Discussing the fluidity of the M&A marketplace and its transition into normalization

Authors: Aaron Zeid, Chris Murphy

2021 Market Report: Representation & Warranties

Representations and Warranties Insurance (RWI) has been an ever-evolving risk transfer product, constantly adapting to changes in the merger and acquisition (M&A) market, and specific needs from the ultimate user and the buyer in an M&A transaction. Continued collaboration between insurance brokers, underwriters and deal advisors has been a driving force behind the product's staying power as they work to find mutually agreeable positions regarding coverage, structure and pricing.

In 2020, we noted that the fluidity of the transactional risk market had finally begun to subside and all signs pointed towards normalization as the market entered a stage of maturation. Of course, slight movements at the margins with respect to coverage and pricing are always expected. Even though we expected this normalization to continue into and through 2020, it was nearly impossible to predict the volatility experienced in 2020.

Understanding representation & warranties insurance

For those unfamiliar with the product, RWI is essentially tied to an M&A transaction. Pursuant to the purchase agreement, sellers make contractual promises about the target company, known as representations and warranties. On an uninsured deal, sellers back up those promises by agreeing to indemnify buyers for any losses that result from a breach. A negotiated portion of the purchase price is placed in escrow to cover any losses sustained by the purchaser. RWI supplements or replaces that escrow. Subject to underwriting, which is essentially diligence on the buyer's due diligence, insurers step into the shoes of the seller, allowing them a cleaner exit as the buyer will look to the RWI to make them whole.

Mergers and acquisitions in general

It isn't a stretch to say that RWI has become the norm in M&A. Even if the transaction isn't insured, it's likely the parties contemplated the use of RWI at the onset of the sale process. With that in mind, it's important to take a look at the both the M&A and insurance markets. In spring 2020, M&A came to a screeching halt. Domestically, the total transaction value in Q2 2020 was $139 billion compared to $595 billion (-328%) the year prior. For that same period, transaction volume was down 17%.1 While it's easy to single out COVID-19 for the overall downturn, it's fascinating to draw inferences based on the large discrepancy in the decrease in total deal value versus deal volume. While it was a period of unparalleled uncertainty, it's reasonable to conclude that private equity and strategic buyers felt safer proceeding with smaller acquisitions that were likely sourced in prior quarters.

However, for larger deals, valuation were increasingly hard to capture, which we believe put the majority of larger transactions on hold until a later date. Moreover, lenders became increasingly conservative, forcing buyers to equitize more of the deal than in prior years. Of course, lenders had similar issues predicting future cash flows for the repayment of the debt, but they were also busy working to provide relief to existing customers. $124 billion was drawn on credit lines in the first month of the crisis alone.

Fortunately, deal flow roared back in the second half of 2020 nearly matching 2019 in terms of both deal value and volume. And it has not shown any signs of slowing down in 2021, with deal values nearly doubled year over year for January 2021.1 We expect this to continue given the current outlook regarding COVID-19 combined with historic levels of dry powder for private equity.

COVID-19 and RWI

We always prefer to see downward pressure on pricing, however the true value of the product lies within the coverage. That could not have played out more clearly over the last twelve months. From March to May 2020, we saw universal COVID-19 exclusions placed on RWI policies that were so broad it was unclear how they would be interpreted in a claims scenario. Over the course of those few months, the RWI product became nearly dormant as buyers struggled to see the benefit of utilizing the product. As we progressed into summer and deal activity picked up, carrier appetite to underwrite COVID-19 increased, and there was a willingness to tailor exclusions to specific known impacts of COVID-19 on the target company. This market flexibility, undoubtedly influenced by brokers and other deal professionals, enabled buyers to regain confidence in the product.

Premium rates

In the Q4 2020, the RWI market experienced rate increases across the board and it was clearly a supply and demand issue rather than the expected response to increased claims activity. For example, one major market leader bound twice the amount of the policies in December 2020 than the previous December, with a corresponding 30% rate increase year over year. Now a few months into 2021, it is clear that most of the rate increases are likely here to stay, albeit a correction more likely related to claims experience instead of bandwidth. Unless the target company operates in a more challenging class of business (e.g., healthcare, financial institutions, etc.), we expect rates for middle market transactions to be similar to what we saw at the end of 2020.

Key market trends include:

  • Insureds that elect to obtain limits of $5 million or will see the minimum premiums increase from $100,000–$150,000 range to the $150,000–$200,000 range.
  • Transactions with enterprise values nearing or greater than $1 billion will continue to experience primary rates higher than in years past. This has a greater effect on the overall pricing as each excess layer of insurance is priced based on the layer underneath it.
  • Any rate increase on the primary bleeds all the way up the tower. Again, we always prefer to see downward pressure on premiums for the benefit of our clients, but it also important to take a strategic long term outlook on the product.
  • Interests should be mutually aligned between all parties to keep pricing at a competitive yet sustainable level for insurers.
  • We have seen other insurance products such as public D&O and cyber experience violent corrections due to underpricing and it has subsequently resulted in reductions in coverage.
  • The initial reaction to carriers unwilling to underwrite risk around COVID-19 was a strong indicator that buyers do not see the benefit in RWI without fulsome coverage.

Please note, due to the variability that we're seeing in this market and specific account characteristics, individual rates may vary.


Claims frequency has been relatively steady compared to years past with about one in five policies being noticed, however, as previously reported, many markets continue to see a rise in claim severity, especially at the $10 million level. AIG provides a comprehensive claims study each year, which indicates that the percentage of claims over $10m in 2019 was 19% with the average claim in that severe band being $19 million. Compare that to 2017, when that percentage was only 8% with the average claim at $19 million, indicating no real movement with respect to the types of breaches that are occurring.

The bulk of the claims still revolve around a few key representations: financial statements, tax, compliance with laws, material contracts, and customers and suppliers. Not surprisingly, financial statement breaches account for nearly twice the amount of claims over $1 million compared to the next closest category, material contracts. We expect claim frequency and severity will likely continue to grow as the overall percentage of insured M&A transactions continues to increase.

Looking forward in RWI

It's clear that RWI is here to stay following the volatility of 2020. Buyers should be aligned with sophisticated advisors, including brokers and counsel, who are experienced in managing transactional risk matters. Although premium can be a key consideration when selecting an insurer, ease of underwriting and positive claims experience often outweigh price in a highly competitive market when considering the placement as a whole.

Please note, a client's risk profile is the primary variable dictating renewal outcomes. Loss experience, industry, location and individual account nuances will also have a significant impact on these renewals. Now, more than ever, it's important to start renewals as soon as possible and work with your Gallagher team to deliver a comprehensive and professional submission to underwriters.

Author Information:


“American Bar Association: M&A Market Update 2021.” Houlihan Lokey, 2021.


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