RWI Market Update: Good News for Buyers

The representation and warranty insurance market across the United States and warranty and indemnity insurance market throughout Europe (collectively referred to herein as “RWI”) are rapidly evolving in light of the choppiness attributed to the recent drop-off in the M&A market. This is particularly evident when compared to the market’s peak at the end of 2021. Given this, it is certainly a better time for clients thinking of purchasing RWI, as we are seeing (i) a decrease or levelling off in policy premiums and retentions, (ii) an increase in the availability of quotes, (iii) more expansive coverage, and (iv) several RWI use case innovations.

Pricing

RWI market rates are largely back to pre-pandemic levels. Average premiums in the United States have dropped from their high of 6% of the acquired policy limit to below 3%,[1] in line with pre-pandemic costs. Similarly, in Europe, where policies have always been less costly, average premiums have dipped below 1% from their 2% averages in Q4 2021. The drastic shift in pricing is largely attributed to a steady decline in deal volume, an increased number of insurers entering the market, investment in talent at the insurer level (thereby increasing each insurer’s capacity to take on more RWI deals), and an increased appetite for, and understanding of, the associated risks.

Retention rates have seen less volatility over the past three years; that said, it is becoming increasingly common to see insurers offer retention rates of below 1% of enterprise value for smaller deals (i.e., deals with an enterprise value less than $100M).

Quotes

As policy premiums and retentions have steadily decreased, the number of available quotes has spiked over the past year. In the United States, there has been a three-fold increase in the number of quotes (i.e., the five-quote average in Q4 2021 jumped to 15–20 in Q4 2022). Similarly, the number of available quotes for European RWI deals remains high but varies significantly across sectors and jurisdictions.

Exclusions

There have been a few important shifts in subject-matter exclusions:

1. Industry coverage. Whereas certain industries can be challenging to insure, throughout Europe and the United States, insurers are becoming increasingly more amenable to broader coverage across industries so long as they see robust due diligence. For example, although deals in the healthcare and financial services space were historically difficult to insure and any policy made available to such deals was often accompanied by significant exclusions, many such exclusions have largely fallen away.
2. Cybersecurity. In the past, the typical approach for cybersecurity coverage was only to provide coverage in excess of, and no broader than, an underlying cybersecurity insurance policy, but such restrictions are largely eroding as the market cools off.
3. COVID-19. The COVID-19 exclusion is slowly fading away across the United States and Europe. In the United States market, the COVID-19 exclusion is only included in approximately 20% of quotes. This is expected to continue to decrease over the next three months. In the European market, the COVID-19 exclusion has nearly disappeared but has some limited use for businesses with significant exposure to pandemic-related tax benefits and grants.
4. Interim Breach. Historically, RWI coverage has excluded any matters that both occurred and were discovered by a buyer between signing and closing (commonly referred to as the interim breach exclusion). Around mid-September 2022, the RWI market experienced a surge in demand for a policy enhancement that would effectively remove the interim breach exclusion. However, given the high fees and specific limitations associated with such enhancement (e.g., restrictions on the type of breach and amount of recoverable loss), it has not been widely adopted by policyholders.
5. Multiplied Damages Cap. In the United States, it was common practice in 2021 to see RWI coverage limited by a cap on multiplied damages recoveries. However, over the course of 2022, such a cap became increasingly rare. To the extent enterprise valuations continue to decrease, this trend will likely persist.

Innovations

The RWI market has seen a number of innovations: (1) RWI is now used in a diverse array of transactions, (2) certain insurers are offering a modified RWI product for smaller transactions, and (3) contingent risk insurance offerings offset known and identified risks arising in M&A transactions.

1. Alternative Transactions. RWI coverage has been extended to a number of alternative transactions, including:
1. Minority interest sales;
2. Take private sales; and
3. Continuation funds.

2. RWI-Lite. Minimum premiums and related fees make insuring smaller transactions prohibitive. However, insurers across Europe and the United States have an increased appetite for smaller enterprise value deals; the typical soft “minimum” deal value has moved from $50M to closer to $10M. To reach this smaller market, certain insurers in the United States have modified their RWI offering and provided a more limited, non-negotiable policy at a lower cost (around $50k). Coverage extends to a non-negotiable synthetic set of reps not tied to the reps in the acquisition agreement.
3. Contingent Risk Insurance. RWI is limited in that it applies to unknown risks, which results in a gap in what can be covered. In an effort to fill this gap, certain insurers offer contingent risk insurance, which can be used to cover known or identified risks.

A Look Forward

Given the slowdown in deal activity and expectation that this trend will continue in Q2 of 2023, we expect to see the RWI market across Europe and the United States mirror 2022 Q4 trends over the next three months.

[1] The statistics used throughout were provided by HWF Partners and Atlantic Global Risk.