Warranty and indemnity insurance
M&A / Merger ModelA policy covering loss from a breach of the seller's warranties, so the buyer claims against an insurer rather than against the seller.
Also written: W&I insurance, W&I, R&W insurance
The buyer takes out the policy in the great majority of cases, even where the seller procures it, so that the buyer has a direct claim against the insurer. The seller's contractual liability then drops to a nominal amount, the escrow disappears, and the deal can be marketed as a clean exit.
It is far more common in Europe than in the United States, and the reason is structural rather than cultural. European mid market sale processes are dominated by private equity sellers running competitive auctions, and a fund that leaves money in escrow cannot make its final distribution or close. Insurance removes that constraint, so it became a standard feature of the European auction package while remaining less uniform in the US.
The policy covers unknown breaches only. Anything actually known is excluded, and the underwriter reads the buyer's diligence reports and will decline to cover areas it believes were not properly investigated. So insurance does not reduce the diligence workload; if anything it disciplines it, because someone else is now reading the reports with money at stake.
The second order effect surprises people. Because the insurer prices what the seller is willing to give, the warranty schedule in an insured deal is often negotiated harder rather than more lightly. A seller offering a thin set of warranties makes the buyer's policy more expensive, which makes its own process less attractive.
Worked example
Illustrative. On a sale at 400, the alternative to a 40 escrow held for eighteen months is a policy with a 40 limit at a 2% premium, costing 0.8.
The escrow costs roughly 5.3 in present value alone at a 10% cost of capital, and it also stops the fund closing. The policy costs 0.8 and leaves nothing behind.
The trap is concluding that the buyer can therefore do less work. The underwriter will not cover what the buyer did not investigate, and a known issue is excluded outright, so it still needs a specific indemnity or a price reduction.