M & A 2015M I N N E A P O L I S ▼ N O V E M B E R 1 8CONFERENCE

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2 0 1 5 M & A C O N F E R E N C E

2 0 1 5 M & A C O N F E R E N C E

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Representation and Warranty Insurance: Updates on This Important and Rapidly Changing Industry

Linda Crow, Faegre Baker DanielsJay Rittberg, AIGCraig Schioppo, Marsh USA Inc.Moderator: Kate Sherburne, Faegre Baker Daniels

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Overview

Protects against unknown and unforeseen losses arising from a breach of the representations and warranties in a purchase agreement.

Why it is used:►Remove or reduce escrow or holdback in the transaction;

extend survival periods►Provide recourse when no seller indemnity possible►Distinguish bid in competitive auction►Protect key relationships or passive investors►Distribute sale proceeds faster

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Types of R&W Insurance Policies

►Buyer-Side Policy (85+% of policies issued)► Insurance replaces sellers’ potential indemnification liabilities► Can enhance indemnification terms

► Extended survival periods, increased cap, materiality scrape► Covers fraud by sellers► Limited subrogation rights against sellers and management team

►Seller-Side Policy► Sellers backstop their potential indemnification liabilities► Mirrors indemnification terms in agreement► Typically excludes fraud of sellers► Knowledge between sponsors and management sellers can be severed

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Insurance Market Evolution

►Broader coverage and better alignment with underlying agreement►Speed of execution – more streamlined underwriting process►Significantly increased limits of liability available►Material reduction in premium rates and deductible levels – enhanced

competition►Greater market awareness►Claims experience

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How You’ll Encounter It

►Private equity has been the early adopter

►Strategic encountering as a Seller-imposed requirement in an auction

►Middle market M&A emphasis and application, but growing in upper middle markets

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Market Growth

►Already an established product in certain markets, has seen significant growth in North America over past 5 years:

►AIG expects approximately 2,000 submissions and 300 policies in 2015

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215 335525

1150

0

500

1000

1500

2011 2012 2013 2014

Number of Submissions

35 59 95

230

0

200

400

2011 2012 2013 2014

Number of Policies Bound

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Pricing

► Diligence Fee: generally $20K - $40K depending on nature of deal► Premiums

► Typically 3.5% – 4% of limit insurance (lower outside of U.S.; higher for smaller policies)► Either party can pay

► Deductibles► Typically 1% - 2% of transaction value (no indemnity deals may be higher)► Buyer-side policies often use escrow account as deductible► Seller-side policies use a negotiated amount► Drop-downs available and erosions available for loss outside coverage

► Limits► Up to $500M of limits available in global market► Hard to insure a deal with a limit lower than $5M► Can be used effectively in transactions from $25M - $3B+

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The Broker

►How to choose a Broker

►What the Broker should do for you

►What information the Broker needs to obtain quotes

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The Insurer

► Preliminary information submitted to insurer:► Acquisition agreement, financial information, offering memo

► Underwriting considerations:► Identity of the buyer, seller and their advisors► Sector of target business and location► Quality of the transaction process► Quality of due diligence/disclosures► Value of transaction► Scope of the warranties – buyer or seller friendly?► Seller’s liability under the agreement► Gap between signing and completion?► Why do they want insurance?► Do both parties know about the insurance?

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The Process

►Give yourself at least 2 weeks to be comfortable (can be done faster, if needed)► Engage Broker► Broker delivers quotes; Negotiate NBIL (2-4 days)► Diligence; pay underwriting fee (5-10 days)

► High level review of due diligence process (if buyer-side) or disclosure process (if seller-side)

► Access to legal, financial, tax, other DD reports (if buyer-side)► Conference call(s) with deal team

► Negotiate policy (a few days, runs concurrent with end of diligence period)►Works on a parallel track to purchase agreement►Can incept at signing or closing

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The Policy

►Conform coverage to your purchase agreement

►Common Exclusions► Known issues identified in disclosure schedules and environmental reports► Asbestos claims► Losses covered in purchase price adjustments► Issue known to a member of the insured’s deal team► Breaches of covenants► Claims for non-monetary relief► Criminal fines or penalties► Fraud of seller (if a sell-side policy)

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The Policy (Cont.)

►Exclusions that may arise depending on industry/facts:► Product liability claims► Underfunded benefit plans► Healthcare billing practices► California wage and hour law issues► Big pharma issues► FCPA

►Can expand coverage from purchase agreement:► Materiality scrapes► Survival periods► Consequential and multiple damages

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The Purchase Agreement

►Could be silent

►Might be “fully baked” (covenants, closing conditions, etc.)

► Indemnification provisions might reference as a first recourse

►May specify that escrow is only available for claims not covered by insurance

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Claims Experience

► Industry-wide, claims payments have ranged from $500K - $25M ► Insurers have dedicated claims professionals and law firm relationships

to offer claims solutions►Brokers and independent advisors serve as advocates for insureds►Examples of claims:

► Financial Statements: Recently paid $25M for a financial statements-related claim

► Accounts Receivable: Seller-side policy responds to claim brought by buyer for breach of financial statement R&Ws related to target’s issuance of over $1M of unrecorded gift certificates

► Patent Infringement: Seller-side policy responds to third-party patent infringement claim

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Frequently Made Claims

►Financial statements, compliance with laws, taxes, and undisclosed liabilities are the most frequently alleged breaches.

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0%

5%

10%

15%

20%

Type of w arranty breach

Financials;AR;Inv. -18% Comp. With Laws/Lit. -17% Tax -14%No. Undisc. Liab. -10% IP -8% Contracts -5%Full Disc. -4% Emp. Ben. -4% Real Prop. -3%Other -16%

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Timing of Claims

►More than half of all claims notices are received within the first 12 months of the policy’s issuance.

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