Key takeaways
- Rep and warranty insurance is now used in approximately 65-70% of PE-sponsored middle market transactions; it allows sellers to reduce escrow from 10-15% of deal value to 0.5-1.0%, materially improving cash at close.
- RWI policies cover losses from inaccurate representations in the purchase agreement, but they contain significant exclusions: known issues disclosed in the data room, purchase price adjustments, fraud by the seller, and forward-looking representations are typically excluded.
- Sellers should still care about the accuracy of their reps even with RWI in place, insurers have a right to pursue sellers for losses caused by fraud, and known issues that were deliberately omitted from disclosure are not covered.
- RWI does not eliminate indemnification risk entirely, the retention (the seller's deductible, typically 1% of deal value) plus excluded matters means sellers retain some exposure even in fully-insured deals.
What rep and warranty insurance is and how it works
Rep and warranty insurance is a specialized insurance product that covers losses arising from breaches of representations and warranties made in the purchase agreement. In a traditional deal, the buyer would look to a seller escrow to recover losses; with RWI, the buyer looks to the insurance policy instead.
The structure: the buyer purchases a RWI policy from an insurance carrier. The policy covers losses above a retention (typically 1% of deal value for the seller's deductible). The buyer pays the premium (typically 2.5-3.5% of the policy limit). The seller escrow, if any, is reduced to a small amount covering only the retention period or specific excluded matters.
65-70%
of PE-sponsored middle market transactions now use RWI
2.5-3.5%
typical RWI premium as % of policy limit
0.5-1.0%
typical seller escrow with RWI, vs. 10-15% without
What RWI covers and what it excludes
RWI policies cover inaccurate representations and warranties made in the purchase agreement, essentially, things the seller represented as true that turned out to be false, resulting in financial loss to the buyer. Common covered matters include undisclosed liabilities, tax issues, employment claims, IP ownership, and environmental matters.
Key exclusions: known risks (anything disclosed in the data room or disclosed schedules to the purchase agreement is excluded), purchase price adjustments (working capital, debt-free cash-free adjustments), forward-looking representations, criminal matters and fraud, government fines and penalties in some states, and deal-specific matters that the carrier excluded based on its diligence review.
RWI claims are filed in approximately 18-20% of transactions where policies are in place. Tax representations and financial statement representations are the most frequently claimed categories. Average time to claim resolution is 18-24 months.
Sellers who receive a fully-insured deal structure (no seller escrow, only a de minimis retention) typically achieve 2-4% higher net proceeds at close than sellers in traditional escrow structures, because the elimination of escrow holdback provides immediate liquidity.
RWI does not mean you can make inaccurate representations without consequence. Insurers investigate claims thoroughly, and if they find evidence that the seller knew about the issue that was claimed (i.e., it was a known issue not disclosed), they will deny coverage and potentially pursue the seller directly. The discipline of accurate disclosure remains fully in force even with RWI.
65–70%
of PE-sponsored middle market deals now use RWI
2–4%
higher net proceeds in fully-insured deals vs. traditional escrow
18–20%
of deals with RWI policies have claims filed
1%
seller retention (deductible) even in fully-insured deals
RWI: With vs. Without
RWI is not free insurance for buyers and sellers. The buyer pays a premium of 2.5–3.5% of the policy limit. The seller accepts a retention of ~1% of deal value. The insurer excludes known issues and gets subrogation rights against the seller if fraud is involved. The net effect is a more efficient allocation of risk, not elimination of it.
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