Representations and warranties insurance (R&W) has come of age as a useful and efficient tool for mitigating transactional risk. Having proven its worth through the peak of mergers and acquisitions in 2021-22, R&W policies have been revised and enhanced through the deal downturn last year in advance of an expected recovery later this year.

That lull has also given time for claims leaders among insurers and brokers to refine their best practices, both internally and in collaboration with insureds.

Notifying Fast and Early

Brokers and underwriters encourage insureds to notify them as early as possible if there might be a claim and to “pressure test” claims to ensure that they are complete, which are not mutually exclusive.

“We want to start the conversation as early as possible if there might be a breach,” said Dana Shafer, vice president and claims practice leader in transactional liability at QBE.

“But you don’t need to have every detail. Just be familiar with your policy. We get plenty of notifications that ask to defer coverage investigation until after they have more details.”

In many cases a breach is the first for the insured, “but we’ve seen hundreds,” said Shafer.

“Sitting at the claims desk, we are not going to play Monday-morning quarterback, and we are going to be careful about what might seem obvious,” Shafer said.

“We don’t want the insureds to get lost in the details, and we don’t expect insureds to know their policy language backwards and forwards, but we do expect collaboration in resolving the claim.”

Shafer added an important caveat in parsing claims under R&W: “The bulk of each policy is specific to that deal. It is heavily manuscripted. That is just the nature of the beast. Claims are evolving over time.”

A Claims Activity Update

That said, QBE is seeing numbers of claims holding steady in frequency, Shafer noted.

Dana Shafer, vice president and claims practice leader in transactional liability, QBE

“Placement is always going to vary with deal flow. We began writing [R&W] in 2015 and the coverage has definitely developed and matured over that decade. We saw a huge expansion in recent years. Most recently we’ve added tax liability and contingent liability to our suite.”

There have been shifts in the types of claims. “For quite some time financial statements were the number one subject of alleged breaches,” Shafer explained. “Those are still among the major issues but have been replaced at the top by alleged breaches in material contracts and in compliance with laws.”

That shift may explain another trend.

“Claims used to come within a year of the deal closing,” said Steven Hong, chief claims officer for transactional risk at Marsh North America.

“The buyer goes through the first accounting cycle and finds things once they have had a chance to get under the hood. Lately we’ve been seeing more claims come in after the first year.”

Signs of R&W Maturation

That highlights one of the key benefits of R&W: its longevity.

“Buyers will usually only get a year of indemnification from sellers,” said Hong.

Most policies cover most reps and warranties for three years, with coverage out to six years for fundamental representations and some tax obligations.

Volume of placements and claims has grown to the point where Marsh has added several positions to Hong’s group, including one to handle contingent liability, which falls under the aegis of transactional risk.

The main benefit to sellers is that R&W reduces or eliminates the need for escrow. “Sellers want their money now, not sitting in limbo,” said Hong.

Another indication that R&W has become a mature segment is that claims have tended to hold steady at roughly one notification for every five transactions insured.

“In 2020 that ratio dropped to about one in six,” said Hong.

“It’s still too early to say what the final claim ratios will be for 2021 and 2022, but 2022 is currently trending higher than 2020 and 2021. It also varies by market, as different underwriters have different appetites for risk.”

One aspect of R&W that mitigates risk for underwriters is the extensive involvement of attorneys.

“These lines are unique in that the buyer always has legal counsel,” for the transaction and by extension for the R&W. “These policies have been vetted by the best lawyers in the country over and over,” he added.

Technology is playing a larger part in the claims process, Hong noted, and not all in obvious ways.

“We have found that artificial intelligence is particularly useful in foreign jurisdictions for translation of documents and statutes. It can be rough, but it is fast and helpful.”

The recent ubiquity of online video conference software has also been important.

“It is a big help to have everyone talking face to face,” said Hong.

“That visibility improves cooperation. We also get screen sharing so people can be very specific about what they are talking about. We sometimes also get video of assets that are subject to claims, which can help insurers better understand the claims.”

What to Keep in Mind

In the balance between early notice of a potential breach, and a detailed claim, Laws stressed that “we do want to be in the loop as early as possible, but we also want the insured to pressure test the claim to help our response time.

“Some claims are quite straightforward,” Laws continued, “like you got a letter from the Department of Labor about a wage and hour violation and fine. Others are more complex. We are concerned with the quantum of loss. It is important for insureds to understand that it may take time for us to respond correctly.”

In terms of due diligence in dealmaking, Laws is philosophical. “We all have imperfect information. The seller has the best information about the business and assets, but even that is imperfect. The buyers, who become the insureds, have the next best information. They have had the opportunity to kick the tires and ask the relevant questions. Still, their information is going to be more imperfect than the seller’s. We’re third, with the least information, but we are counting on the seller’s disclosures and the buyer’s due diligence to get the right place for all parties.”

Laws also stressed that R&W is not a substitute for a sound program of liability insurance, as well as E&O and D&O coverage.

“Our [R&W] business is evolving along with our other lines,” he said. “We are comfortable seeing and paying claims. That shows to our insureds and to the business community the maturity and reliability of [R&W].” &

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