As we emerge from the COVID pandemic and the risk environment for corporate America remains high, now is a good time to revisit a question critical to private equity firms and strategic buyers in the mergers and acquisitions (M&A) community: Do representations and warranties (R&W) insurers still pay claims? The answers will surprise you.

At the beginning of 2020, on what turned out to be the eve of the pandemic, Lowenstein Sandler’s Insurance Recovery Group first ventured to answer that question because clients purchasing R&W insurance (RWI) asked it. By 2020, RWI had become a staple of M&A transactions because sellers required a swift and permanent exit from the transaction—and, given the frenzied pace of deal flow and heightened competition in the market, they could demand it. But buyers wanted to know whether RWI claims were handled differently from claims under more mature and commoditized insurance policies. In other words, would R&W insurers behave substantially like a seller that provided a contractual indemnification, i.e., in a commercial manner, or would the insurers look for ways to avoid reasonable, fair, and prompt resolution of claims? 

We surveyed RWI market stakeholders to develop a data-driven answer to that crucial question. The results—published in our August 2020 report “Getting Paid: A Look at Representations & Warranties Insurance”—showed that the vast majority of claims presented for coverage (71 percent) fell entirely within the self-insured retention (SIR). But when buyers needed coverage for claims that exceeded the SIR, R&W insurers generally honored their coverage obligations, with 87 percent of respondents reporting that a negotiated claim payment was made. At that time, we noted that the playing field appeared uneven because so many claims fell within the SIR, and we predicted a need for recalibration of the risk transfer model. We also observed that policyholders had many tools available to position their claims for early and reasonable resolution along with maximum recovery.

Fast-forward to 2023. As market conditions have changed dramatically during the past three years due to the pandemic, significant event-driven litigation, the emergence and explosion of special purpose acquisition company (SPAC) transactions, and a new laser focus in the board room on environmental, social, and governance (ESG) issues, the time seemed right to take another look at RWI claim trends and how the market was maturing.

Our refreshed RWI claim survey of 154 market participants (private equity, investment banking, strategic buyers, insurance brokers, and insurers) reveals surprising results. Some aspects of RWI claims remain steady. For example, the time it takes to resolve a claim is about the same (though trending up), and financial statement breaches remain the predominant type of claim that follows, usually shortly after a transaction closes.

However, many differences and new trends have developed in only three years. The most significant change is in how R&W insurers approach claims. While buyers increasingly need access to RWI for claim payments because sellers will not provide traditional indemnification, securing payment for claims has become much more challenging—it takes several years to get paid, the claim process is adversarial and resource-intensive, claim payment values are coming down, and more litigation and alternative dispute resolution (ADR) proceedings appear to be on the horizon.

Our survey also revealed an important and surprising trend about why it is taking so long to navigate the claim process: insurers are digging into the fundamental issue of whether a breach has even occurred; and then getting bogged down in how to value the loss that flows from the breach. Policyholders are perplexed and frustrated because they expect R&W insurers to understand the deal, the nature of the business operations, and the risks that were assumed when the R&W policy was sold. In other words, the RWI claims market is headed in the direction of becoming a commoditized insurance product that does not fit the needs of M&A stakeholders, who expect the RWI policy to function as an effective and responsive risk-transfer solution. The players in the M&A space expect speed, return on investment, and rational commercial behavior– they do not have time for, or interest in, litigation or “re-due-diligencing” the deal through an insurance claim process. R&W insurers will be well-served to implement an immediate course correction so that consumers of the RWI product continue to see value in it.

Finally, our survey revealed that new types of claims and breaches are emerging. Of particular note, cyber/privacy claims are gaining fast on financial statement breach claims for the top slot and environmental claims ticked up. Most interesting of all, ESG has made an immediate impact in the RWI claims space—and that applies to both ESG-driven and ESG-focused companies—with 49 percent of respondents reporting a breach claim involving an ESG company and 32 percent reporting that the claim itself involved the breach of an ESG representation.

In the following pages, we delve deeper into these findings and trends and provide our commentary on where the market is headed and should go.

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