Client Advisory: Representations and Warranties Insurance Top Claims Trends for 2021

November 2021 

In a company purchase and sale agreement, Representations and Warranties Insurance (RWI) covers the buyer’s losses from unknown breaches of representations and warranties on the part of the seller.

RWI is generally structured to either replace or enhance the seller’s indemnity to the buyer—the vast majority of RWI policies are placed in the name of the buyer. Sellers also may purchase insurance to backstop their contractual indemnity, but that is less common.

There are now more than 25 insurers offering Representations and Warranties Insurance, including some of the largest and best known in the insurance industry. With M&A activity at an all-time high, RWI is commonly used by both financial and corporate buyers.

McGriff’s Transactional Liability Practice places dozens of RWI polices each year for transactions of all sizes across a wide variety of industries. Based on input from the McGriff Executive Risk Advisors (ERA) Claims Team, this Client Advisory will examine the top RWI claims trends for 2021.

We will see more RWI claims going forward

As the number of M&A deals has increased and the popularity and acceptance of the RWI product has soared, we will surely see more claims down the road.

The RWI policy covers the Insured for breaches of the seller’s “fundamental” representations (those relating to the ability of the seller to conduct the transaction) and tax representations for six years. The policy typically covers breaches of general/operational representations for three years.

While not likely, a policy placed in 2021 could in theory have a claim reported in 2027 for breach of a “fundamental” representation or warranty, or a tax representation. While claims are usually reported in the first three years after a deal closes and the policy is placed, the tail life can extend to six years. So far this year, our ERA claims team has seen a 250% increase in reported RWI claims over 2020.

Timing of breach discovery

Approximately 50% of claims will be reported in the first year after placing the RWI policy.

We examined our RWI claims portfolio and took a closer look at when claims were first reported. Interestingly, 50% of claims were made within the first year post-close. Breaking that down further, claims reported post-close from 0 to 6 months represented 40% of our total notices, 6 to 12 months represented 10%, 12-18 months represented 30%, 18-24 months represented 5%, and greater than 24 months represented 15%.

In RWI, the deductible (or retention) typically reduces, or “drops down,” to a lower percentage (generally one-half of the original amount) after a set period of time (usually a year). Since 50% of our claims are presented after the first year, those claims would have the benefit of a lower deductible.

Overall claim frequency holds steady

Approximately 20% of RWI policies will have a claim reported to the carrier.

The number of McGriff RWI-reported claims match the global trend whereby approximately 1 in 5 (20%) RWI policies will have a claim made sometime during the policy period. While the frequency has held steady for the past few years, the severity of the claims and the total amount of losses under the policies being reported has increased.

One additional observation is that more clients are choosing to report claims out of an abundance of caution, or reporting them early. Clients would rather report a claim early in accordance with the policy, even if the claim is not close to the retention, so that the insurer can’t make a “late notice” argument in the future.

Early claims reporting benefits both the insured and the insurer because it promotes preemptive dialogue between the two sides and experts and outside counsel, if necessary. Insurers would rather be notified early in order to better understand the nuances and complexities of the claim.

Top three categories of breaches

The top three categories of breaches reported to McGriff are related to taxes, undisclosed liabilities and material contracts.

With respect to breaches most commonly alleged under RWI policies, the top three categories of claims we see are: (1) tax related (22%), (2) undisclosed liabilities (19%), and (3) material contracts (13%).

These top three categories are followed by: litigation (9%), compliance (9%), environmental (9%), financial statements (6%), intellectual property (3%), consents/approvals (3%), condition and sufficiency of assets (3%), and property-related breaches (3%).

More outside experts

Both insurers and clients in RWI claims are hiring outside experts more often.

RWI insurers (and clients) are increasingly retaining outside legal counsel and forensic accounting experts to assist in their analysis of the claim, especially complex claims. We’ve seen accounting experts hired in claims involving financial statements, tax issues, and undisclosed liabilities, among others. Experts are often brought in to review financial statements, invoices, etc., and dissect any complex accounting issues involved in the claim.

Outside legal counsel are usually M&A attorneys experienced in the subject matter of the claim who can help the adjuster facilitate dialogue regarding the alleged breach and loss. If the insurer and client both hire outside legal counsel and experts, this often results in a discussion among the experts to analyze the claim and determine the total amount of the loss under the policy.

The exchange of documents involved in the claims process raises the issue of attorney-client privilege. In their claim investigation, insurers often will request a laundry list of documents. When a client meets this request, they must be careful not to waive attorney-client privilege by disclosing privileged information to a third party.

To minimize the risk of waiving the privilege:

• Opt for verbal instead of written communications
• Ask the insurer to make a good faith effort to preserve the privilege
• Only present information absolutely necessary to evaluate the claim
• Avoid disclosing privileged information

For questions about this advisory, please contact:

Lisa Frist, JD
Vice President, Claims Account Executive
404.497.7590
LFrist@mcgriff.com

To learn more about McGriff Executive Risk Advisors, please contact:

David Sellars
Executive Vice President, Co-Division Leader
Executive Risk Advisors
404.497.7582
DSellars@mcgriff.com

Dusty Cahill
Executive Vice President, Co-Division Leader
Executive Risk Advisors
404.497.7537
DCahill@mcgriff.com