Demystifying W&I insurance for M&A finance professionals – Part 2: The W&I process and claims

Humour me for a second will you? An M&A transaction is a lot like a skydive. No, really, it is. High octane. No guarantees. A sharp intake of breath just before the “jump” and the hope of an exhilarating ride. There's also a deep hope that all will end well. But at least there's the comforting thought of the reserve parachute just in case the unthinkable were to happen.

In my mind, W&I insurance is to M&A what a reserve parachute is to a skydive.

The skydiver hopes they’ll never need to call on the reserve, but it may prove invaluable. Of course having a reserve parachute is all well and good but for it to work, it needs to be of high quality, stowed away safely and ready to be deployed quickly. The outcome hinges on a good end-to-end process and knowing what to do in case of an “emergency”. ?As a W&I underwriter, you hope every M&A transaction will land on its feet but you are also poised to respond if something goes wrong.

In Part 1 we delved into the basics of W&I insurance, to understand what a W&I policy covers and why it’s used. In this edition, Part 2, I set out the W&I process and where the W&I parachute is most regularly deployed.

First, let’s review the key steps in placing a W&I insurance policy and find out where the FDD team fits in…

With thousands of W&I policies placed globally each year [1], the Insured can expect the W&I process to be handled with care by experienced professionals from start to finish. The "reserve parachute", so to speak, is in good hands.

These days there’s a mature W&I placement market with a host of highly skilled and specialised M&A insurance brokers and M&A lawyers. These brokers and lawyers are well versed in securing an M&A insurance policy for their clients through speciality insurers or Managing General Agents (“MGA”s). These brokers and lawyers will collectively handle thousands of M&A insurance enquiries and placements every year. W&I insurance can be deployed on big-ticket deals and low to mid-market deals alike, and across all sectors. Different insurers will have a preference for different types of M&A transaction depending on their "risk appetite". But let’s be clear on the respective roles:

• The broker’s role is to help its client, the policyholder, secure the best possible policy.
• The role of the specialty insurer or MGA is to underwrite the transaction and ultimately deliver the policy to the insured party. In the event of a claim it is the insurer’s capital that is ultimately at risk.

Parties involved:

?The end-to-end W&I process

This end-to-end process can span a matter of days or weeks depending on the deal complexity, size and overall dynamics. Underwriters are used to working at M&A pace.

So how does policy pricing work for your client?

Pricing is entirely bespoke and also dynamic given the competitive marketplace, but as a rough guide[2]:

Do W&I policies really work? How many claims are made on policies and in what areas[1]?

c. 11% of policies result in a claim notification, with deviations by jurisdiction. With the boom in M&A activity in 2021 the expectation is that this will (inevitably) lead to a higher number of claims notifications in the next few years

c. 1 in 20 of policies placed resulted in a paid claim

c. 95% of successful claims were paid within 2 years, whilst a quarter were settled within 12 months

c. 45% of claim notifications since 2016 related to third party claims, or have an element of seller non-disclosure or fraud which are virtually impossible to diligence

What are the most common types of warranty breach?

It's common for W&I policy claims to be made in respect of multiple warranty categories, but year on year we consistently see a podium finish for Accounts and Tax warranties as a key source of W&I claim.

When we say “Accounts” warranties, what do we mean exactly?

From a W&I perspective, the FDD team’s work typically supports a set of accounts focused warranties, which are tailored to the specifics of a transaction and are subject to SPA negotiation. I’d broadly characterise them in three categories:

1. Accounts / Financial statements… talk to the quality or accuracy of the financial statements, as well as the basis on which the accounts have been prepared (e.g. accounting standards applied or whether audited and for which time periods);
2. Management accounts and Locked box accounts… attest to the quality or accuracy of the management accounts prepared by management over a period of time; and
3. Post accounts date warranties… make statements as to circumstances or matters arising during an interim period, for instance the non-existence of liabilities outside the ordinary course of business after a certain date.

As we've just seen, certain warranties presented by the Seller may turn out to be false because of misstatements or omissions in the financial information being warranted. This may be because of mathematical mistakes, misinterpretations of relevant information, misapplication of certain accounting standards, inadequate disclosures or situations involving fraud or misrepresentation. In these cases the Insurer may be on the hook for losses suffered.

What kind of claims are made around the financial statements and accounts warranties?

Amongst others:

• Inappropriate application of accounting principles such as revenue recognition;
• Solvency and going concern;
• Accounting irregularities/fraud;
• Undisclosed liabilities; and
• Valuation of inventories and trade receivables.

Can you point to any recent examples?

There are a number of recent cases with public judgements that are interesting case studies of the W&I product at work, such as:

• Finsbury Food Group
• Gram Equipment
• Schur Flexibles

Looking for advice to improve coverage for your clients? Stay tuned for Part 3, the final instalment of this three-part series, where we explore this further...

Can't wait until then and want to learn more now?

Thanks for reading. Comment below or contact me: [email protected]

To learn more about Icen Risk: www.icenrisk.com

Missed Part 1? Find it here.

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

• ￡115 million 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

Any use of this publication or reliance on it for any purpose or in any context is at your own risk, without any right or recourse against Icen Risk Limited or any of its employees.

[1] Source: HWF Market Claims Study 2023

[2] Source: CMS European Private Equity Study 2023