Representations and warranties insurance has become a common feature for M&A transactions in recent years. The product, commonly known as R&W insurance, is a way to protect buyers from unanticipated risks associated with the target business, says Celeste Owens, vice president of transactional liability at HAUSER. R&W insurance transfers to the insurer the risk of certain financial losses stemming from a breach or inaccuracy of a representation about the target or the seller in the purchase agreement.
The COVID-19 pandemic has complicated matters, forcing insurance carriers and underwriters to grapple with an unforeseen contagious disease that has caused widespread business disruption and whose long-term implications remain largely unknown.
Faced with the need both to manage their books and attract and retain R&W policyholders, R&W insurers have had to decide whether to exclude any COVID-19-related losses from their policies outright, or to take an approach that is more palatable to their clients—namely private equity firms, which are a source of repeat business.
So far, there has not been industry-wide consensus. Underwriters from Euclid Transactional and Liberty Global Transaction Solutions who spoke on the panel noted that the situation is fluid. Insurers continue to monitor the situation and assess their varied approaches.
“AT THIS TIME, WE’RE TRYING TO APPROACH EACH DEAL ON A CASE-BY-CASE BASIS TO DETERMINE IF AN EXCLUSION IS APPROPRIATE.”
Underwriting Counsel in the Liberty Global Transaction Solutions Group, Liberty Mutual
“At this time, we’re trying to approach each deal on a case-by-case basis to determine if an exclusion is appropriate,” said Brittani Marszalek, underwriting counsel in the Liberty Global Transaction Solutions Group at Liberty Mutual.
In cases where the impact is perceived to be low, Liberty may designate the matter as a “heightened risk” in its quote and evaluate it further during the underwriting, rather than adding a full exclusion up front. For deals where the impact is expected to be significant, the firm is more likely to propose an exclusion in the quote with a notation that it will consider narrowing or removing the exclusion, pending the findings of underwriting and due diligence, Marszalek said.
In contrast, Euclid Transactional’s approach as of late April is to add a coronavirus exclusion when providing quotes for new deals. At the time of the webinar broadcast, the firm’s policies exclude “the impact on the target company to the extent it’s attributable to COVID-19,” said Shawn O’Neill, managing director on the underwriting team at Euclid, adding that the firm will continue to assess the situation and modify its position.
Ai Tajima, counsel in Goodwin Procter LLP’s Risk Management & Insurance practice, has successfully negotiated narrowly tailored COVID-19 exclusions. On the panel, she mentioned a technology deal where the target’s business had minimal impact from the pandemic. In this case, the exclusion was significantly narrowed from the insurer’s standard COVID-19 exclusion.
She also cited a health care deal involving a target that postponed elective procedures and reduced its in-person operations starting in March. Her team was able to limit and clarify the scope of the exclusion by identifying the underlying events to be excluded, adding a date range that matched the known period of business disruption, and making additional changes to the policy language. “We narrowed it as much as we could to try to preserve coverage for the unknown,” Tajima said.
For parties considering adding COVID-19-specific representations during a deal, panelist Yem Mai, a managing director at Marsh JLT Specialty, recommends against it from an R&W insurance perspective, if the intent is to get the R&W policy to cover COVID-19 in any manner. “Typically, we advise that you may not want to have those types of specific reps in the purchase agreement,” he said. Including them could trigger concern from the underwriter and prompt it to exclude COVID-19-related coverage.
As always, it’s important to be specific, and the policy should be reviewed in the context of other transaction documents. Triggering R&W insurance coverage requires demonstrating a breach in the representations in the purchase agreement, as qualified by the disclosure schedules. A generic disclaimer about the impact of COVID-19 on the business in the disclosure schedules could make a breach difficult to prove, regardless of how any COVID-19 exclusion in the policy is negotiated. To maximize coverage, “make sure the disclosures are narrowly tailored with respect to the specific representation that applies to that issue,” Tajima said.
The pandemic is having an impact on the reps and warranties market in another way, too: Minimum deal sizes that insurers are willing to cover have been declining since the COVID-19 outbreak began.
“I just closed a $4 million enterprise value deal the other week,” Mai said. “I’ve been in this business as an underwriter and as a broker for the last eight-plus years, and that’s the smallest deal I’ve ever seen, but we did it.”
The R&W market has continued to evolve since the webinar was recorded in late April, says HAUSER’s Owens. R&W insurers have not yet reached consensus on how to approach COVID-19-related coverage, but they have indicated a willingness to be flexible.
Those that were particularly rigid initially have since demonstrated a willingness to modify their template exclusion, so long as the modifications do not eviscerate the spirit of their exclusion.
“Negotiating exclusions is a very delicate dance and you have to understand the insurer’s underlying interests to have a sense of where they can move and where they cannot,” Owens says. For those that were somewhere between rigid and flexible, their pre-underwriting quotes resemble Liberty’s: They indicate a willingness to analyze risk factors in underwriting to determine whether an exclusion is necessary.
“At the end of the day, the R&W market wants to be there to support M&A deal activity,” Owens says. “As a broker, I am happy to see that insurers are hearing our feedback and adapting.”
Watch the full webinar discussion, courtesy of ACG Los Angeles:
Kathryn Mulligan is the editor-in-chief of Middle Market Growth.