Representations and Warranties Insurance (RWI)

The benefits of RWI and an overview of typical coverages.

Representations and Warranties Insurance (RWI)

Why RWI is Preferred

In a private equity deal, the seller of the business makes certain Representations and Warranties about the business during the transaction process. 

Traditionally, the buyer would hedge against inaccurate or incomplete information through an indemnity provision, where funds are held in an escrow account for a survival period. However, a Reps and Warranties Insurance Policy (RWI) has become a preferred option. 

RWI replaces the indemnity provision and provides several benefits: 

  • Enhanced deal certainty
  • Preservation of relationship
  • Risk is shifted to a third party
  • Seller exposure is mitigated 
  • Higher indemnity limits 
  • Longer survival periods
  • Efficient claims resolution
  • Cost savings

Perhaps the greatest benefit of RWI is that it acts as an instrument for keeping the deal on pace to close and alleviates negotiating indemnity provisions. 

Skin in the Game

RWI covers unknown gaps in the seller's representations and warranties about the company that causes loss or liability to the buyer. Carriers will negotiate policies so that both sides have skin in the game when it comes to provided coverage. 

The scope of RWI coverage may vary depending on the policy terms. Generally, RWI policies cover a wide range of representations and warranties, including financial statements, tax compliance, litigation, environmental liabilities, intellectual property, and employee matters.

Like most insurances, RWI excludes known issues, criminal activity, fines or penalties, or willful or intentional acts. Specifically, the coverage excludes (“carves out”) purchase price adjustments or underfunded pensions. 

Buyer Side Strategy & Coverage

An RWI is used to supplement a buyer’s existing indemnification limits, or otherwise provide coverage to a buyer in lieu of traditional indemnification limits. 

For buyers, integrating RWI into their M&A strategy can help enhance deal certainty, protect against financial losses, and streamline the overall transaction process. Conducting thorough due diligence, engaging experienced advisors, and aligning the interests of both parties are key considerations for buyers pursuing RWI coverage.

Seller Side Strategy & Coverage

An RWI is used to backstop a seller's existing escrow or indemnification obligation to the buyer. 

For sellers, offering RWI coverage can be a differentiating factor that attracts potential buyers and facilitates a smoother transaction. Sellers should ensure their representations and warranties are clear and well-drafted, engage experienced advisors to navigate the RWI process, and consider the potential benefits of offering RWI coverage to prospective buyers.

Application Process for RWI

The application process for RWI involves several stages:

  1. Information Gathering: The insured party, typically the buyer, provides detailed information about the transaction, including the nature of the representations and warranties, the target company's financials, legal compliance, and any known risks. Based on an initial application, carriers will provide non-binding indications to give an idea of coverage and cost. 
  2. Underwriting: Once an insurer is selected, they are paid an underwriting fee to continue due diligence. The insurer evaluates the transaction and associated risks, conducting their due diligence. This process includes reviewing the purchase agreement, financial statements, and may involve discussions with legal and financial advisors. 
  3. Policy Negotiation and Binding: Once the underwriting process is complete, the insurer and insured party negotiate the policy terms, including the coverage, deductible, and policy limit. The policy is then issued once both parties reach a mutual agreement.

What does a claim look like? 

Claim amounts range anywhere from $50,000 to $1M+, as shown by these three RWI Policy lawsuits in NYC.  Reasons range from misrepresenting competitive advantages, misstated financials, or the condition of physical assets. 

Policyholders need to perform a strong, factual investigation before submitting a claim to a carrier. It is recommended that detailed post-close due diligence be performed, as all of the data room materials will be made available. 

In most claims cases, something is usually known prior so the buyer needs to be specific on what was breached, what is on the line for them as a company, and who or what was known to cause the loss. 

Understanding the policy language and what is or is not covered is important prior, but becomes paramount in submitting a claim. 

Most policies will be specific on what needs to be included on a claim, including providing estimated damages. 

Market Trends 

The RWI market has witnessed significant growth in recent years due to increased awareness and understanding of the product's benefits. Insurers have adapted to market demands, offering more comprehensive coverage and streamlining the application process. 

2021 and 2022 were record-breaking years in the M&A market, and many insurance carriers began underwriting RWI due to the demand. Activity has slowed in 2023 and 2024, but carriers haven’t brought down their interest in writing the coverage. 

With more insurance supply than demand, the market is currently favorable to the insured. Policies are more competitive from a pricing standpoint, and/or more program enhancements are available for companies looking for coverage. 

RWI underwriters are currently emphasizing physical asset reviews more than prior years, requiring buyers to get closer reviews on the equipment or assets being purchased. 

Insurance is highly cyclical, so as demand for certain product lines cools or claims come due, RWI trends can revert or subside.