Demystifying W&I insurance for M&A finance professionals – Part 3: Take-aways

In Part 1 and Part 2 we placed W&I on the M&A map and pointed out the key features and landmarks in the land of W&I. But it would be remiss of me to airlift you in and leave you to stumble around in the dark while you try to guide your client to their desired destination. So I’ve taken the liberty of preparing some hints and tips for FDD teams. Your very own W&I “night vision goggles” if you will. Benefits include: A smoother process and better outcomes for your client. So try them on for size, adjust to suit your needs and I hope to see you on a W&I backed transaction very soon!

Shining a light on the W&I underwriting process

Underwriting tends to take a two-pronged approach, with the transactional risk assessed at both a macro-level (think overall deal dynamics) and a micro-level (such as specific matters coming to light in DD and their relevance to the warranties presented by the Seller).

As part of the macro-level review, underwriters will weigh up the overall deal dynamics and also like to hear directly from the client to understand the key pillars of the investment case as well as the valuation basis. This helps underwriters to understand how the Buyer has navigated the transaction’s material risks beyond what’s presented in the DD reports.

At a more granular level, the underwriter will review the outputs of all diligence workstreams, including FDD, but also Commercial, Technical, Tax etc. For underwriters its critical to form a clear assessment of the diligence across all workstreams to support the entire suite of warranties. In general, the more evidence presented to reduce the perceived exposure or uncertainty, the better the W&I policy cover. FDD undoubtedly plays an important role here.

Broadly speaking, the underwriter's review of the FDD comprises:

1. A review for material exposures that haven't been adequately disclosed or diligenced. As we saw in Part 1, the W&I policy is intended to protect the Buyer from major undisclosed liabilities or unsubstantiated assets that i) did not come to light at the time of sale, and ii) would have affected the valuation or investment decision. Underwriters will generally be concerned about matters that could give rise to a material loss and not run-of-the-mill matters that crop up in the ordinary course of business. More on this later.
2. A reconciliation of the FDD scope with the accounts warranty suite. This typically entails the following:

So how does this translate into an insurance policy?

Once the underwriter has appraised the underwriting materials and made a commercial assessment of the transactional risk at hand, the underwriter presents a set of terms reflecting the depth and breadth of the insurance on offer (known as “coverage”).

Without getting too far into the weeds, a policy will cover a suite of warranties, which is then caveated to limit policy "coverage" by way of:

1. “general exclusions” for specific risks to be carved out of the policy if not adequately disclosed pre-sale (e.g. a particular type of tax risk in a certain jurisdiction that hasn’t been reviewed or a specific material accounting risk that hasn’t been concluded upon in DD); and
2. “warranty comments” detailing, for all the express warranties offered by the Seller, which warranties are insurable as drafted and which require further refinement. This thought process can be illustrated as follows:

Note A: Matters are insurable but need to be limited, for instance, by introducing “qualifiers” to specific warranties in respect of “materiality” or “seller’s knowledge”, or by tweaking the drafting to better reflect the facts presented in the DD / wider disclosure process or risk appetite of the Insurer.

Note B: Matters are excluded from cover entirely. This may be because of inadequate disclosure or as a matter of market practice (such as forward-looking statements, which in the absence of a crystal ball can’t possibly be proven to be true at the point of signing an SPA).

What practical advice do you have for FDD practitioners?

Without any further ado, let me fetch your pair of night-vision goggles.

There are three key points that I’d encourage you to think about during your next W&I backed transaction.

And a final point on underwriting questions:

Underwriters aren’t trying to catch anybody out but simply want to better understand each “risk” being presented to them, especially since we are getting up to speed late in the process. Of course, underwriters’ expertise and understanding of matters will vary, but we do our best to ensure our questions stick to relevant and potentially material issues. Generally speaking, underwriters are looking for you to elaborate on the contents of the FDD Report (which we do read, I promise!) and want to understand the level of comfort that you’ve derived so we can make informed decisions. It really helps when your answers to our underwriting questions help us to bridge this knowledge gap. This helps us determine coverage or gives us a chance to explore what additional comfort can be provided.

What else should you be aware of in the world of W&I?

As the W&I offering becomes more and more sophisticated, a larger pool of advisors and specialists is involved in the end-to-end W&I process as outlined below:

1. Contingent risk insurance: Popularity in contingent Tax and Intellectual Property (“IP”) risk insurance continues to grow. These are identified risks that, while not yet crystallized, could, if they occurred, cause damage or loss to the buyer or target company (i.e. "Known Unknown" risks). As IP becomes more and more integral to the business of target companies, buyers are increasingly focusing on insurance products to manage IP exposures.
2. Broader expertise: Beyond financial and tax warranties, other areas receiving more attention include IT, cybersecurity and ESG (particularly environmental). Multidisciplinary advisors are increasingly being called upon. Appropriate in-house expertise within underwriting firms allows cover to be offered in these areas where possible.
3. Claims handling: It’s critical that the efficiency of claims handling matches the growth in popularity of the product. More specialisms are entering the M&A insurance market (finance, tax, intellectual property, cyber) which enables a more efficient and better understanding of claims made and a slicker claims handling process. Forensic accountants may be involved in more complex claims.

Want to learn more?

Thanks very much for reading. My hope is that these articles have gone some way to demystify the W&I offering and that you have gained more confidence to engage with the product, which will lead to better outcomes for your clients.

From a claims handling perspective, you'll find W&I sitting at a unique intersection between disciplines such as legal, insurance and accounting. Recent case law and judgements shed a fascinating light on W&I insurance at work and highlight the importance of a joined up multi-disciplinary approach to claims. If you're interested in learning more on these topics then take a look at this insightful article produced recently by BDO .

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Want to learn more about Icen Risk: www.icenrisk.com

Missed the previous editions? Find them here: Part 1 and Part 2

Icen Risk in a nutshell:

• Specialist M&A insurance solution provider with some of the most experienced underwriters in the transactional risk market with specialisms including:

o?? W&I (including ex Big Four FDD and TDD practitioners)

o?? Tax

o?? Intellectual Property

o?? Environmental

• ￡115m line size (A+/A rating)
• UK and European operations (London/Amsterdam/Vienna/Milan)
• In house Spanish, Italian, Polish, German, Dutch, South African and UK underwriting expertise. We also work with external counsel globally to support on cross-border transactions
• Dedicated in-house claims handling alongside our insurance capital providers

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