Synthetic tax deeds, knowledge scrapes and growing use of warranty and indemnity insurance on auction processes and for SME deals are some of the emerging trends of the last 6-12 months.
Underwriters and managing general agents (MGAs) continue to enter the market, driving changes to both coverage positions and pricing. Deal sizes, warranties and geographies that a year ago would have been either uninsurable, or uneconomical to insure, are now becoming commonplace thanks to greater competition and a growing drive to use warranty and indemnity (W&I) insurance products.
Below are some of the W&I insurance market trends we have recently seen.
1. Tactical use of W&I on auction processes
Sellers are using W&I insurance strategically to enhance their position; they will prepare draft versions of the Share Purchase Agreement (SPA) ahead of an auction process, alongside a policy that covers the warranty suite on offer. Typically this set of warranties is broader than a usual auction draft, as sellers take the opportunity to limit their liability, while offering protection to bidders by virtue of the insurance.
Certain insurers are now starting to offer a ‘synthetic’ tax deed when sellers are unwilling or unable to offer a conventional tax deed that the buyer can claim against.
Conversely, buyers are taking auction draft SPAs, sharing a broad suite of their desired warranties with insurers, and checking to see what coverage they can get. The intention is then to submit an SPA where buyers have the necessary protections and the seller’s potential liability is limited by the insurance. This also reduces the strain on the seller’s time during the auction process, as the negotiation of warranties between seller and buyer is transferred to buyer and insurer. As a result, the bid is more attractive to the sellers compared with other uninsured offers.
2. Synthetic tax deeds
Certain insurers are now starting to offer a ‘synthetic’ tax deed when sellers are unwilling or unable to offer a conventional tax deed that the buyer can claim against. The first draft is either provided by the insurer (based on a reasonable draft) or by the buyer, which the insurer then marks up.
Even though the ultimate liability might be similar to a tax covenant provided by the seller, there is currently a materially increased premium charge of 20% for the insurer agreeing to cover a tax covenant that has essentially not been negotiated between buyer and seller. Lockton expects this to be offered by more and more insurers, which will probably bring down the price.
Transactions with deal sizes of between £5-30m are starting to use W&I insurance as it becomes more economical to insure.
3. Knowledge scrapes
When giving warranties, sellers may look to limit the scope of the warranties with a ‘knowledge qualifier’ – ie, the seller qualifies the warranty with ‘to its knowledge’ language. Some sellers are successful in implementing a general knowledge sweeper across all warranties, known as a ‘knowledge scrape’.
Knowledge scrapes, previously uncommon in the marketplace, are now being offered by a small handful of insurers. They are offered in two ways:
• When the full suite of warranties is qualified by the knowledge of the seller’s deal team in the SPA, underwriters remove this blanket qualification and instead apply only the “necessary” qualifiers to certain warranties (eg, threatened litigation, or target breaching third party IP); or
• Warranties drafted as per negotiation between buyer and seller. When underwriting, the insurer considers each warranty on its merits and where it is comfortable with covering it absolutely, it scrapes the knowledge qualifier for that warranty in the warranty spreadsheet.
In Europe the warranties that are most likely to be breached relate to financial statements, compliance with laws and material contracts.
There tends to be a 10% additional premium cost for the initial scrape.
4. SME deals
Two new insurers have recently joined the market, focusing on SME deals. These insurers are offering limits of £5m for £45,000 premium, allowing smaller deals to make use of the W&I product.
Until now, minimum premiums for a W&I policy were around £65,000 regardless of the limit purchased. Transactions with deal sizes of between £5-30m are starting to use W&I insurance as it becomes more economical to insure. We have also started to see traditional W&I markets drop their minimum premiums in response to this competition.
The Lockton US team has seen much higher claim volumes than the UK/European team, resolving over 30 claims in the last five years. It currently has 20 ongoing cases.
The European market doesn’t see this kind of claims frequency, resulting in considerably lower premiums. Insurers also tend not to disclose specific information on individual claims paid. That said, from discussions, we know that all of the major insurers have paid out, in some cases on multiple occasions, and a number of them now employ a specific W&I claims handler.
In Europe the warranties that are most likely to be breached relate to financial statements, compliance with laws and material contracts, which is consistent with warranty claims historically.
The W&I market is always evolving and its appetite for insuring global mergers and acquisitions shows no sign of slowing down.