Underwriting the deal: Risk and expectation management in corporate M&A

Insurance underwriting of company acquisitions: identifying transaction risks

By virtue of its sector, jurisdictional exposure, financial history, asset base and other considerations, each company is unique and therefore when seeking to acquire a target company, a purchaser will undertake due diligence to better understand the intricacies and the condition of the assets that it will inherit. Similarly, when warranty and indemnity (W&I) insurance is built into the scope of a transaction, the insurer will conduct its own analysis on the target and its assets before a policy is incepted to better understand the extent of its financial exposure in the event that a warranty is incorrect; this process of insurer analysis is what constitutes “underwriting”.

Due diligence reports

W&I insurance provides cover in respect of unknown and undisclosed matters that give rise to a breach of warranty or indemnity; it is not intended to provide cover for undiligenced matter. Considered due diligence therefore remains paramount as a suitably scoped due diligence exercise will tend to bring a transaction within insurer appetite. During the underwriting process, an insurer will not commission its own due diligence on the target but will instead review the findings of the due diligence reports prepared by or on behalf of the buyer. As such, the more thorough the diligence exercise, the broader the insurance cover that might be afforded. At a minimum, an insurer will require sight of legal, tax and financial due diligence reports and over the past year we have seen a trend emerge amongst buyers whereby technical, commercial, environmental and insurance diligence reports are also prepared (see our previous article on Transactional risk mitigation tools: Warranty and Indemnity and Due Diligence for further discussion on this topic).

Underwriting questions

Following the review of the diligence reports, the insurer will ask a series of questions which seek (i) to better understand the transaction and the scope and adequacy of the diligence, (ii) to clarify any areas of misunderstanding and fill in gaps in the insurer’s knowledge, and (iii) to assist the insurer in gaining comfort with the accuracy of the warranties on the basis of the diligence carried out. These questions are commonly known as “Tranche 1” and “Tranche 2” underwriting questions; with the former being more general in nature and the latter being tailored to the specific details of the transaction and due diligence findings.

Underwriting call

The underwriting call is an exploratory conversation which gives the insurer the opportunity to speak directly to deal team members and diligence advisers and enables any outstanding concerns to be discussed and addressed such that the insurer can provide as fulsome cover as possible. The insurer will use the written responses to the underwriting questions as the agenda for the call, focusing only on areas where it requires further detail. For this reason, not every deal requires an underwriting call and in recent years, there has been a trend towards insurers requiring underwriting calls on only larger or more complex transactions.

Considered due diligence remains paramount as a suitably scoped due diligence exercise will tend to bring a transaction within insurer appetite

European vs US approaches

The preceding paragraphs consider how underwriting takes place in a typical European transaction; in the US, a slightly different approach is taken. Given the uptick in US investment into Europe and insurers generally being more flexible in their ability to cater for different transaction styles and disclosure standards, US style policies or policy enhancements are now offered as standard by London market insurers. US policies carry higher premiums but are considered to be more “insured friendly” by virtue of their lighter approach to exclusions and a raft of inbuilt ‘enhancements’ when considered in comparison to their European counterparts. These include, for example, non-disclosure of the data room and due-diligence reports and payment of loss on an indemnity basis.

A US style underwrite usually takes the form of a longer underwriting call (often in the region of 2 to 3 hours) and no antecedent “Tranche 1” and “Tranche 2” questions; that said, insurers are often open to providing a set of questions in advance of the underwriting call which will form the agenda; thereby arguably blurring the lines of distinction between the US and European approaches to underwriting.

WTW’s team is experienced with advising on both US and European styles of underwriting and are able to guide clients through either process. Whilst underwriting traditionally takes 7 to 10 business days (though this can be expedited where required), as a general theme the past year has seen deals tending to take longer from conception to closing, leaving more time to analyse targets and to seek broker involvement. As such, WTW always recommend commencing underwriting with plenty of time in order to allow for any identified areas of concern to be considered, analysed and overcome.

How can WTW help

WTW’s Transactional Risks team is made up of qualified lawyers and tax and accountancy practitioners who, in their former careers, frequently drafted due diligence reports on companies ahead of acquisitions. This experience positions us well to guide clients through the underwriting process and add value at each stage to help ensure that the policy procured meets all the needs of the insured and addresses the nuances of the transaction and matters discovered during diligence; as every transaction is unique, every transaction requires a bespoke solution.

We take time to properly understand each client and their position so that we can obtain the insurance fit for them. Clients have plenty to consider when undertaking transactions and therefore the WTW team seek to make the insurance process as straight forward as possible, utilising our wealth of industry experience and leveraging trusted industry relations to negotiate purpose-built policies on your behalf.