Here's how R&W insurance may look after COVID-19
Study: Representation and warranties (R&W) insurance policyholders should move quickly with claims and come well-armed to the claims process.
It requires time and effort on the part of policyholders, but claims under representation and warranties (R&W) insurance policies do, in fact, get paid.
That was one of the top findings from a new survey report by national law firm Lowenstein Sandler. It also answered a key question about R&W insurance, which has boomed in recent years alongside record M&A volumes.
Though reduced deal flow and COVID-19′s widespread disruption of the economy could, at least in the short term, shake up the R&W landscape, survey data suggests that broad, longer-term changes to the market may be on the horizon. The data also shows that policyholders should move quickly with claims, come well-armed to the claims process and refuse to take “no” for an answer.
Here’s more about the survey findings and the outlook for the R&W market.
How the R&W process works
R&W insurance aims to remove risks from balance sheets and largely supplant traditional seller indemnity in transactions. This, in turn, can minimize buyer-seller disputes and help maintain commercial relationships.
Yet despite the R&W market’s growing popularity, it was not clear whether such claims were being paid by insurers. To that end, Lowenstein conducted a broad survey of R&W insurance market participants consisting of private equity funds, investment banks, operating companies, R&W insurers, and R&W insurance brokers. The survey revealed that for claims that exceed the R&W policy’s self-insured retention, 87% of claims resulted in a partial payment after negotiation. Still, a clear majority — 71% of respondents — had at least one claim that remained within the policy’s self-insured retention (SIR), meaning that no payment was made or required.
The survey also showed why it is important for policyholders to move quickly to begin the claims process — a key issue because 45% of the time, respondents reported that it takes more than six months for them to submit a claim. Moving faster than that is a good idea for several reasons but getting paid quickly is at the top of the list. Most respondents reported it takes between three and 12 months for the issuance of a coverage position letter and six to 18 months after the claim notice submission before payment is received.
The survey also revealed disagreement on why coverage is denied. Insurers and brokers identified a lack of insurer consent for claim resolution, while policyholders indicated that insurers first take the position that no breach has occurred, then pivot to no loss has been suffered, and then cite the actual knowledge exclusion to avoid coverage.
But policyholders, insurers and brokers largely agree that some recovery results after a challenge is made to the R&W insurer’s initial denial and further negotiation takes place. The survey confirms that policyholders who fight back will be rewarded as a strong majority report that claim payments exceed 50% of the claimed loss when challenged.
Additionally, the survey found that financial services has far and away the largest number of R&W claims; most claims result from direct harm to buyers rather than claims from third parties, and a clear majority of claims stem from deals with seller indemnification.
Financial statements form the foundation for most claims — likely because one of the first things a buyer does after closing is examine the company’s financial statements and records to confirm they actually got what they paid for.
Policyholders: Take the initiative, despite COVID
In the short term, all stakeholders involved with the R&W market should expect exclusions related to COVID-19 and broader pandemic concerns. But in the long run, insurers will likely apply some broader learnings from COVID-19.
For instance, R&W insurers will likely examine employment matters and maintenance of key business relationships, as the pandemic has raised the profile of diligence concerning business continuity and contingency planning. Simultaneously, there will be a greater emphasis on cyber risk. That emphasis was growing before the pandemic, but it has accelerated with the global shift to remote work conditions where technology vulnerabilities have been magnified. R&W insurers will give careful, deal-by-deal consideration when it comes to insuring risks related to how effectively companies transitioned into this new environment.
It is also likely that insurers operating under a cash-is-king mindset will further extend the claims process, looking much more closely at claims to substantiate losses and damages. But deal flow will eventually return, and when it does, our survey data shows some adjustments to the R&W market are necessary.
Some insurers will look to leave the R&W space due to competition, capacity and reinsurance constraints. Those insurers will be more resistant to paying claims because they will no longer have the need to protect their reputation on payment of claims. Further, in the absence of collecting ongoing premiums, those insurers will have limited dollars to pay the claim.
However, many insurers will look at the numbers — that, for example, just 29% of claims currently exceed the SIR — and they will remain in the market. As deal flow returns, policyholders should demand greater competition and alignment of the risk-reward model by seeking lower SIRs, lower premiums and continued customization of policy terms.
The final key headline from the survey is the importance of assembling an experienced claim advocacy team. Indeed, it will take a village that includes brokers (to manage and leverage business relationships), coverage counsel (to articulate the legal basis for coverage and negotiate maximum value for claimed losses), and accounting experts (to credibly demonstrate the breach and support loss valuation). This dream team must be proactive in advancing the claim, whether it is providing prompt notice of all actual or potential breaches, informing insurers of any ongoing negotiations with the seller and/or any other third parties who may be held responsible for the loss, or preparing a well-documented proof of claim.
Given the disruption of COVID-19, it is possible policyholders will delay or fail to take this initiative. But based on what the survey reveals, that would be a mistake.
Lynda Bennett (lbennett@lowenstein.com) is chair of the Insurance Recovery Practice at Lowenstein Sandler LLP. Eric Jesse (ejesse@lowenstein.com) is an attorney in the Insurance Recovery Practice at Lowenstein Sandler LLP.
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