Given the current state of the market, deal flow is down and, therefore, so is the number of submissions getting sent to representations and warranties insurance (RWI) underwriters. Underwriters are poised to strike when the market picks back up again but, in the meantime, where does that leave us?
Our clients are actively reaching out to us with questions on the current state of the mergers and acquisitions (M&A) market, what they can expect with the RWI placement process, what it will cost, etc. We thought a simple FAQ blog would be helpful for anyone else who may have the same questions. This is not an all-inclusive list of questions, by any means, so please feel free to reach out with any others with which we may be able to help.
Is now a good time to get RWI?
To be clear, the answer to this question will always be a resounding “yes,” but I’ll elaborate. Now is a great time to consider RWI—especially for deals that historically may not have been within the underwriter’s risk appetite.
Competition in the market is high. On average, we’ve been receiving about 15 NBILs (non-binding indications) per submission this year. That’s a big group to select from. In past years, we would have considered five to seven NBILs a successful marketing process, giving clients a broad range of quotes to choose from. This increase is partly due to the current state of the M&A market but, despite that, we are still seeing new underwriters enter the market, keeping competition high.
Terms are as clean as we’ve ever seen with very few, if any, deal-specific exclusions at the submission stage. We’ve also seen a position shift on certain risks from underwriters in an attempt to make their quotes more competitive. For example, we’ve had some success lately removing the “excess and no broader than” requirement for underlying insurances such as cyber.
In the past, the RWI policy would sit excess and no broader than any underlying insurance—the key component being the “no broader than” portion. As an example, let’s say the target company is a manufacturer. There is a recall on one of their products, and their underlying product liability policy excludes recalls.
In this situation, if the “no broader than” provision was in place, there would be no coverage under the RWI policy for this claim. We expect this provision will make its way back into circulation once the market turns around, but time will tell.
In addition to the terms provided, underwriters have come down quite a bit with pricing and retention. As we enter Q3 2023, the average ROL (rate on line—calculated by dividing premium/limit) that we have received is about 2.55%. This is not the ROL for the winning NBIL, mind you, but the cumulative average of all quotes received.
To put this number in perspective, the average ROL in 2022 was about 4%. For several years, the standard retention—the amount the insured must pay in the event of a claim before the policy limit kicks in—was 1% of the purchase price. Currently, the average quoted retention is about 0.76% of the purchase price with many underwriters offering an initial retention as low as 0.5%.
The lowered retention is the result of increased competition in the market in addition to the fact that, historically, a number of claims simply eroded the retention instead of breaching the full amount, leaving underwriters with some leeway to make their NBILs more attractive.
All in all, with the low pricing/retention along with buyer-friendly terms, yes, now is a good time to use RWI.
What should we do if we are handling diligence internally? Do we have to write it down?
For the most part, underwriters are fine with internally prepared diligence. They don’t necessarily like it, per se, but they’ll work with it. However, we’ll add a note of caution. The vast majority of diligence reports that underwriters see are prepared by reputable third-party providers who are more or less following the same playbook as their competitors.
This majority has set the bar for what parameters/scope the underwriters expect to see with all diligence reports. In certain instances, experienced internal diligence specialists may focus on the risks that they know are material for their purposes whereas third-party providers will leave no stone unturned.
If the internal reports are lacking in any of these diligence areas, the result could be a lengthy list of follow-up questions or, worst case scenario, an exclusion for the risk that underwriters feel did not receive adequate diligence. If you are conducting internal diligence, we highly recommend sending a scope of work for the underwriter to review prior to formal engagement.
Do you need to memorialize the diligence in a report or memo? For the most part: yes. We’ve had instances where the underwriter was able to talk through an area of diligence (i.e., tax) on the call, but that concession was deal/risk specific. With no report to review, the underwriters will essentially be starting their review of the diligence on that topic from scratch during the diligence call. It’s doable but a far less efficient process.
Sections on the diligence call with no written report tend to last quite a bit longer and typically result in a fairly lengthy list of follow-ups. The final product will be roughly the same regardless, but with no report provided, it could add an administrative burden to your diligence team addressing the underwriter’s concerns. Let your broker know as soon as you can if you think an area of diligence will not have a corresponding report.
What’s the smallest limit we can buy?
Underwriters have shifted their position on what would be considered the ideal target company. One of these changes is the size of the deal, which has opened the door for a lot of lower middle-market transactions that would have otherwise used a traditional indemnity structure.
Historically, we haven’t had too much trouble getting coverage for “small deals,” which I’ll define here as an enterprise value below $20 million. However, due to minimum premiums and underwriter appetite, we used to recommend a limit of at least $5 million, resulting in coverage that was higher than the market standard (we typically see a limit equal to about 10–15% of the purchase price). Currently, we’ve had little to no trouble in getting terms for limits as low as $3 million while keeping the same ROL as for the larger deals.
If you’re looking for limits below $3 million, Fusion has a product that may suit your needs. Allow me to introduce you to Mio (M&A insurance online). This product is designed to cover limits between $1 million and $10 million and purports a streamlined placement process (no diligence call required). Let us know if you’re interested in learning more about Mio, and we will be happy to discuss the details.
Also, if your question did not make this list of FAQs, or if you need more information on any of our responses, please reach out.