I have a surprising truth for you. It goes against everything you’ve been taught or experienced when it comes to insurance companies.
When you have a Representations and Warranty (R&W) policy and there is a breach, your best course of action is to be as cooperative as you can with your insurer.
Doing so will maximize the amount of money you are awarded as damages, and you’ll get your money faster. Unlike traditional car, health, or home insurance, companies holding Rep and Warranty insurance aren’t actively trying to find a way to deny your claim based on information you give them.
There is a financial incentive to pay these claims. These policies generate great cash flow to Insurers with six and seven-figure premiums per policy. At the same time, these high revenue policies incur extremely low losses by industry standards, so policyholders have leverage over Underwriters right now.
If word got out that an R&W Insurer was reluctant to pay a legitimate claim, the M&A industry would literally abandon that insurer. It’s easier to simply approach another, more reliable insurer. The attorneys and advisors that bring deals to insurers are repeat players, who won’t risk their clients with an insurer that may not pay a claim. An increasing number of companies are entering this field—and that competition has the dual impact of keeping rates low and favorable claims treatment high.
Rep and Warranty policies cover large, often complex business deals in industries that the Underwriters don’t really know.
Much more due diligence is done on these Rep and Warranty policies than on other insurance policies, but it’s still not enough to decide a correct claim. Before they settle on the correct amount for your claims, they need more information. And as a policyholder, you’re the one who’s going to provide it to them.
But what does that cooperation look like?
The relationship starts when you apply for the policy.
Because of the amounts of money involved, there is a lot of due diligence done for a Rep and Warranty policy; they are very thoroughly vetted. That’s why this process alone can cost from $25,000 to $50,000. As a result, Underwriters are very clear about the risks involved before they make the deal.
These Underwriters are not actuaries. They are all M&A attorneys with experience in this field. They’re experts. It’s as if occupational therapists and physicians oversaw new policies for Workers’ Comp insurance.
They know the likely risks in a deal. They know what questions to ask during the due diligence process. They know the responses they’re looking for.
As the policyholder, that’s where you come in. You have an important job at this stage of the process. The Underwriters don’t perform the due diligence themselves; they depend on the diligence you and your attorneys completed. Typically, there will be emails and several conference calls.
When they ask a question, answer honestly to the best of your ability, without omitting key information. Do that, and you’ll get a policy that offers the best coverage.
Of course, not every possible risk will be exposed in this process—but that’s why you have insurance.
Working with Underwriters through a Claim
So you’ve secured your Rep and Warranty policy. The two parties negotiate a sales contract that both can accept and sign on the dotted line.
But what happens if there is an issue down the line and you have to file a claim? Previously unknown tax liabilities might come up, or a key supplier may want to renegotiate its contract and raise its prices. The #1 most common cause of Rep and Warranty losses is financial misstatement: the Seller “innocently missed” some figures right before the sale.
As the policyholder, you start the process by notifying the insurance company, in writing, that you are making a claim. The insurance company opens a file on your case and puts together a dedicated claims team.
They’ll want to know what the breach was, what you think the damages were, and why. This is where cooperation comes in again. It truly should be a collaborative process.
You should send, again in writing, all the data and information the insurance company asks for. But this is not just a data dump: there will be a lot of conference calls in which you walk the Underwriters through the materials you submit.
Remember that while they’re experts in mergers and acquisitions, the Underwriters aren’t experts in every industry they write policies for. You’ll have to educate them.
Let’s say that several months after purchasing a company, the Buyer is facing a lawsuit based on something that happened back when the Seller still had control.
The cost of that lawsuit is going to be a certain amount—that’s one set of damages for the claim. But you also have to look at damage to the company’s reputation. How will it affect sales?
You have to look at historical data to see the diminution in valuation. You discuss that variable with the Underwriters, make your case, and come to an agreement.
Let’s say a company acquires a candy manufacturer. The value of this company was tied to its contract with a big box store chain. Unfortunately, once the deal goes through, the big box store says it doesn’t want the candy anymore unless the price is reduced.
As a result, the value of the company is reduced. But by how much? That’s what the claims process tries to figure out.
When the extent of damages is not clear-cut, forensic accountants and industry experts might be brought in to help calculate damages.
The broker who secured your Rep and Warranty coverage can also be an important partner in the process; they can translate complex insurance language for the uninitiated. Brokers provide essential avenues of communication between the policyholder and R&W claims team that literally accelerates the process to a favorable outcome.
Denied Claims Are Very Rare
Don’t think of all this as the insurance company looking for a way to get out of paying you.
Yes, an insurance carrier wants to limit its exposure and mitigate its losses. They’ll only approve claims that have been properly examined. They do want to pay you, but they want to pay a fair amount based on sound data.
If this process sounds daunting, consider that the scope of this “investigation” (not to mention the expense) is a fraction of what would be necessary if you had to engage an attorney and sue the Seller.
It boils down to being as forthcoming as possible: the more information you provide, the faster you’ll walk away with your check.
R&W Insurance companies don’t usually deny a claim. And when they do, the policyholder often already knew the claim would be denied. They simply filed the claim to have it on record.
If you’ve made the smart decision to use Rep and Warranty insurance in your next merger or acquisition, do it right.
From the very beginning, think of your insurance company Underwriters as collaborators. You’ll not only speed up the claims process and maximize the amount paid—you’ll also secure the best coverage from the beginning.