Although the independent insurance agency mergers and acquisitions (M&A) market has cooled in recent years from the breakneck pace of earlier this decade, it remains steady. There seems to be no shortage of potential buyers for quality agencies.
A part of M&A transactions that is increasing in popularity is representations and warranties insurance (RWI,) sometimes called “transactional insurance.” This specialty insurance product serves as a guarantee of the representations that a seller makes in an M&A transaction. It covers unexpected costs resulting from breaches of the seller’s representations.
“For example,” says Bob Sargent, founder and chief executive officer of eSpecialty Insurance, an agency headquartered in Utah, “there could be errors in financial statements. It could be you ‘repped’ that you are writing X amount of business in this state ,and in fact it turns out you didn’t have a license. You have a contract that says you have this relationship with this carrier and in fact it was just canceled. An employee left and they’ve provided notice that they are going to sue for wrongful termination, but that’s not in here. Those are the kinds of things that could be in the reps and warranties that could come up.”
Though this type of insurance may be unfamiliar to many agency owners, Sargent says it has actually been around for a long time. Historically, providers were reluctant to insure transactions smaller than $10 million. Sargent says there is now much more of a market for smaller deals. One estimate reported that RWI may be used in as many as one-quarter of private M&A transactions.
RWI fills in gaps created by escrow requirements. Purchase agreements typically require a portion of the sale proceeds to be deposited in an escrow account as security against possible breaches of representations. This prevents the seller from receiving the full purchase price until years after the transaction closes. RWI reduces or eliminates the need to escrow funds.
Either party to the transaction may purchase the policy, though the purchase offers often do not specify who will buy it. “What usually happens is nobody thinks about it until they get down to the brass tacks,” Sargent admits.
Purchasers buy the RWI policy in most cases, but it does not necessarily solve all their problems. Escrowed funds cover breaches that insurance does not, such as known breaches and breaches of covenants. The party buying the insurance also pays the policy premium and bears the self-insured retention.
There also may be an underwriting fee. Sargent explains that the fee, which can be sizable, pays part of the cost for a team of attorneys experienced in this area to review the transaction documents. Fees are often not applicable on smaller transactions.
The policy premium is based on the limit of insurance which is a function of the deal’s value. Sargent says the limit is typically 10 to 15% of the value, and the premium is some portion of that. For example, the limit for a $20 million deal might be $3 million, and the premium would be some fraction of $3 million.
Coverage is virtually always underwritten by surplus lines carriers. Standard provisions exclude coverage for forward-looking warranties such as projections of future sales and adjustments to the purchase price, among others. Sargent cautions that each policy is as unique as the deal it is insuring, so generalizing about coverage is difficult.
The 2024 Agency Universe Study by the Independent Insurance Agents & Brokers of America reported that one-third of the country’s 39,000 independent agencies anticipate some type of ownership change in the next three years. Given that fact plus the interest private equity firms have shown in acquiring agencies, M&A activity should hold steady or increase in the near future. Actors on both sides of the negotiating table should expect RWI to be part of those transactions.
