W&I insurance in corporate acquisitions: When is warranty insurance worthwhile?

What W&I insurance can cover

The insurance covers contractually defined losses arising from an incorrect warranty or from certain tax liabilities under the SPA. Typical areas include:

Cover typically begins with fundamental warranties relating to the existence, ownership and right of disposal of assets. This is supplemented by financial warranties relating to financial statements and management accounts, as well as representations regarding material contracts, assets and financing.

Depending on the business model, coverage may extend to IP, IT, cybersecurity and data protection, employees and pensions, licences and compliance, as well as environmental matters, product liability, insurance and legal disputes. Tax risks may be covered under the general tax provisions or through separate tax cover. It is always crucial that the relevant area has been adequately reviewed and that the policy actually reflects the contractual guarantee.

The policy does not automatically follow every word of the SPA. It contains its own definitions, exclusions, liability limits and procedural rules. For this reason, a coverage spreadsheet or a comparable side-by-side comparison is used to highlight any discrepancies between the warranty and the insurance cover.

In principle, the insurance covers the unknown risk of a breach of warranty. The policy determines what constitutes relevant knowledge. It is customary to take the actual knowledge of a defined deal team as the basis. The mere technical availability of a document in the data room does not automatically constitute knowledge in every case. However, areas that have been inadequately reviewed or are recognisably problematic can be excluded.

What is not covered, or is only covered to a limited extent, on a regular basis

Typical exclusions relate to:

Excluded, in particular, are breaches of warranties known to the defined deal team and matters that were specifically disclosed during due diligence, in the data room or in the disclosure documents. For such known risks, indemnity, a purchase price adjustment, escrow or a special contingent risk policy remain the appropriate instruments.

Forward-looking statements, business plans and forecasts, as well as purchase price adjustments arising from locked-box or closing accounts, are also generally not covered by warranty insurance. Environmental contamination, certain pension risks, cyber incidents or tax issues may only be insurable to a limited extent or subject to special assessment.

In addition, there are legal and standard market exclusions, such as those relating to wilful misconduct, fraud and inadmissible subjects of insurance. The precise list of exclusions is transaction-specific and should not be analysed only after the SPA negotiations have been concluded.

An identified risk can be mitigated through a specific indemnity, escrow, purchase price reduction or a separate contingent risk or tax policy. Some risks are insurable following further due diligence, whilst others remain permanently excluded.

Seller fraud is treated on a case-by-case basis. Depending on the terms and conditions, a buy-side policy may protect a buyer acting in good faith even in the event of wilful misconduct on the part of the seller. The insurer then typically retains rights of recourse against the persons responsible. The specific fraud provisions must therefore be checked in the policy.

Costs, sum insured and excess

Premiums and terms depend primarily on the size of the deal, the desired limit, the sector and the jurisdictions involved. The quality of the due diligence, the scope of the warranty catalogue and the number of identified risk areas also influence the underwriting assessment.

Other factors include the excess, term, tax cover, exclusions and the time pressure involved in the process. A competitive brokerage process can help to compare quotes. The quality of a policy is determined by the balance between cover, exclusions and claims handling. The premium rate alone remains a poor benchmark for this.

The premium is typically calculated as a one-off percentage of the sum insured, not of the total purchase price. Depending on the structure, broker commission, underwriting fees and insurance tax may also be added.

The sum insured is based on the negotiated liability profile and does not necessarily have to correspond to the purchase price. Fundamental guarantees can be covered by a higher limit or special extensions.

The retention can be structured as a fixed amount, a percentage of the enterprise value or a decreasing retention. For certain transactions, solutions without a significant retention are also offered. The de minimis and basket clauses in the SPA and the policy must be aligned with one another.

Rather than planning on the basis of flat-rate percentages, a non-binding market indication should be obtained at an early stage. This will show the premium, retention, exclusions, terms and available extensions for the specific deal.

The SPA Process

The W&I structure runs in parallel with the due diligence and SPA negotiations. At the outset, the broker draws up a broker briefing based on initial transaction information and obtains non-binding indications from various insurers. Once the preferred provider has been selected, access is granted to the data room, the draft SPA and the due diligence reports, followed by the actual underwriting review. During the underwriting call, the insurer discusses outstanding issues with the buyer and their advisers. The results are incorporated into the schedule of cover, exclusions and the policy. At the same time, the SPA and the insurance must be aligned so that definitions, liability limits and the claims mechanism are consistent. The policy is usually finalised and becomes binding upon signing. Between signing and closing, a ‘bring-down’ may be required to confirm new information and changes. The premium, tax and underwriting fee are paid in accordance with the agreed fund flow, and the cover comes into effect as stipulated in the policy.

W&I works best when the process does not begin only after due diligence has been completed. Early involvement makes it possible to structure the scope of the due diligence and the SPA in such a way that avoidable gaps in cover do not arise in the first place.

Cross-border: Why foreign buyers almost always require W&I

For buyers from abroad, the policy resolves several issues at once. It eliminates the risk of having to pursue a German seller for years after closing and of having to enforce a claim across borders. It safeguards the future business relationship if the seller remains on board as a managing director or minority shareholder, as claims are directed against the insurer rather than the individual. At the same time, it enables the seller to make a clean exit without being tied to an escrow arrangement, which is an advantage in a competitive bidding process. In international auction processes, the insured structure is therefore often specified in the terms of reference from the outset.

Legal and contractual framework

The SPA and the policy are two separate contracts. The SPA governs the seller’s obligations. The policy specifies the extent to which the insurer assumes this risk.

Firstly, the insured warranty breach, the definition of loss and the disclosure standards must be consistent between the SPA and the policy. The same applies to knowledge, materiality thresholds, legal consequences and the treatment of purchase price reductions or multiplier losses. Excess, de minimis, basket, cover limits and terms must be aligned with the seller’s remaining liability. Different limits or special cover may be required for tax matters, fundamental warranties and identified individual risks. Finally, the claims settlement process requires clear rules on notification, cooperation and defence. Buyers, sellers and insurers should know who manages third-party claims, what consent to settlements is required and how claims against other liable parties are handled.

In a typical buy-side structure, the seller is liable for operational warranties only to a limited extent, if at all, whilst fundamental warranties, covenants, purchase price obligations and fraud are dealt with separately. The policy must not inadvertently undermine this division. Known risks remain outside the scope of general W&I cover. They must be addressed separately in the SPA or through specialist insurance. The W&I structure is therefore part of the contractual architecture, not a substitute for it.