W&I insurance is fast becoming an important tool in M&A

A growing number of M&A professionals are coming to see the value of W&I insurance in reducing the risk on deals, allowing sellers to make a clean exit, offering protection for buyers, and giving both parties security and peace of mind. Over the last decade, it has become increasingly popular with dealmakers across emerging Europe as familiarity with the product has grown and its benefits have become more widely recognised.

For the seller, it limits their liability post-closing, separating them from the target business, and avoids the need to have sale proceeds held in escrow accounts as a guard against future claims. From the buyer’s perspective, it can mitigate concerns over the seller’s financial position or its ability to cover claims. Buyers often use it to make their bids more attractive to sellers and to protect the value of their investment once deals are done, ensuring there are funds if there is a claim post-acquisition. It can help buyers secure finance because of the additional security it provides to banks.

Blazej Zagorski, CMS partner in Poland, said: “It has become a well-recognised tool that we see in many deals and one that can be successfully placed in the transaction framework. People increasingly have a good experience with it and realise it has a useful role to play in moving towards signing and closing a deal.”

By providing a method to reduce risk for both sides, it can also streamline and accelerate the negotiating process, bringing benefits that override the expense and effort involved. Rodica Manea of CMS Romania said: “Arranging insurance can be time-consuming and comes at a cost, but the overall positive compensations overcome these downsides.”

However, as Marija Zrno Prosic, CMS partner, Croatia, notes, W&I insurance tends to be more widely used on large transactions over EUR 100m and less so under EUR 25m. “What we see locally is the increased interest in W&I insurance in M&A and the reason why it is not used so often locally is because of unfamiliarity with the process and terms thereof and late consideration of its use in a transaction,” she explained.

Broader understanding

As W&I has become more widely available and used across the region, in Poland, Hungary, Romania, the Czech Republic and Slovakia, expertise has increased and practitioners have adapted their services to the needs of individual markets. Real estate was an early adopter, thanks to the high proportion of institutional investors in the sector, while another driver has been the growing presence of private equity firms in the M&A market, where warranties and indemnities allow funds to make a clean exit.

Piotr Nowicki, counsel in the CMS tax team, Poland, said: “W&I insurance and tax liability insurance remains a popular tool for dealmakers in Poland and has been a part of the Polish M&A market for almost a decade, led by the booming Polish real estate market.”

In Romania as well, Rodica Manea has seen the rising use of W&I insurance, including with a focus on real estate and private equity or institutional investors. She has observed: “In line with current trends on the Romanian M&A market, the industry sectors most active in using W&I insurance proved to be real estate, technology, manufacturing, and healthcare. Notably, we have seen increased appetite in sectors where insurers have historically shown less interest, in particular renewables.”

In the not-too-distant past, W&I insurance may have required an introduction and education even for experienced deal professionals, whereas now an expanding number of investors, corporate advisers and lawyers are familiar with the concept and the products. In a growing global market for W&I insurance, the industry itself has become more aware of the attractions of emerging Europe as a place to do business and underwrite risks, creating a community of brokers and underwriters with a deeper understanding of the needs of the region.

Piotr Nowicki added: “At the same time, the focus of underwriting is also extending and underwriters pay close attention to the quality and scope of not only the legal, but also the financial and tax due diligence. The increasing interest in W&I insurance has also led to further enhancement of the product itself. They are becoming more comprehensive with fewer exclusions.”

In Slovenia, according to Sasa Sodja, CMS partner, although such policies have been around for some time, they are not yet a standard solution, partly because of unfamiliarity with the product and, in the case of some insurers, unfamiliarity with the jurisdiction. She added: “Nevertheless, the Slovenian market is increasingly exploring W&I policies as an alternative to escrow accounts and hold-backs in higher value transactions.”

Blazej Zagorski said: “We see lots of capability locally that can drive this tool, and as the market becomes more mature, it can be used to mitigate a growing number of risks that might be identified in the due diligence process.”

Widening areas of cover

The potential risks covered by W&I insurance is steadily increasing as the market adapts to economic conditions and users’ needs. A recent trend has been less use of blanket exclusions for Covid-19, but they’re becoming less common as insurers grow more cautious about risks associated with the war in Ukraine.

According to Piotr Nowicki, more attention is being paid to accounts and financial related warranties. He explained: “Breaches of accounting warranties are sometimes used by claimants as a ‘catch-all’ mechanism to capture issues that do not fall within other categories. Similarly, the increasing number of tax audits in Poland also leads to claims being filed concerning tax warranties.”

Customer and supplier contracts are also an area of focus, particularly where a business relies on a small number of customers or suppliers, while there is more appetite for covering environmental issues and cybersecurity where the potential damage caused by cyberattacks and data breaches can be enormous. ESG is a key growth area, as Rodica Manea pointed out: “With the high-profile nature of ESG matters coupled with an increase in regulations focused on transparency and social issues, such as health and safety, payment practices and performance reporting, we expect to see an uptick in buyers seeking contractual and specific warranty protection for ESG-related matters. There will be further innovation in the W&I market as buyers look to mitigate ESG risks.” For more details on how ESG is making a bigger impact on M&A, see the separate section in this report.

As a tool in negotiations, W&I insurance can be used to fill gaps that may have been missed during the due diligence using post-placement policy enhancements that allow parties to review missing areas of due diligence after a deal is done. The evolution of the market has seen the development of so-called synthetic warranties which are negotiated between the buyer and the W&I insurer rather than as part of the purchase agreement between buyer and seller, saving on time and costs.

Alongside W&I is the development of specific tax insurance, which can be used in situations such as corporate restructurings in anticipation of a potential sale in the future, creating a policy that addresses tax risks that otherwise might represent a deal breaker in M&A negotiations.

Despite the growing use of policies, businesses unused to W&I insurance did not include it in their transaction planning and often left it too late, observed Marjia Zrno Prosic, adding: “It takes more time for smaller markets such as Croatia get start using it more often and the increased interest we see locally will likely increase its use. The key step is better acquaintance with the details and due consideration before the transaction.”

The underwriting process could be seen as an unwanted burden said Sasa Sodja and sellers might want to close a deal early with tweaking the terms for the benefit of a W&I policy. In addition, “such insurance hedges the unknown risks where, in local deals, it is the unknown risks that can be the biggest divide between parties”.

A sophisticated market

W&I insurance is becoming a more sophisticated market and playing a more important role in the evolution of M&A in emerging Europe.

Rodica Manea said: “With the growth in competition, W&I insurance services are becoming more sophisticated and need to reflect market demands for different pricing and coverage options. While W&I insurance expands, more claims are expected to arise and other types of liability products are also expected to become popular, including tax, contingent liability, and environmental insurance.”

Piotr Nowicki added: “The increase in M&A market penetration by W&I insurance and the growing refinement of the product will undoubtedly result in the growth of the market. The outlook of the W&I insurance market is quite bright.”

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