A favoured transactional risk mitigation tool, warranty and indemnity (W&I) insurance has become instrumental in protecting against potential losses from breaches of warranty in an M&A transaction. Previous articles in this series have considered issues such as the strategic use of W&I insurance but once you have actually entered into a transaction there are practical considerations and requirements that will impact the availability of W&I insurance on the deal. One such consideration is due diligence (DD) which provides the basis for W&I insurers to assess the risk and insurability of a transaction.
At a minimum a W&I insurer will expect legal, tax and financial DD to have been done on a target company however insurance due diligence (IDD) is another DD area that can assist in identifying relevant operational risk and liability information on the target company by way of an examination of the target’s insurance, thereby contributing to the overall risk management strategy and widening the potential scope of W&I insurance cover.
The scope of IDD will vary based on factors such as deal complexity, industry-specific risks, geographic locations, transaction structure and time constraints. Additionally, the scope will be customised based on whether the transaction is an acquisition, disposal or refinancing deal. While such variations may require adjustments in the depth and focus of IDD, there are three key outcomes that all IDD will seek to achieve:
01
All M&A transactions carry a certain amount of risk. IDD allows buyers to proactively identify and understand potential risks associated with the target, and to ascertain the effectiveness of current and future insurance policies. This insight empowers deal parties to ensure a smoother post-transaction transition, providing comfort that risks have been independently tested and are well understood.
02
Comprehensive IDD aids in evaluating the target company’s existing liabilities and exposures. By undertaking a thorough examination of the target’s policies, gaps and inadequacies in coverage can be identified allowing deal teams to make more informed decisions regarding the target's financial exposures.
03
Understanding the target's insurance portfolio assists buyers in assessing the true value of the business. Neglecting this information may impact financial model assumptions or prevent a buyer from making an accurate determination as to the purchase price or specific indemnities that are required to account for uncovered risks.
Whether you are a vendor, buyer or financer, in practice this gaining of insight into a target’s operations allows for future insurance premium costs to be ascertained through a valuation of insurance premium forecasts and a consideration of factors influencing premium values in the short to mid-term. IDD also gives an assessment of the target’s sums insured, sub-limits and deductibles, creating a clear and concise schedule of insurance requirements. Finally, IDD is a useful tool in confirming the target’s compliance with regulations and contractual obligations, shining a light on potential liabilities and securing the integrity of the deal.
The DD exercise is integral to the W&I insurance process. An insurer will expect that the subject of each warranty that is to be insured under a W&I policy will have been considered in DD. When it comes to IDD the insurers focus will be both on relevant warranties (and the IDD addressing those specific issues) but also on the target’s existing level of insurance cover. Depending on the target industry, W&I insurers will expect a target to have a comprehensive suite of business insurances including (where relevant) cyber, product and service and professional indemnity.
Where such insurances exist, W&I insurers may be willing to sit in excess so that if a claim exhausts the limit on such an underlying insurance policy, the W&I insurance would (in the event that there was also a breach of warranty) provide excess cover up to the W&I policy limit. On the flip side, where such underlying insurance is not in place or where IDD finds it to be inadequate, a W&I insurer may be inclined to exclude W&I cover for that particular area, leaving the existing insurance as the only backstop.
IDD will also consider the claims history of existing insurance policies and similarly, this is likely to be a consideration for W&I insurers in their decision as to whether they sit in excess of existing insurance. An active claims history on underlying insurance may disincline a W&I insurer from providing affirmative top up cover where they view the claims history and matters which underlie it as being outside of their risk appetite.
Engaging with WTW as your IDD provider early on in the process will stand you in good stead when it comes to securing W&I cover further down the line. The scope of IDD can significantly impact W&I coverage so it is essential that this be as broad as possible Insurers will expect that the methodology of the review is clearly documented. Key focus areas will include the history of the target and how this relates to the warranties being given.
Transactional risk insurers will not be interested in forward-looking integration of the target into the buyer’s group and so the focus will always be on the current state of the target as opposed to post-merger integration plans.
Regardless of whether you are having IDD conducted as a seller or as a buyer, the earlier IDD is undertaken the better as having to delay a transaction because of incomplete DD can be an unwelcome eventuality. Some deal parties rely on inhouse expertise to prepare their DD reports and while this can be done, the aim should always be to reflect a similar structure and content as would be achieved in an external IDD report.
In addition to matters of scope and focus, the credentials of the review team, including their experience, qualifications, role and focus area within the buyer will help insurers gain comfort that the DD has been carried out by a suitably qualified individual. Insurers however maintain a strong preference for external diligence and if internal diligence is being contemplated in any area this should be brought to the W&I brokers attention as early as possible so that market appetite can be gauged, insurer expectations managed and where required external advisors can be appointed.
In the past three years WTW’s Global M&A advisory team has undertaken more than 2,600 IDD engagements. You can be assured that you are being advised by a market leading team of over 200 M&A practitioners, with backgrounds extending across corporate law, tax and accountancy. WTW have a proven track record of providing solutions to complex risk management issues, drawing on deep expertise and strong industry relationships to gain unique insight into the market. As a team we leverage this experience to provide our clients risk mitigation support and guidance through a combination of transactional risk insurance solutions and IDD.
Our expert advisors collaborate with all stakeholders involved in an M&A transaction, including sellers, buyers and financers. We are able to deliver comprehensive IDD and advisory services, ensuring the viability of the target’s insurance programme and optimising the client’s position.
