required by the insurance market to of-fer cover for the exposure is significantly more intrusive; sometimes counsel’s opinion as to the extent of the liability may be required.
Premiums for bespoke tax liability poli-cies will be higher than for W&I insur-ance: 3.5% to 5% is the average range al-though 10% is not uncommon. Subject to the nature of the tax risk, a retention will usually only apply to the defence costs aspect of the cover.
Tax matters continue to be the most common known risks that are insured in the market, but in theory any known matter that has a legal risk profile can
be insured. For example, actual and po-tential litigation matters and environ-mental issues have been insured by the markets.
EVIDENCE ON CLAIMS
In general, warranty claims are reason-ably uncommon. The experience of the insurance market bears this out but, due to confidentiality, hard statistics on the number of claims and payments made is not available.
However, based on recent analysis of the London market, it is considered that of the projects insured, one in six policies has a claim notification made against them. Not all notifications turned into claims: some were below the policy excess and others ultimately were not valid breaches. It is known that there have been numerous settlements agreed, some into eight figures.
Jannan Crozier is a senior associate and David Allen is a partner at Baker & McKenzie LLP; Brian Hendry is Execu-tive Director, Transaction Solutions at Willis Limited.
