From a cost perspective, there’s never been a better time to deploy Representations and Warranty (R&W) insurance in M&A deals.
In my own experience, as well as conversations I’ve had with M&A specialists, we’ve seen premiums for R&W policies drop steadily in just the last several years… and the downward trend is forecast to continue.
This is good news for Buyers and Sellers who want the protection offered by this specialized insurance.
Let’s talk numbers.
The price range for R&W premiums is based on a percentage of the Policy Limit selected. Since 2013, that range has been 2% – 4% (i.e. $200,000 – $400,000 for a $10M policy). In 2010, premiums were typically 10% of Policy Limit ($1M for a $10M policy). An amazing drop.
Last year, R&W premiums were in the 3% – 3.2% range. Halfway into 2018, we’ve seen a sizable drop in the rates to 2.25% – 2.8%. There are several clear reasons for the drop in premium price:
- The entrance of more insurers into the market is driving rates down.
- More capacity is available to write R&W policies, so the supply of insurance remains ahead of demand.
- Claims activity remains favorable for insurers. (Insurance companies do pay claims consistently… but there just aren’t that many of them compared to the number of policies written.)
It’s important to note that premiums are just one aspect of the cost incurred when taking out an R&W policy.
There is also an underwriting fee from the insurance company, and tax is due on the premium to the State of Domicile of the Buyer.
Underwriting fees have been rising due to higher demand for prompt processing of Insurer diligence on deals. These fees routinely run $35,000 to $50,000 on deals with transaction values of $50M+. There are some markets offering $20,000 fee levels, but only for the sub-$35M deals.
Tax rates are applied to the policy premium and run from 3% to as much as 7.5% of the policy premium, making taxes a material line item to definitely be aware of.
Still, all in all, it’s a small price to pay for a policy that puts the risk in a business transaction onto a third party – an insurance company. And it also vastly reduces the amount of the purchase price held in escrow (a huge bonus to the Seller).
Broker “Tricks” to Watch Out For
A drop in premium rates is obviously advantageous to Buyers and Sellers. And insurance companies are happy to sell more policies and expand this market.
But traditional brokers at large agencies, whose commission is based on the premium paid, are claiming that they’re losing money on these R&W deals with the lower rates.
As a result, these brokers are tending to go after larger M&A deals with resulting larger insurance premiums. They’re also engaging in a practice that, while perfectly legal, should certainly give you pause.
Do you ever look at your cell phone bill and notice all the “mystery” charges with vague descriptions? Some brokers have seemingly been inspired by that practice and have started to add a “Broker Fee” as a line item to the bill they send policyholders. This is an extra charge on top of what they are paid in commission.
It could be $25,000… $50,000… even $75,000 or more in fees.
These fees add zero value to your deal. And, if you see that fee, I encourage you to push back or get a new broker.
There is one exception where a Broker Fee could be somewhat justified: arrangements where the broker receives no commission and charges the fee instead. In these cases, the premium paid by the policyholder could be reduced a bit. But in general, by imposing this Broker Fee, the bottom-line cost is higher for the client.
Are brokers really losing money on these R&W deals?
Brokers are receiving less than they used to. But it’s the large firms that have potential losses because they have huge overheads – legacy expenses like IT systems, swanky offices, bloated staff, costs for conference sponsorships, and more. These big companies provide all types of insurance; R&W is just one of them.
Bigger isn’t always better. Bigger is just… bigger.
At Rubicon, we don’t charge a Broker Fee because R&W is our focus, and we’re a boutique firm with a cost-effective business model. Commissions cover our costs and then some.
Pricing is top of mind for anybody considering R&W insurance to cover their M&A transaction. And with premium rates falling consistently, it’s more cost effective than ever to take out one of these policies.
With the protections offered by R&W insurance to both Buyer and Seller, it’s a no-brainer to grab one of these policies.
How insurance brokers decide to be compensated for their services is entirely up to them. As long as any such fees are disclosed to the policyholder, there is no limitation on the number or amount of fees that can be applied.
But again, I stress that if such fees are part of your R&W terms, you should consider negotiating them out entirely or seek a new R&W insurance broker that does not charge such fees.
If you’re interested in how current pricing trends could impact an R&W policy to cover your next M&A deal, be sure to download my free Representations and Warranty Insurance Cost Calculator.