Warranty and indemnity insurance (W&I) is increasingly popular in mergers and acquisition transactions between businesses of all sizes, having once been an assurance only utilised by large entities in sales or purchases of commercial businesses. As W&I becomes more common as part of the transaction deal, business vendors and purchasers are asking which party should bear the cost — and the answer is, it depends.

The purpose of warranty and indemnity insurance is to protect against financial losses arising from breaches of terms or misrepresentation that may be discovered after the transaction is completed.

  • For buyers it's a practical adjunct to their due diligence on the terms of sale of the company they are purchasing
  • For sellers it enables a clean exit once the sale is completed, even if some deficit is discovered at a later time.

Who takes out the policy and pays the premium?

In the case of a buy-side W&I policy, since the buyer will benefit from the insurance cover provided by a W&I insurance policy, naturally the buyer is expected to bear the full cost of the premium.

Advantages of W&I for the buyer

If there are multiple bidders tendering for the sale the buyer may offer to pay the premium. Attaching a W&I policy to a bid, so that the seller can exit a transaction with no residual liability, differentiates the bid in a positive way, especially if the buyer is paying the premium in full.

When the W&I policy is purchased by the sell-side it enables to buyer to claim any loss in breach of the warranty from the seller directly. The seller may claim against the W&I cover and depending on the policy terms the insurer may control the defence and settlement of any claims.

Advantages of W&I for the seller

If the opts for W&I cover they can realise and distribute the proceeds from the sale with no or only minimal residual liability and no or reduced need for escrow, providing a fast, clean exit. Sellers may also opt to pay the premium on W&I insurance to make the deal more appealing.

Market demand for splitting W&I as a business sale transaction cost

Given that W&I cover delivers advantages to both buyers and sellers, splitting the cost of the cover could be an option in some situations.

In cases where the buyer and seller consider W&I insurance premium costs part of the overall transaction, costs can be adjusted accordingly in the purchase price or can be 'sliced and diced' in a number of ways.

Limits and coverage top-up

Sometimes sellers seeking W&I cover instruct their broker to source lower limits (eg: 10‒30% of transaction value) on the assumption that if this cover is inadequate from the buyer's perspective they can top it up with an additional insurance amount or take out any specific enhanced policy coverage at its own cost.

This concept is becoming more common and, if added into terms of the deal, it avoids any ambiguity or last minute negotiations on which party pays the premium.

In summary, the W&I premium can be allocated in a number of different ways to suit the deal structure. Either way, it is important to address the question as early as possible.

How Gallagher can help with arranging warranty and indemnity insurance

"Warranty and indemnity insurance is increasingly embedded into transactions as a key risk management tool, giving buyers and sellers additional confidence in a transaction," Antony Butcher, National Practice Leader M&A Insurance Services, says. "Businesses considering a purchase or sale should contact Gallagher and our specialists can help advise on the type of cover that should be considered."

Access the benefit of our mergers and acquisitions expertise in Australia and internationally, as well as a detailed explanation of these market trends, in planning your upcoming deals and transactions.

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