July 1, 2019

R&W Insurance: Is the Day of Reckoning Coming?

R&W insurance has proven to be a boon to both buyers & sellers and is an important reason why the M&A market has been so robust over the past several years. But a recent blog by Prof. Brian Quinn flags a new study suggests that the day of reckoning may be coming for the R&W insurance market. The study says that buyers and sellers have transferred the risk of mispriced deals to insurers in a big way, and that a change in market conditions might make RWI terms less favorable & insurers more prickly. Here’s an excerpt:

RWI has been in a soft cycle since it emerged as a widely used form of coverage, around 2015. The soft cycle may explain the reluctance of RWI insurers to use coverage defenses aggressively. An insurer known to pay claims at a slower or lower rate than its competitors may find that it is not solicited by brokers for quotes. Given that there are currently over twenty providers of RWI coverage, it may be particularly easy for brokers to retaliate against insurers that refuse to pay claims. And indeed, the structure of the RWI market around claims would seem to reflect this soft cycle dynamic.

A harder market might correct some of the incentive problems generated by RWI. Insurers might only offer policies when there is a substantial seller indemnity. They might stop offering full materiality scrapes or bring back the policy exclusion for DIV/ multiplied damages. Likewise, a hard market might allow insurers to press coverage defenses ex post, thus inducing insureds to take greater care ex ante.

The study goes on to ask whether RWI coverage can survive a “hard market.” The value of the policies is based in large part on the breadth of their coverage, and if coverage narrows, both buyers & sellers may find a traditional seller indemnity to be a more attractive option.

John Jenkins