The past decade’s robust mergers and acquisitions volume sparked the rapid growth of representations and warranties (R&W) insurance. This coverage provides protection from losses due to a seller’s breach of representations in the acquisition agreement and is intended to remove risks from balance sheets and largely supplant traditional seller indemnity in M&A transactions. But a key question has lingered: Are insurers actually paying R&W claims?
According to a Lowenstein Sandler survey of executives involved in the R&W market, insurers are—but there are caveats. For claims that exceed the R&W policy’s self-insured retention (SIR), 87% of respondents say at least a partial payment was negotiated for all R&W claims. But more than two-thirds reported having at least one claim that fell within their policy’s SIR. To secure maximum value from a policy, consider the following insights:
Make Claims Promptly
Policyholders often submit a claim long after discovery of a breach—45% take more than six months, according to the survey. Because of the time it takes to secure a claim payment, policyholders should report far sooner. Most respondents said it took between three and 12 months for the issuance of a coverage position letter and six to 18 months after the claim notice submission to receive payment.
Policyholders might wait to report a claim to see if the loss will exceed the SIR. But regardless of whether it ultimately does, there is no usually harm in making a claim. Insurers expect claims, and if the loss exceeds the SIR, policyholders will be glad they reported it early, depriving R&W insurers of possible coverage defenses. Moreover, the SIR is subject to an aggregate, so while the claim may be within the SIR, policyholders will get credit against the retention and will be that much closer to securing insurance recovery in the event of another claim.
The perceived cost of pursuing a claim may be another reason policyholders wait to report. However, although third-party advisors can require an upfront investment, litigation is only needed to secure coverage about 20% of the time.
Be Ready to Negotiate
While the survey shows that R&W insurers are paying claims, the negotiation process can be protracted. Initially, it is common for insurers to issue denials to R&W claims, but those denials do not end the process. Policyholders usually can secure some form of payment for their claims if they are willing and able to pursue them.
As to why coverage is denied, insurers and policyholders are divided. Policyholders say insurers typically begin by taking the position that no breach has occurred, or no loss has been suffered, or by citing the actual knowledge exclusion in the policy. Insurers and brokers say the biggest reason for claim denial is the lack of insurer consent for claim resolution.
Regardless, policyholders have ways to fight back and to avoid these coverage defenses. No breach or loss coverage defenses often depend on applicable case law and counsel’s ability to advocate the policyholder’s position. In these cases, it is imperative to work with coverage counsel to frame facts and circumstances against the applicable policy language and law to secure and maximize recovery. For the actual knowledge exclusion, policyholders can limit the number of deal team members subject to the exclusion.
For lack of insurer consent (as well as other defenses including late notice or waiver of subrogation), policyholders can first provide prompt notice of all actual and potential breaches. They should then keep insurers informed of all negotiations taking place with the seller and any other third parties that may be held responsible for the loss. Finally, policyholders should avoid providing broad releases to sellers or other responsible parties without first discussing it with their insurer.
Getting to Yes
Despite different views on why claims are denied, 86% of policyholders and 89% of insurers and brokers agree challenging the insurer’s initial denial and engaging in further negotiation results in some measure of recovery. A strong majority report that claim payments exceed 50% of the claimed loss.
For policyholders, a comprehensive statement of claim can get the insurer meaningfully engaged in the negotiation process, helping to avoid litigation or arbitration. However, insurers are often concerned about their reputations in the tight-knit R&W community and in the court of public opinion. Buyers can gain future leverage during policy placement by negotiating for the right to commence litigation in open court if a coverage disagreement cannot be resolved amicably.
Policyholders should also challenge existing market conditions to secure optimal pricing and retentions, and assemble strong advocacy teams to quickly move the insurers from claim denied to claim paid. These efforts will help ensure that R&W insurers keep paying claims.
The COVID-19 Factor
It is important to note that the survey was conducted just before the disruption of COVID-19 began to fully materialize. The pandemic will likely extend the R&W claims process as insurers try to retain cash and take a closer look at claims to substantiate losses and damages. However, R&W insurers that go down this road may create long-term risks to any reputation they have built up for claim payments.
More broadly, reduced M&A activity in the near term could impede market changes for R&W insurance. But insurers likely view their R&W portfolios favorably—just 29% of claims exceed the SIR—so they will probably remain active in the space and wait for deals to resume. That should pave the way for policyholders to demand optimal policy premiums and SIRs and customized policy terms.