Warranty and indemnity
In this chapter of our Annual Insurance Review 2021, we look at the main developments in 2020 and expected issues in 2021 for warranty and indemnity.
Key developments in 2020Before the escalation of the COVID-19 pandemic, 2019 and early 2020 saw a steady increase in the demand for and usage of warranty and indemnity (W&I) insurance, particularly on high-value acquisitions.
COVID-19 inevitably caused a significant decline in the number of mergers and acquisitions (M&A) transactions globally, thereby reducing the demand for W&I insurance, at least in the first half of 2020. For those transactions proceeding with the benefit of W&I insurance, COVID-19 has had a number of effects on underwriting, which we discuss below.
Aside from impacting deal flow, COVID-19 has also impacted the type of M&A activity that is currently taking place, with a marked rise in the number of distressed M&A transactions. This has in turn increased demand for synthetic W&I policies, in which warranties are stapled to the policy itself and negotiated directly with the insurer (rather than being set out in a share purchase agreement). Such policies are often used where sellers, the target management team or insolvency practitioners are reluctant or unable to provide any warranties.
From a claims perspective, both the frequency and severity of claims continue to increase. This is certainly reflected in the uptick of W&I claims we were instructed on in 2019-2020. Some underwriters have estimated that a claim is now made on 1 in every 5 policies, with larger claims (exceeding USD10m) making up an increasing number of total claims. Breaches of tax, material contract and financial statements warranties continue to represent the main areas of breach. To date, COVID-19 does not appear to have had an identifiable impact on claims.
What to look out for in 2021
COVID-19 has already had an impact on underwriting and will continue to do so over the course of 2021.
Underwriters are likely to place increased weight on due diligence and particularly on areas impacted by COVID-19 such as financial statements; the treatment of employees; supply contracts; banking covenants and COVID-19 specific measures (such as government support obtained by target companies). Underwriters will also be keen to understand how COVID-19 has impacted target company financials and the purchase price.
On policy wordings, the evolution of COVID-19 related exclusions will also prove to be an important feature of W&I insurance in 2021. While a large number of underwriters adopted "blanket" COVID-19 exclusions at the start of the pandemic, a number of underwriters are now adopting a more nuanced approach, whereby a COVID-19 related exclusion has been narrowed down to apply to certain areas of concern only. As the pandemic evolves, we expect to see the wording of COVID-19 related exclusions to continue to develop too.
Although the initial reduction in M&A deal flow arguably led to some downward pressure on pricing across the market, this is likely to be temporary. 2021 may well see a pricing correction reflecting increased deal flow (driven forward by private equity funds) coupled with some capacity leaving the W&I market and the impact of claims, which we discuss above.
Leaving the impact of the pandemic to one side, we can expect to see the continued evolution of and increasing demand for W&I insurance (such as the use of W&I insurance on public to private deals) and related transaction liability insurance products.
Authored by Amisha Jobanputra.
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