:quality(80))
Soft-Stapled W&I as the Standard Approach
In M&A practice, the vast majority of W&I processes are conducted as “soft-stapled” processes. This means that the seller’s side initiates the W&I workstream by contacting a specialized broker and commissioning the broker to solicit quotes and prepare a report summarizing the insurers’ offers (known as a Non-Binding Indications Report or NBI Report). Once the NBI Report is available, the W&I workstream “flips” from the seller’s side to the buyer’s side, and the buyer (or the various bidders) actively drives the W&I workstream forward.
In this scenario, the buyer (or each individual bidder) selects the W&I insurer; negotiating the W&I policy is also the responsibility of the buyer (or each individual bidder). The seller’s side is typically only minimally involved in the W&I workstream —since the final negotiated policy is often attached in draft form to the final SPA, the seller also gets to see the final policy, but as a rule, the seller is generally only interested in the provisions regarding “subrogation rights” (i.e., the insurer’s rights of recourse against the seller). Since it is an absolute market standard that subrogation rights apply only in cases of willful misconduct or fraud, the corresponding clauses in the W&I policy are rarely controversial.
One advantage of soft-stapled processes is that the seller can use the NBI report to gain an understanding of the key parameters (particularly the expected costs and exclusions) of the W&I workstream and structure the transaction accordingly. After reviewing the NBI report, the seller will, for example, be aware that an exclusion for known or disclosed risks is to be expected. To avoid buyer-side demands for indemnities or purchase price reductions related to these issues, a prudent seller will have the broker assess the extent to which known risks can be insured under specialized policies. The buyer—who, in the current market environment, is almost always also the policyholder—can, in turn, negotiate the policy themselves according to their preferences and tailor it to their risk appetite.
If the seller has not prepared the W&I workstream, an NBI report can, of course, also be prepared by the buyer. Preparation on the seller’s side is not a prerequisite for a successful W&I process.
Preparation Is Key: A Well-Thought-Out NBI Report Is Half the Battle
The buyer selects the insurer based on the NBI report. This report should be prepared by an experienced W&I broker who has a comprehensive understanding of all relevant aspects and possesses negotiating power with the insurers.
A meaningful NBI report or a well-founded recommendation from the broker should address the following aspects:
Costs of the W&I policy on an “all-in basis” for various market-standard scenarios. Care must be taken to ensure that all costs are accounted for (including the insurer’s advisory fees, taxes, the broker’s commission, and premium surcharges for standard market-based additional services provided by the insurer, known as “enhancements”). Given the current historically low premium levels and often relatively small differences in pricing among insurers, the cost of the policy is not the decisive criterion for many policyholders (especially since there are good reasons in Germany for the W&I insurance premium to be tax-deductible).
Enhancements and Integration with the SPA. Enhancements can—often for extremely modest premium surcharges—create significant added value in transaction structuring and thus substantially accelerate negotiations between the principals. For example, if the seller is only willing to offer a narrow definition of loss in the SPA, but the insurer offers to broaden the definition of loss in the policy for a small premium surcharge, this point of contention no longer needs to weigh on the negotiations. The NBI Report should outline all options available in the insurance market and, in particular, discuss enhancements that are especially relevant given the positions of the principals. For example, if the seller is unwilling to provide guarantees as of closing, the “Synthetic Cover as of Closing” enhancement may be particularly attractive to the buyer. It is unfortunate when, during SPA negotiations, an issue for which a precisely tailored enhancement is available on the market becomes a decisive point of contention—and the retained insurer is unable to offer that enhancement.
Exclusions and Coverage Position. The NBI Report should not only include the insurers’ detailed comments on the warranty catalog but also all standard exclusions and deal-specific exclusions from the insurers. For example, if a financial services provider is being sold, the NBI report should mention whether an exclusion related to “capital inadequacy” is to be expected; if a pharmaceutical company is being sold, the NBI report should address the conditions under which coverage for product liability risks is conceivable.
Underwriting Style and Track Record. W&I insurers—as well as individual underwriters at the insurers—have different styles when it comes to risk assessment (“underwriting”): An experienced broker can assess how many resources the underwriting process is likely to tie up on the buyer’s side (for example, how many written questions from the insurer can be expected and whether a conference call will be necessary to clarify follow-up questions), how detail-oriented or, conversely, commercially focused or “flexible” insurers typically are in their underwriting approach, and how quickly insurers typically respond to changes in transaction documents or due diligence reports during the underwriting process. Since the W&I market is very dynamic and underwriters frequently move between W&I insurance teams, the selection of an insurer should always be based on a current recommendation from a specialized broker.
Due Diligence Requirements. The insurance coverage in W&I policies generally reflects the scope of the due diligence to a large extent. In other words, it is generally difficult to include issues in the insurance coverage that were not examined during due diligence. It therefore makes sense to involve the W&I broker in the design of the due diligence process and to have them comment on the scope of work of the due diligence teams. An experienced broker will also discuss critical aspects of the planned due diligence with the insurers and incorporate the insurers’ positions on these matters into their recommendation. For example, W&I insurers are willing, to varying degrees, to work with due diligence reports prepared by the buyer themselves (internally) and to insure subsidiaries of the target company in jurisdictions of (extremely) minor importance even without due diligence conducted in that country (so-called “blind spot cover”). If a large number of companies are being sold or if the target company has a complex contractual landscape, the buyer may also consider a “sampling approach” in its due diligence (i.e., they will define a sample representative of the risk factors and base their risk assessment on that sample). The sampling approach should be discussed with the relevant insurers at an early stage to avoid negative surprises later in the process.
Policy Front End. All W&I insurers remain willing to negotiate the terms of W&I policies on a transaction-specific basis (this is also unavoidable in order to align the purchase agreement with the W&I policy). However, experience shows that some W&I insurers demonstrate greater flexibility in this regard than others. Experienced W&I brokers know which insurers are particularly willing to accept policyholder-friendly clauses (such as a particularly narrow interpretation of the exclusion for disclosed facts) and also have a rich repertoire of policyholder-friendly policies that can be used as a basis for policy negotiations.
MGAs vs. Insurers and the Structuring of “Towers.” Not all providers of W&I insurance coverage are traditional insurers—some also act as underwriters or “Managing General Agents” (MGAs) (i.e., they are not licensed as insurers but hold authorizations from reputable insurers to underwrite these risks). This structure has been established in the W&I market for decades but may be more or less advantageous depending on the policyholder’s preferences. In the (extremely unlikely) event of a dispute between the policyholder and the MGA, the policyholder would, for example, have to take action against the insurers represented by the MGA. If, due to the size or complexity of the transaction, no single insurer is able to insure the transaction on its own—making a syndicated insurance program (“tower”) necessary—it may also be important for the policyholder to structure the tower as simply as possible (i.e., involving as few insurers as possible). For corporate groups, an existing working relationship with insurers regarding other risks may also be a relevant selection criterion.
Claims Track Record. Some W&I brokers have established specialized claims brokerage teams that manage claims and therefore have practical experience regarding how insurers handle claims. Given the rising number of claims, meaningful comparisons can already be drawn between certain insurers: For example, some insurers generally prove to be more cooperative and faster in their claims review, which is partly due to the fact that they have specialized (German-speaking) in-house claims expertise. With MGAs, it should also be noted that underwriters must involve the insurers they represent to varying degrees in the review and assessment of claims.
Rating. An excellent rating (at least “A-” from Standard & Poor’s) should be a given for a W&I insurer. Specialized W&I brokers constantly monitor the creditworthiness of the insurers with whom they work.
Licensing in Non-EU Countries. If the policyholderis not an EU entity, the selection of an insurer must take into account whether the potential insurers are licensed in the policyholder’s home country. For example, not all W&I insurers are authorized to insure Swiss or U.S. policyholders.
Holding the Insurer Accountable: Reliability of the NBI Indications
Once the insurer has been selected and underwriting has begun, it is the broker’s responsibility to “challenge” any deviations in the final W&I policy from the NBI indications and minimize them as much as possible.
Changes to commercial parameters (premium, offered deductible, amount of premium surcharges for enhancements) are extremely rare in practice and generally occur only if certain basic assumptions (primarily enterprise value, level of disclosure in the data room) turn out to be completely incorrect.
Changes to the offered coverage (i.e., additional exclusions or warranty commentaries) are more common. The broker assisting with the transaction should review such changes in detail and verify that they are in line with market standards. Additional exclusions, for example, should only be accepted if they are justified by systemic risks that have come to light due to significant gaps in the disclosures in the data room or in the due diligence process.
