Protecting Buyers and Sellers

M&As Fuel Reps and Warranties Coverage

Representations and warranties policies evolved into an efficient and effective capital solution.
By: | March 24, 2016 • 4 min read

Demand for representations and warranties coverage is on the rise for a number of reasons: increased M&A activity, a continued seller-friendly market, and the increased acceptance of the insurance product by deal makers, including law firms and investment bankers.

Kirk Sanderson, senior vice president, transactional risk, Equity Risk Partners

Kirk Sanderson, senior vice president, transactional risk, Equity Risk Partners

When the product became available about 10 years ago, buyers primarily purchased R&W as supplemental indemnity coverage when they were unable to get sellers to provide what they considered to be adequate indemnification protection under the transaction agreement, said Kirk Sanderson, senior vice president, transactional risk at Equity Risk Partners in New York City.

Sanderson’s firm was recently acquired by HUB International Ltd.

But in today’s market, sellers are essentially mandating that buyers take a reps and warranties policy to remain competitive in an auction scenario while providing very limited indemnification and zero escrow to buyers, Sanderson said.

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“Private equity firms and their outside counsel have really pushed the envelope over the past three to four years on developing the R&W insurance policy into a highly efficient and economically favorable capital solution,” he said.

Renee Szalkowski, senior vice president and transaction liability practice leader at Lockton in New York City, agreed. Sellers in prospective M&A deals now have more leverage to demand that buyers take out R&W policies to suit their own purposes, she said.

“They are dictating terms, including providing little or no indemnity in deals where they don’t have to set aside a large percentage in escrow for 12 or 18 months,” Szalkowski said.

Renee Szalkowski, senior vice president and transaction liability practice leader, Lockton

Renee Szalkowski, senior vice president and transaction liability practice leader, Lockton

Moreover, there is greater acceptance of the product because pricing — at 3 percent to 4 percent of limits purchased — is more reasonable, and the underwriting process more streamlined, she said.

The manuscripted polices are now underwritten by ex-M&A attorneys and are more insured-friendly, based on “actual knowledge” definitions, with limited subrogation against sellers and an increased appetite for certain types of damages, she said.

The “actual knowledge” exclusion in older vintage policies was much more expansive, said Matthew Heinz, managing director at Aon in New York City, and a 2016 Power Broker® in the Private Equity category.

He said the current exclusion is much narrower and makes it harder for the carrier to prove that the insured had actual knowledge of a breach at binding and to prove that the exclusion should apply.

In general, Heinz said, reps and warranties coverage terms have gotten a lot better, and are closer to the traditional indemnity provided by sellers in transactions.

Some exclusions, such as those limiting the breadth of recoverable loss for consequential damages or diminution in value, are frequently removed, providing the buyer with coverage terms that more closely approximate the types of loss the buyer would seek to recover from the seller if there is a breach.

An example would be the availability of consequential damages in connection with a seller’s breach of a regulatory compliance representation.

“If a target company was not compliant with some regulation and must pay a fine and shut down a portion of its operation as a result, the buyer would seek to recover not just the immediate financial impact of the breach (i.e., the fine), but also any consequential damages resulting from the shut-down, including lost profits,” Heinz said.

“Today’s policies allow for this coverage,” he said.

Using R&W Strategically

Matthew Heinz, managing director, Aon

Matthew Heinz, managing director, Aon

Reps and warranties policies are also more strategic now, as opposed to being driven by concern over heightened risk, Heinz said.

“Clients are strategically incorporating policies into the front end of deals, rather than when an issue comes up,” he said. “Sellers have been able to exit deals more cleanly by pushing buyers to obtain insurance coverage.”

Without insurance, sellers might have to indemnify the buyer up to 10 percent of the deal size, and potentially leave an escrow in place up to that amount, Heinz said. But now the seller may only need to put 1 percent or less in escrow, with the remainder of risk allocated to the insurance market in the form of a buy-side reps and warranties insurance policy.

Premiums have also come down from a range of 4 percent to 6 percent pre-2008, to the 3 percent to 4 percent range in the current market, he said.

Szalkowski and her team expect reps and warranty insurance will continue to be in high demand over the next year as the M&A landscape remains competitive.

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“Sellers are retaining post-closing equity positions more frequently and selling management is staying involved,” she said.

“This will result in buyers continuing to use reps and warranties policies to protect these relationships post-closing.”

However, clients should not expect prices to fall further in the near future just because “quite a few” carriers have entered the R&W insurance market, Szalkowski said.

“Notwithstanding increased supply and given increased demand, the fact that insurers that have been around for a while are paying claims means that overall pricing is holding steady,” she said.

Katie Kuehner-Hebert is a freelance writer based in California. She has more than two decades of journalism experience and expertise in financial writing. She can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Property

Insurers Take to the Skies

This year’s hurricane season sees the use of drones and other aerial intelligence gathering systems as insurers seek to estimate claims costs.
By: | November 1, 2017 • 6 min read

For Southern communities, current recovery efforts in the wake of Hurricane Harvey will recall the painful devastation of 2005, when Katrina and Wilma struck. But those who look skyward will notice one conspicuous difference this time around: drones.

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Much has changed since Katrina and Wilma, both economically and technologically. The insurance industry evolved as well. Drones and other visual intelligence systems (VIS) are set to play an increasing role in loss assessment, claims handling and underwriting.

Farmers Insurance, which announced in August it launched a fleet of drones to enhance weather-related property damage claim assessment, confirmed it deployed its fleet in the aftermath of Harvey.

“The pent-up demand for drones, particularly from a claims-processing standpoint, has been accumulating for almost two years now,” said George Mathew, CEO of Kespry, Farmers’ drone and aerial intelligence platform provider partner.

“The current wind and hail damage season that we are entering is when many of the insurance carriers are switching from proof of concept work to full production rollout.”

 According to Mathew, Farmers’ fleet focused on wind damage in and around Corpus Christi, Texas, at the time of this writing. “Additional work is already underway in the greater Houston area and will expand in the coming weeks and months,” he added.

No doubt other carriers have fleets in the air. AIG, for example, occupied the forefront of VIS since winning its drone operation license in 2015. It deployed drones to inspections sites in the U.S. and abroad, including stadiums, hotels, office buildings, private homes, construction sites and energy plants.

Claims Response

At present, insurers are primarily using VIS for CAT loss assessment. After a catastrophe, access is often prohibited or impossible. Drones allow access for assessing damage over potentially vast areas in a more cost-effective and time-sensitive manner than sending human inspectors with clipboards and cameras.

“Drones improve risk analysis by providing a more efficient alternative to capturing aerial photos from a sky-view. They allow insurers to rapidly assess the scope of damages and provide access that may not otherwise be available,” explained Chris Luck, national practice leader of Advocacy at JLT Specialty USA.

“The pent-up demand for drones, particularly from a claims-processing standpoint, has been accumulating for almost two years now.” — George Mathew, CEO, Kespry

“In our experience, competitive advantage is gained mostly by claims departments and third-party administrators. Having the capability to provide exact measurements and details from photos taken by drones allows insurers to expedite the claim processing time,” he added.

Indeed, as tech becomes more disruptive, insurers will increasingly seek to take advantage of VIS technologies to help them provide faster, more accurate and more efficient insurance solutions.

Duncan Ellis, U.S. property practice leader, Marsh

One way Farmers is differentiating its drone program is by employing its own FAA-licensed drone operators, who are also Farmers-trained claim representatives.

Keith Daly, E.V.P. and chief claims officer for Farmers Insurance, said when launching the program that this sets Farmers apart from most carriers, who typically engage third-party drone pilots to conduct evaluations.

“In the end, it’s all about the experience for the policyholder who has their claim adjudicated in the most expeditious manner possible,” said Mathew.

“The technology should simply work and just melt away into the background. That’s why we don’t just focus on building an industrial-grade drone, but a complete aerial intelligence platform for — in this case — claims management.”

Insurance Applications

Duncan Ellis, U.S. property practice leader at Marsh, believes that, while currently employed primarily to assess catastrophic damage, VIS will increasingly be employed to inspect standard property damage claims.

However, he admitted that at this stage they are better at identifying binary factors such as the area affected by a peril rather than complex assessments, since VIS cannot look inside structures nor assess their structural integrity.

“If a chemical plant suffers an explosion, it might be difficult to say whether the plant is fully or partially out of operation, for example, which would affect a business interruption claim dramatically.

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“But for simpler assessments, such as identifying how many houses or industrial units have been destroyed by a tornado, or how many rental cars in a lot have suffered hail damage from a storm, a VIS drone could do this easily, and the insurer can calculate its estimated losses from there,” he said.

In addition,VIS possess powerful applications for pre-loss risk assessment and underwriting. The high-end drones used by insurers can capture not just visual images, but mapping heat, moisture or 3D topography, among other variables.

This has clear applications in the assessment and completion of claims, but also in potentially mitigating risk before an event happens, and pricing insurance accordingly.

“VIS and drones will play an increasing underwriting support role as they can help underwriters get a better idea of the risk — a picture tells a thousand words and is so much better than a report,” said Ellis.

VIS images allow underwriters to see risks in real time, and to visually spot risk factors that could get overlooked using traditional checks or even mature visual technologies like satellites. For example, VIS could map thermal hotspots that could signal danger or poor maintenance at a chemical plant.

Chris Luck, national practice leader of Advocacy, JLT Specialty USA

“Risk and underwriting are very natural adjacencies, especially when high risk/high value policies are being underwritten,” said Mathew.

“We are in a transformational moment in insurance where claims processing, risk management and underwriting can be reimagined with entirely new sources of data. The drone just happens to be one of most compelling of those sources.”

Ellis added that drones also could be employed to monitor supplies in the marine, agriculture or oil sectors, for example, to ensure shipments, inventories and supply chains are running uninterrupted.

“However, we’re still mainly seeing insurers using VIS drones for loss assessment and estimates, and it’s not even clear how extensively they are using drones for that purpose at this point,” he noted.

“Insurers are experimenting with this technology, but given that some of the laws around drone use are still developing and restrictions are often placed on using drones [after] a CAT event, the extent to which VIS is being used is not made overly public.”

Drone inspections could raise liability risks of their own, particularly if undertaken in busy spaces in which they could cause human injury.

Privacy issues also are a potential stumbling block, so insurers are dipping their toes into the water carefully.

Risk Improvement

There is no doubt, however, that VIS use will increase among insurers.

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“Although our clients do not have tremendous experience utilizing drones, this technology is beneficial in many ways, from providing security monitoring of their perimeter to loss control inspections of areas that would otherwise require more costly inspections using heavy equipment or climbers,” said Luck.

In other words, drones could help insurance buyers spot weaknesses, mitigate risk and ultimately win more favorable coverage from their insurers.

“Some risks will see pricing and coverage improvements because the information and data provided by drones will put underwriters at ease and reduce uncertainty,” said Ellis.

The flip-side, he noted, is that there will be fewer places to hide for companies with poor risk management that may have been benefiting from underwriters not being able to access the full picture.

Either way, drones will increasingly help insurers differentiate good risks from bad. In time, they may also help insurance buyers differentiate between carriers, too. &

Antony Ireland is a London-based financial journalist. He can be reached at [email protected]