The following is a Q&A interview with Akerman's David Birke, co-chair of the firm's M&A and private equity practice, and Craig Warnke, a managing director in Marsh's transactional risk practice. The interview outlines the surge in interest in and utilization of representations & warranties insurance over the past few years, factors in deciding which of the burgeoning number of insurers to select, and the increased breadth of coverage available. Also discussed are other considerations of which prospective insureds should be aware before purchasing these increasingly important policies for their transactions.

David Birke (Akerman): Less than 10 years ago, some buyers offered representation & warranty policies to try to gain a competitive advantage in an auction process—or sellers might purchase a sell-side policy. Now it seems as though every seller expects the buyer to purchase a buy-side R&W policy. What percentage of middle-market deals use a buy-side R&W policy as the primary source of indemnity?

Craig Warnke (Marsh): While it's difficult to put a precise percentage on the deals using R&W insurance, we can affirmatively state that it is simply market standard for middle-market M&A deals to feature a buyer-side R&W policy. The increase in usage of the product over the past two to three years in North America is tremendous and shows no signs of abating. For example, see the chart below that shows the number of transactions using R&W insurance via Marsh in North America. Given our market share and the continuation of current trends, we would estimate that in 2018, well over 1,200 middle-market M&A transactions will utilize R&W insurance.

David: Early on, there were only a handful of insurers writing R&W policies. How much has the insurer base expanded and are the newcomers traditional underwriters or alternative providers?

Craig: The expansion of the underwriter base in the R&W insurance marketplace has been nothing short of remarkable. Just a few years ago, we could find that our clients had only one (or even no) option for a difficult to place risk, given the limited number of players in the market. That same risk today would likely attract multiple and attractive quotes from insurers. In 2018, there are approximately 20 credible underwriters capable of providing primary R&W insurance terms on middle-market M&A transactions, with many others willing to participate on excess layers. Given the sheer number of market participants, there is well over $1 billion of R&W insurance capacity that can be deployed on a single transaction should the need arise, which was recently validated on a transaction where Marsh placed aggregate policy limits in excess of $1 billion on a recent transaction.

The expansion of underwriting capacity has come from both traditional insurance companies as well as from managing general underwriters (MGU). For insurance companies, the R&W sector represents an attractive source of premium growth that covers risks generally uncorrelated with their overall book of business. This also made it relatively easy for experienced and entrepreneurial underwriters to start their own MGU and find insurance company partners.

David: Are buyers choosing insurers strictly based on price and exclusions or are other factors significant to the decision?

Craig: Pricing is certainly a significant factor for our clients when it comes to choosing an underwriter. In light of the prior discussion, the increase in the number of R&W insurance underwriters has led to dramatically increased competition in this sector, resulting in lower premiums across the board. We estimate that premiums for primary R&W insurance are approximately 10 percent lower than 2017 premiums (and this follows on the heels of a 9 percent pricing decrease in 2017 from 2016).

While clients are enjoying the benefits of lower pricing, our advice to them is that pricing is just one facet to consider and should not be the determining factor in selecting an insurer. We believe that the “right” insurer for a particular transaction is a function of the coverage being provided (with an emphasis on any deal-specific exclusions), ability to execute, claims-paying history, relationship(s) with the client or counsel, along with the premium.

David: Have you seen insurers getting more comfortable with risks that they seem to have previously been excluding (e.g., government reimbursement and FLSA matters)?

Craig: In short, yes. Underwriters have expanded their underwriting appetite in response to the competitive landscape plus a favorable loss history across the industry. Issues that may have been categorically excluded a few years ago, including government payor reimbursement risk and FLSA matters (just to name two examples), are now eligible to be covered under an R&W policy subject, of course, to satisfactory underwriting results. Though insurers have liberalized their underwriting appetite, they have not relaxed their underwriting standards as coverage is still predicated on the buyer having done robust and comprehensive due diligence.

David: What trends are you seeing in claims being asserted under R&W policies and how are the insurers responding? How long does it typically take for claims to be paid?

Craig: We are simply seeing more claims being made under these policies—but this is purely a function of more policies being written. We have not observed a meaningful increase in the percentage of our policies that have claims, which remains in the range of 10 percent to 15 percent, depending on policy year. The biggest driver of claims across our portfolio is breaches in the financial statements representations—with taxes, employee benefits and compliance with laws claims not far behind.

Insurers have taken the increase in claims in stride and have taken (in our estimation) a very reasoned approach in claims settlements and negotiations. In just the past year, we've secured payments in the tens of millions of dollars for our clients under these policies.

As to the timing of claims payments, it's very fact-specific and depends on the nature of the underlying claim and whether it's tied to underlying litigation, etc. I've had claims settle in as quickly as 60-90 days while others have gone on for a number of years.

David: What are some of the more material issues of which a buyer needs to be aware in selecting a policy?

Craig: When utilizing R&W insurance on a transaction, buyers need to be thoughtful about their due diligence process, ensuring that they don't view the procurement of the policy as a substitute for due diligence. As stated earlier, the insurers are expecting buyers to do thorough and robust due diligence on every transaction. That said, insurers do recognize that a “one size fits all” approach doesn't work in today's marketplace, and they are willing to accommodate each buyer's approach—as long as the work gets done.

Buyers should also focus on working with seasoned advisors in the R&W insurance process, as executing on aggressive deal timelines is critical to the success of the transaction.

David F. Birke is co-chair of the M&A and private equity practice at Akerman. Craig P. Warnke is managing director at Marsh.