Warranty and Indemnity (W&I) insurance has become essential in global mergers and acquisitions (M&A) transactions, and South Africa is no exception. This specialised insurance product provides financial protection to buyers and sellers against unknown liabilities that may arise from breaches of warranties and indemnities in transaction agreements. As M&A activity continues to grow in South Africa, understanding the importance and benefits of W&I insurance is crucial for organisations looking to mitigate risks and facilitate smoother transactions.
In summary, W&I insurance is designed to transfer the risk associated with breaches of representations and warranties from the buyer or seller to an insurance provider. By providing financial protection, it facilitates smoother negotiations and transactions under the following types of Coverage:
- Buy-side Policy: Protects the buyer against losses from breaches of the seller’s representations and warranties.
- Sell-side Policy: This policy protects the seller, usually by allowing them to recover losses incurred due to breaches of their representations and warranties, thereby reducing the need for escrows or holdbacks.
According to Pierre Du Preez, Executive Head of RBS’s corporate division, “W&I insurance has become a critical component in modern M&A transactions, offering both buyers and sellers peace of mind and a smoother path to closing deals.” W&I Insurance has become increasingly important for South African organisations for the following reasons.
1. Risk Mitigation
- W&I Insurance transfers the financial risk associated with breaches of warranties and indemnities from the buyer or seller to the insurer. This is particularly important in South Africa, where the complexity and size of transactions are increasing. By having W&I insurance, organisations can protect themselves against potential financial losses arising from unknown liabilities, thereby reducing the overall transaction risk.
2. Facilitating Clean Exits
- For sellers, W&I insurance supports a clean exit by removing the need for extensive warranties and indemnities. This is especially beneficial for private equity firms and other investors who prefer to avoid post-closing liabilities. By transferring these risks to the insurer, sellers can exit the transaction without the burden of potential future claims.
3. Enhancing Buyer Confidence
- For buyers, W&I insurance provides additional comfort and security. It ensures that any claims for breaches of warranties or indemnities can be made against the insurer rather than the seller. This simplifies the indemnification process and protects the buyer from the risk of the seller’s insolvency or unwillingness to pay.
4. Smoother Negotiations
- The presence of W&I insurance can streamline negotiations between buyers and sellers. It reduces the need for contentious discussions over the scope and extent of warranties and indemnities, as both parties know that the insurer will cover potential claims. This can lead to faster deal closures and more amicable relationships post-transaction.
5. Competitive Advantage
- In competitive bidding scenarios, buyers who offer W&I insurance as part of their proposal can gain a significant advantage. Sellers are more likely to favour bids that include W&I insurance because it limits their post-closing liabilities and ensures a smoother transaction process. This can be particularly advantageous in the South African market, where deal competition is intense.
Implementing W&I insurance in M&A transactions involves a rigorous due diligence process to identify the scope of representations and warranties. It also acts as a strategic negotiation tool, enabling better deal terms, reducing escrow amounts, and extending coverage duration beyond typical seller agreements. In the event of a claim, the insured party must prove the breach and the resultant loss, after which the insurer indemnifies the loss up to the policy limit.
Let’s summarise the Benefits and Key Features of W&I Insurance.
- Risk Transfer: Shifts potential financial losses from the buyer or seller to the insurer, providing significant peace of mind.
- Deal Facilitation: This can bridge gaps in negotiations, making it easier to finalise deals by resolving disputes over indemnity provisions.
- Enhanced Bidding: Buyers may be more willing to bid competitively, knowing they have protection against unknown risks.
- Clean Exit for Sellers: Allows sellers to distribute sale proceeds without retaining funds for potential future claims.
- Policy Period: This typically aligns with the warranty survival period as stated in the acquisition agreement, covering the period after the deal closes.
- Coverage Limits: Specifies the maximum amount the insurer will pay for claims.
- Retention/Deductible: The amount the insured must bear before the insurance coverage kicks in. Depending on the negotiations, this can be shared between buyer and seller.
- Exclusions: Standard exclusions apply, such as known breaches, fraud, and certain high-risk representations.
W&I insurance is a valuable risk management tool in M&A transactions. It offers protection against financial losses due to breaches of representations and warranties. Its ability to facilitate smoother and more secure deals makes it an essential component in the arsenal of both buyers and sellers in the M&A landscape. The strategic use of W&I insurance can make the difference between a stalled negotiation and a successful acquisition.
Risk Benefit Solutions (RBS) is uniquely positioned to offer W&I insurance to South African clients through our established partnerships with London markets. Unlike many local brokers, we have the expertise and connections to secure this specialised Coverage, ensuring you have the best protection available for your M&A transactions.
RBS is a leading independent BEE Level One short-term insurance brokerage with offices in Cape Town, Johannesburg, and Gqeberha. Let RBS indemnify you or your client for any upcoming mergers or acquisitions.
About RBS
Risk Benefit Solutions, better known as RBS, originated as an entrepreneurial-focused services business in 1998 and today is one of the largest fully-fledged black-owned insurance brokers in South Africa and a Level One B-BBEE contributor. Celebrating 25 years in business this year, our growth has contributed to offering clients a unique approach to risk management by positioning our skilled resources as an extension of our client’s risk management team. Our company covers various services, including Insurance Broking, Risk Management, Commercial and Corporate Risk Advisors, and Corporate Vehicle Hire Services. With its head office in Cape Town, RBS has offices in Gauteng, the Eastern Cape and globally, represented through its board membership with WING (Worldwide Insurance Network Group).