Reps & Warranties

Reducing Friction for M&As

The reps and warranties market is growing rapidly, but some newer players may have taken on more risk than they realize.
By: | February 20, 2018 • 6 min read

Strong demand and booming capacity are driving the market of representation and warranty insurance, which is used by companies to transfer to underwriters risks of future liabilities originated from the acquisition of another firm.

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In the past few years, the number of carriers who offer this coverage has increased from half a dozen to more than four times as many. As a result, terms and conditions have become much more favorable to insurance buyers, while premium rates have gone down consistently.

Even so, they remain significantly higher in the United States than in Europe or the UK.

More importantly, however, in the current market, it is possible for companies to buy coverage for virtually any kind of liabilities arising from an M&A deal. This includes tax liabilities and risks that, not long ago, markets were leery of, such as intellectual property infringements, Medicare and Medicaid billing, product recall, product liability and even environmental risks.

On the other hand, the explosive pace of growth in this market also means higher loss ratios and raises concerns that some new arrivals in the segment may not be fully prepared to face the challenges of the product.

“There are more underwriters who want to get involved in this segment than there are people with the skills required to underwrite the risk,” said Emily Maier, group leader of Transaction Solutions, Woodruff Sawyer & Company.

Emily Maier, group leader of Transaction Solutions, Woodruff Sawyer & Company

For a couple of decades, R&W coverages were mostly a tool deployed by private equity investors to unblock M&A deals by taking off the table the risk that liabilities unknown at the time of the transaction would cause significant losses to the buyer in the future.

It has gradually replaced, in a growing number of transactions, a demand that sellers deposit a share of the price paid into an escrow account — for several years — to show their confidence in the veracity of the R&W included in the sales and purchase agreement (SPA).

The insurance coverage makes the deposit unnecessary, liberating sellers to fully dispose of the capital raised immediately as they see fit.

As a result, in a competitive M&A market, investors have increasingly purchased the coverage to make their bids more attractive to sellers of coveted assets. It also helps to reduce the risk of friction between the new owners and the talent acquired along with the physical assets.

Jonathan Gilbert, senior managing director, Crystal & Company, estimates that, while not long ago one out of every 20 transactions was covered by R&W insurance, today the ratio reaches between 75 percent and 80 percent of the total.

A large majority of policies are purchased by buyers, who can have additional forward coverage, which is not the case with sellers.

Buyers can also insure any amount they want, while sellers can only insure up to the limit of liability. But Maier has spotted a growing number of sellers purchasing the coverage as well, as its scope of use expands.

“I have seen sell-side policies where the seller is much smaller than the buyer, and so it does not necessarily have as much bargaining power,” she said. “There are also situations where international buyers come from a jurisdiction where the market is not as familiar with this product and do not feel comfortable with it.”

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Demand has attracted a growing number of insurers and MGAs to the markets, and prices have fallen accordingly.

Brian Benjamin, global head of M&A Insurance, XL Catlin, estimates that rates dropped 10 percent in 2017, reaching between 2.8 percent to 3.5 percent of the primary limit in the American market, which is one of the most expensive in the world. Not long ago, rates between 4 percent and 5 percent of the purchased limit were standard in the market, he said.

Rates are higher in America due to factors such as the higher risk of litigation, lower disclosure of data requirements imposed on sellers and more expensive claims than in other markets.

Policies offer a mix of first-party and third-party liability coverages, and third-party liability risk tends to be higher in the U.S., Benjamin remarked. On the other hand, he noted U.S.-based coverages tend to be broader in scope, with narrower and less frequent exclusions than in other markets.

Maier has noticed that the market is taking almost all kinds of liability risks, as carriers compete to offer more attractive terms and conditions.

“I have not seen a lot of requests from clients that have not been met from carriers,” she pointed out.

Soft conditions are also bringing retention levels down, Gilbert added. “Previously, insurers would often require a retention equal to 1.5 percent to 2 percent of deal value. Now it has fallen to 1 percent, especially for larger deals,” he said.

“There are more underwriters who want to get involved in this segment than there are people with the skills required to underwrite the risk.” — Emily Maier, group leader of Transaction Solutions, Woodruff Sawyer & Company

Some exclusions can be added to the coverage, and among the most common are forward-looking warranties. Carriers do not like to cover purchase price adjustments and any known issues such as pending litigations or product recalls that are already expected.

Other thorny issues include the underfunding of pension plans, wage and hour disputes and union activity. On cross-border deals, transfer pricing liabilities also tend to be excluded.

A key element to the underwriting process is the due diligence that buyers are supposed to perform on their targets before closing a deal, as carriers base the wording of the policy on the analysis their clients have done on the risks represented by the transaction.

Insurers may refuse to provide the coverage if the due diligence is poorly done, or they can come up with a high number of exclusions if they see material gaps in the information provided.

“We would rather write good deals at a more competitive price rather than increase price and write bad deals. We believe that the market has under-priced certain metrics,” said Bryce Guingrich, managing director of R&W, Vale Insurance Partners.

Maier, however, notes that some underwriters are less demanding regarding the due diligence of deals in a quest to attract customers.

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Studies by AIG and UK brokers Paragon reveal that the frequency of claims in R&W policies is firmly on the rise. Rob Brown, the global practice leader of M&A insurance at Lloyd’s insurers Neon, believes some of the new entrants into the market have underestimated the level of losses that carriers can suffer in this line.

Another development is that capacity is increasingly being offered in new jurisdictions. Buyers must also keep in mind considerations such as the local expertise that they want the underwriter to offer them and the jurisdiction where the insurance premium will be taxed.

The insurance contract is likely to stay open until the negotiation is concluded. That can mean an eleventh-hour rush to finalize the coverage, requiring an intense time commitment from brokers and underwriters.

“Timescales are very tight, and they require people who can understand the transactions and respond to situations very quickly,” Brown said. &

Rodrigo Amaral is a freelance writer specializing in Latin American and European risk management and insurance markets. He can be reached at ris[email protected]

More from Risk & Insurance

More from Risk & Insurance

4 Companies That Rocked It by Treating Injured Workers as Equals; Not Adversaries

The 2018 Teddy Award winners built their programs around people, not claims, and offer proof that a worker-centric approach is a smarter way to operate.
By: | October 30, 2018 • 3 min read

Across the workers’ compensation industry, the concept of a worker advocacy model has been around for a while, but has only seen notable adoption in recent years.

Even among those not adopting a formal advocacy approach, mindsets are shifting. Formerly claims-centric programs are becoming worker-centric and it’s a win all around: better outcomes; greater productivity; safer, healthier employees and a stronger bottom line.

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That’s what you’ll see in this month’s issue of Risk & Insurance® when you read the profiles of the four recipients of the 2018 Theodore Roosevelt Workers’ Compensation and Disability Management Award, sponsored by PMA Companies. These four programs put workers front and center in everything they do.

“We were focused on building up a program with an eye on our partner experience. Cost was at the bottom of the list. Doing a better job by our partners was at the top,” said Steve Legg, director of risk management for Starbucks.

Starbucks put claims reporting in the hands of its partners, an exemplary act of trust. The coffee company also put itself in workers’ shoes to identify and remove points of friction.

That led to a call center run by Starbucks’ TPA and a dedicated telephonic case management team so that partners can speak to a live person without the frustration of ‘phone tag’ and unanswered questions.

“We were focused on building up a program with an eye on our partner experience. Cost was at the bottom of the list. Doing a better job by our partners was at the top.” — Steve Legg, director of risk management, Starbucks

Starbucks also implemented direct deposit for lost-time pay, eliminating stressful wait times for injured partners, and allowing them to focus on healing.

For Starbucks, as for all of the 2018 Teddy Award winners, the approach is netting measurable results. With higher partner satisfaction, it has seen a 50 percent decrease in litigation.

Teddy winner Main Line Health (MLH) adopted worker advocacy in a way that goes far beyond claims.

Employees who identify and report safety hazards can take credit for their actions by sending out a formal “Employee Safety Message” to nearly 11,000 mailboxes across the organization.

“The recognition is pretty cool,” said Steve Besack, system director, claims management and workers’ compensation for the health system.

MLH also takes a non-adversarial approach to workers with repeat injuries, seeing them as a resource for identifying areas of improvement.

“When you look at ‘repeat offenders’ in an unconventional way, they’re a great asset to the program, not a liability,” said Mike Miller, manager, workers’ compensation and employee safety for MLH.

Teddy winner Monmouth County, N.J. utilizes high-tech motion capture technology to reduce the chance of placing new hires in jobs that are likely to hurt them.

Monmouth County also adopted numerous wellness initiatives that help workers manage their weight and improve their wellbeing overall.

“You should see the looks on their faces when their cholesterol is down, they’ve lost weight and their blood sugar is better. We’ve had people lose 30 and 40 pounds,” said William McGuane, the county’s manager of benefits and workers’ compensation.

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Do these sound like minor program elements? The math says otherwise: Claims severity has plunged from $5.5 million in 2009 to $1.3 million in 2017.

At the University of Pennsylvania, putting workers first means getting out from behind the desk and finding out what each one of them is tasked with, day in, day out — and looking for ways to make each of those tasks safer.

Regular observations across the sprawling campus have resulted in a phenomenal number of process and equipment changes that seem simple on their own, but in combination have created a substantially safer, healthier campus and improved employee morale.

UPenn’s workers’ comp costs, in the seven-digit figures in 2009, have been virtually cut in half.

Risk & Insurance® is proud to honor the work of these four organizations. We hope their stories inspire other organizations to be true partners with the employees they depend on. &

Michelle Kerr is associate editor of Risk & Insurance. She can be reached at [email protected]