Until this year, illustrating the market for representations and warranties (R&W) insurance has been akin to hitting a moving target. In 2019, we began to experience a normalization of the market. There has been continued growth of the product, and while there were slight changes across the board in terms of buyers, pricing, retentions, coverage and claims, these movements were not as material as in prior years.


Competition between R&W insurers remains strong, and capacity continues to increase each year. The cost or premium associated with a policy is based on a percentage of the limit, also known as the rate on line (ROL). ROL has continued to drop, but as noted above, the significance of the decrease has begun to normalize. Retentions on R&W have followed suit. Notably, in 2019, the economic viability of the product has expanded substantially for deals under $25 million.

In 2019, the normal distribution of policies was priced between 2.50% and 2.75% ROL, a slight decrease from last year. Policies that ventured outside the normal distribution could be attributed to a few factors. Healthcare and financial institutions continue to be considered riskier classes of business and consequently are priced higher. Smaller transactions with smaller limits can bump into minimum premiums and cause the ROL to jump above 3%. Conversely, buyers who conduct extensive due diligence on target companies that are viewed as favorable classes of business from an underwriting perspective may see the ROL dip as low as 2.20%–2.30%. Additionally, larger transactions with sizable limits have ROLs much lower than the median, simply due to economies of scale; the layers of insurance higher on a tower command much lower premiums.

Policy retentions continue to experience a normalization at 1% of enterprise value (EV), dropping to 0.5% 12 months after close; however, market competition has put downward pressure on retentions as well. Clean deals with interest from numerous insurers may see underwriters get creative by offering retentions starting at 0.9% or 0.8% of EV, dropping to 0.50% or possibly lower. In certain situations, a $0 retention could apply to true fundamental reps in the purchase agreement. As noted above, the retention movements tend to mirror premium costs on R&W policies. The riskier classes of business and the smaller transactions could see retentions at higher starting points. Transactions with EV greater than $500 million will likely have initial retentions at 0.75%.

Before 2018, R&W insurance was primarily used for middle-market private equity transactions, with the sweet spot somewhere between $50 million and $750 million in terms of EV. Last year, we noted that market appetite increased for transactions valued between $20 million and $50 million. The expansion was a result of both increasing carrier appetite and an increasing desire for the product from sellers and buyers alike. This trend has continued into 2019, and deals valued as low as $10 million are seeing more traction from many carriers. Traditionally, minimum premiums and retentions limited the usability and benefits of the product on deals with enterprise values lower than $25 million. And where there was appetite to insure, it was very limited. Today, there are carriers that are aggressively pursuing deals between $10 million and $50 million, and insurers that previously only considered deals over $50 million are entertaining transactions below $25 million. Increased competition for smaller deals has resulted in slightly lower minimum retentions and premiums, which has subsequently expanded the demand for the product among first-time insureds.

Claims Data

R&W insurance has been around for nearly two decades, but it wasn’t until a few years ago that the product started to become a customary piece of private equity and corporate transactions. With that in mind, the claims data provided by AIG is increasingly useful each year, as the claims and the handling of claims mature. The claims areas largely remain the same, with breaches of financial statements, tax representations, compliance with laws and material contracts accounting for nearly two-thirds of claims. About half of claims are reported in the first 12 months of the policy period, and usually correlate with a full audit cycle where the alleged breach is discovered and reported.

The number of claims made on R&W policies has remained relatively constant with about 1 in 5 policies experiencing notice of a claim. Notably, initial retentions typically remain at 1% of EV, so it is common for claims to not exceed the policy’s retention. The most notable shift is the uptick in the number of material claims amount. In AIG’s 2018 report, the number of material claims (over $10 million) more than doubled from 7% to 15% year over year. In this same period, the percentage of large transactions (over $500 million EV) has remained constant. This indicates a changing claims environment as there is not a direct correlation between material claims and a percentage increase in large transactions. Claims arising under R&W insurance tend to be much more complex than other types of insurance. Each policy is custom-tailored to the specifics of the transaction, so the nuances of what may or may not covered can vary greatly under each policy. Moreover, R&W insurance policies more often than not will pick up consequential or multiplied damages. While policy wording is generally silent on these matters and does not provide an affirmative grant for special damages, the intent is to cover these damages to the extent the insured can show they are relevant and justifiable. It’s critical to have an experienced broker that can navigate the complexities of creating a bespoke policy, and more importantly, has the ability to interpret and guide clients through complex claims situations.

Looking Forward

In the past five years we have witnessed R&W insurance evolve from a private equity bidding tool to a customary risk transfer instrument. Carriers and brokerage firms are seeing their books, which used to be saturated by PE buyers, change to a nearly 50-50 split between strategic and PE buyers. As we look toward the future, we may see a similar rise in popularity for tax liability insurance. Tax liability insurance intends to provide coverage when a governmental authority such as the IRS challenges a certain tax position resulting in a merger or acquisition. Generally, the policy can provide reimbursement for taxes, interest and the cost to defend a challenge by the IRS. As the tax system continues to increase in complexity, the desire for this product will likely increase as well. Even with the best of intentions and the proper tax and legal advice, a certain tax position can still be challenged by a governmental authority. Additionally, interpretations of certain tax positions are subject to change from year to year. Buyers are now looking to tax liability insurance to help provide certainty in these situations while also minimizing funds held in escrow, similar to R&W insurance. We predict this trend will continue to increase in 2020 and beyond.

When taking a look at the recent trends in R&W, many of which are noted above, it is reasonable to suspect a small pricing correction is forthcoming. Each year sees more policies issued than the last, coverage continues to expand, and market competition is driving down pricing and retentions. If recent claims trends continue, particularly the severity of the claims seen in 2018, it is likely insurers will begin to push back on pricing. We believe R&W has long-term viability and can sustain a price increase, but buyers will likely draw a line in the sand should there be any reduction in coverage. R&W insurance is an elective purchase, and broad coverage weighs heavier with buyers than the price.

The information contained herein is offered as insurance industry guidance and provided as an overview of current market risks and available coverages and is intended for discussion purposes only. This publication is not intended to offer legal advice or clientspecific risk management advice. Any description of insurance coverages is not meant to interpret specific coverages that your company may already have in place or that may be generally available. General insurance descriptions contained herein do not include complete insurance policy definitions, terms, and/or conditions, and should not be relied on for coverage interpretation. Actual insurance policies must always be consulted for full coverage details and analysis.
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