The Origins of W&I as “Liability Insurance” for Sellers
The W&I insurance product was originally used—unlike today’s common practice—not on the buyer’s side, but on the seller’s side. The parties would typically agree in the purchase agreement on seller warranties and the liability limit; in the event of a breach of warranty, the buyer would first hold the seller liable before the seller sought reimbursement for the incurred costs from the insurer. Today, this so-called “seller’s policy” is the absolute exception, and the vast majority of policies are taken out on the buyer’s side.
The Rise of the Buyer-Side W&I Policy
The buyer-side W&I policy works fundamentally differently: It is typically already incorporated by the seller into the first draft of the purchase agreement, in which the seller provides their seller warranties to the usual extent—but at the same time sets the liability limit at €1. The buyer, in turn, approaches the insurance market with the help of a broker or insurance advisor and takes out a policy that, in the event of a claim—i.e., a breach of warranty—pays out directly to the buyer as the policyholder—thus releasing the seller from liability. Only in the case of guarantees that were fraudulently misrepresented does the insurer, after compensating the buyer, have a right of recourse against the seller. The most obvious advantage of the buyer-side policy thus lies with the seller: No escrow account is required, and the proceeds from the sale can be distributed directly or reinvested. This so-called “clean exit” for the seller was the main driver of the success of W&I insurance in the 2010s.
The Growing W&I Insurance Market
The success of W&I insurance was accompanied by an expansion of available insurance capital: In addition to traditional insurers—some of which established M&A insurance divisions—there is a growing number of specialized insurance agencies, known in English as Managing General Agencies or “MGAs,” which underwrite risks using debt capital. Increasing competition has led, for one thing, to a significant drop in insurance premiums—which are now often well below 1% of the insured amount. Furthermore, a process of differentiation has taken place: For example, some MGAs have identified small and medium-sized enterprises as a niche market—so that W&I insurance is now being used in an attractive and cost-effective manner for transactions with enterprise values in the low single-digit millions.
The Evolution of W&I Insurance—More Than Just a “Clean Exit”
Above all, however, insurance coverage has been further developed and increasingly tailored to the needs of buyers. Insurers are offering buyers an ever-growing range of “synthetic” coverage elements. In this context, “synthetic” means that the insurance coverage extends beyond the liability originally provided for in the purchase agreement—that is, it not only mirrors it but modifies and expands it. A classic example of a synthetic element is an extension of the term of the warranties to up to 10 years. Or, a specific warranty that was still limited to the seller’s knowledge in the purchase agreement is insured in the policy as if it were not knowledge-qualified (in English, this coverage extension is called a “knowledge scrape”). As a standard practice, insurers now also offer synthetic tax indemnification for cases in which the seller was unwilling to provide such an indemnification in the purchase agreement. W&I insurance thus now offers buyers a high level of flexibility, giving them “breathing room” in negotiations with the seller.
W&I Insurance in the Current Market Environment
Taken together, these developments and the increased appeal mean that W&I insurance is increasingly sought not by the seller but by the buyer, and thus continues to be in demand even in an increasingly “buyer’s market.” It also cannot be ruled out that seller-side policies may make a comeback—specifically when buyers demand “standard” liability provisions in the purchase agreement and sellers seek coverage on the insurance market. Another option: in transactions involving distressed or insolvent companies, where the insolvency administrator is not permitted to provide guarantees, the buyer can negotiate a fully synthetic guarantee package with the insurer. This versatility suggests that W&I insurance is here to stay and will hold its own even in a turbulent market environment in the short or medium term.
This is further supported by the currently comparatively low transaction volume, combined with fierce competition among the nearly 30 insurers and agencies now operating in the German market: It has never been so affordable to insure transactions.
