Warrant Insurance

Question 1

What is the concept and idea behind Warranty & Indemnity Insurance ?

Answer 1

▪ W&II is a deal risk management product
▪ Some sellers, originally Private Equity, were technically not in a position to give long-lasting representations & warranties
▪ This has as of recently expanded also into the corporate world and often times sellers are looking for options to realise a c lean exit
▪ W&II is a tool to address this asymmetry of a buyer wanting to get more liability coverage than a seller is prepared (or able) to give
▪ Methodology: buyer can sue warrantors up to their cap and the claim against insurer for additional liability under policy

Question 2

. What can be insured and what is more problematic or even excluded?

Answer 2

Exclusions are:
⎯ Known risks (these will need to be factored into the purchase price or – if particularly serious – into the overall decision to buy the target) including matters
disclosed in the SPA or in the Data Room
⎯ Future projections (e.g. budget or business plan)
⎯ Asbestos and similar toxic substances
⎯ Product liability risks
⎯ Secondary taxes
⎯ Pensions
▪ Problematic are:
⎯ Purchase price adjustments, no-leakage warranties and adequacy of accruals
⎯ Compliance issues (e.g. fines)
▪ Note: may also cover specific indemnity issue (for an additional premium)

Question 3

Are there any limits from a monetary perspective

Answer 3

Policies cover losses over a specified deductible, such deductible usually being 1-2% of Enterprise Value
▪ Policies are available with or without any seller liability retention/the latter is more expensive)
▪ The insured limit usually ranges between 10 - 30% of the Enterprise Value

Question 4

What does it cost

Answer 4

One-off premium of typically 1 - 2.5% of the policy limit in Europe though the level will be influenced by a variety of factors such as level of deductible, amount and
duration of cover, perceived (by insurer) quality of Due Diligence

Question 5

. How does the process to enter into W&II look like?

Answer 5

▪ Generally, 12 to 18 business days, subject to availability of “close to final” transaction documents/ full set of Due Diligence documentation available for
review by insurer

Question 6

How often is W&II triggered and how can behavior of insurers be described in case of damage?

Answer 6

Notification of claims are made for under 1/8 of the policies of two (exemplary selected) major German W&I insurers
▪ 2/3rd of the claims are uncovered in the first 12 months, reaching ~90% after 18 months
▪ Depending on source, the most frequent type of claims are regarding tax and financial statements
▪ Claims are normally settled without court/ arbitral proceedings
▪ Insurers tend to handle claims reasonably as they acknowledge that “claims are part of the game” and realise that they need to worry about their reputation in handling
claims (it is probably fair to say that this is not the case if there is a breach in representations and warranties as given by a corporate seller without W&II)
▪ Average policy limit as % of deal value is c. 30%

Question 7

Are there actually any advantages of a seller giving representations & warranties versus an insurer doing so?

Answer 7

Protection where seller requires a low maximum liability amount or is not willing/ able to give any representations & warranties at all
▪ In individual cases, the scope of insurance may be broader than the catalogue of guarantees provided or in SPA
▪ Reduced solvency risk of seller

Question 8

What is important to keep in mi

Answer 8

A comprehensive Due Diligence review is crucial
▪ Based on the wording of most insurance contracts, claims related to warranties given as per the closing dates are excluded, IF buyer gains knowledge of breach after
signing but prior to closing
▪ Payments under a W&II policy may be taxable income at buyers level. If gross-up is desired, this is usually reflected in higher premium

Question 9

Key drivers behind purchase

Answer 9

Buyer
▪ Protection when buying from seller providing limited W&I, e.g. a low cap
▪ Extension of warranty period and warranty cap
▪ W&I insurance distinguishes a bid in a competitive process
▪ Reduces concern over enforceability of seller’s indemnity/financial status
Seller:
▪ Alternative to high liability caps
▪ Cleaner exit, no expensive escrow needed. Freeing up sale proceeds
▪ No long tail liabilities (not to worry about future claims)
▪ Potential for higher purchase price due to transferring risk to insure