Category Archives: Insurance Business and Regulatory Developments

Representations and Warranties Insurance Beyond the Current Cycle of Merger Activity: Will Those Chickens Come Home to Roost?

Representations and warranties insurance transfers the risk of certain known unknowns and unknown unknowns from transaction participants to the underwriting insurer.[1] Such risk transfer can create moral hazard especially where one of the parties to the transaction, i.e. the seller (and also the underwriting broker), receive the majority, if not all, remuneration on the deal and exit the stage before the unknowns become knowns. It also can create a situation where insurers who seek an expanded share of what has been called a “prolonged sellers’ market” may face deteriorating claims and be left with an undesirable position when the economic waters recede.[2]

What is Representations and Warranties Insurance

Representations and warranties insurance provides coverage for financial losses resulting from a breach of a representation or warranty made by a seller in a purchase and sale agreement. It is a subset of transactional risk insurance and sometimes called M&A insurance or warranty and indemnity insurance. Counterparties used to address these type of risks through negotiated escrows which kept the risk allocated among the parties to the transaction. Transactional parties often now lay that risk off to an insurer’s balance sheet.

The Domestic Market Has Grown at an Astronomical Pace

The market for representations and warranties insurance exploded in the past decade. According to one of the major brokers, total industry limits (combined primary and excess) approached $14.7 billion and generated approximately $526.5 million in premium on more than two-thousand issued policies in 2016.[3] That is remarkable growth for a product that reportedly generated $10 billion in bound coverage worldwide in 2013 and was on virtually no one’s radar screen before the recent M&A uptick which followed the Great Recession.

As of 2018, a representations and warranties policy is generally priced between 2.25% to 4% of the limit of liability with market capacity and appetite for large transactions increasing. Typically, 1-3% of enterprise value is retained, but it has been reported that recent retentions have gone below 1% as the market tightens among insurers competing for market share.

Reported Claims Experience

AIG was one of the first insurers to write representations and warranties insurance (referred to as warranty & indemnity insurance outside the domestic market) and has published three annual reports on its claims experience. According to those reports, approximately one-in-five (19.4%) policies written result in a claim.[4] The largest deals from a dollar perspective (deal size over $1 billion) generate the highest claims frequency (24%) and the largest average claim ($19 million). An increased year-on-year claims frequency was reported across all classes of deal size. According to AIG, nearly half of all material claims (46%) resulted in what was termed a mid-sized payout (payment on the claim between $1 million to $10 million) with an average settlement of $4 million over the five year period of policies written between 2011-2016. That reported average settlement was up, from $3.5 million, in the prior report.

In 2018, AIG for the first time provided data broken down on breach type by industry sector as set forth below.[5]

AIG’s reported claims figures suggest that insureds have become more sophisticated in their use of the product with an impact on the frequency and severity of claims.

Judicial Determinations of First Impression

In 2017, the United States Court of Appeals for the Seventh Circuit became the first court of review to address a claim for indemnity under a representations and warranty policy in a published opinion.[6] A $23.4 million stock purchase deal for a specialty dairy products company which resulted in a $10 million settlement between the corporate buyer and the family members who had sold their 100% interest in the company was at issue before the court. The sellers purchased a seller’s warranty and indemnity insurance policy with an aggregate cover of $10 million over a $1.5 million retention which provided coverage for various representations made in the deal documents on a claims made basis with a policy period extending for six years after the closing.

The Seventh Circuit affirmed summary judgment in favor of the insurer. The court held that the settled claims were for breach of general representations for which the deal documents capped damages at $1.5 million. As a result, the damages attributable to covered claims (fraud claims were excluded under the policy) were limited to the amount of the insured’s $1.5 million retention such that the insurer had no liability. The court recognized that had the settlement been structured in a different way or the claims been litigated, such that allegations were made against the sellers in a complaint filed with a court of record subject to Federal Rule of Civil Procedure 11 or a state court equivalent, then the insurer might have been liable. The saving grace for the insurer here appears to have been that the insureds rushed to settle and did not structure their settlement in a way to invoke coverage. The court also recognized that the insured failed to give the insurer sufficient time to review and approve/reject the settlement before consummation.

While Ratajczak resulted in a decision for the insurer, the opinion left much room for creative buyers or sellers to structure claims in a way to obtain coverage where the policy drafter might have intended otherwise.

The Current M&A Cycle

M&A activity remains robust and many leading experts predict the trend to continue through 2018.[7] Representations and warranties products appear here to stay and have a place in a well-managed portfolio. However, these policies have long tail risk typically providing coverage for general representations up to three years and fundamental representations up to six years with some market participants reportedly offering longer coverage periods in an attempt to capture market share. What will happen if the current M&A market turns and current policyholders look to hedge loses by making increased claims or potentially assigning their interest in policies including assignments made in bankruptcy. Insurers would be well served to keep an eye on market conditions and work through strategies to address any increase in claims percentage or severity in advance of any economic downturn as such claims experience may directly impact loss ratios.

[1] The phrase unknown unknowns was popularized by former Secretary of Defense Donald Rumsfeld who on February 12, 2002, stated at a Department of Defense news briefing: “Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.” Transcript available at http://archive.defense.gov/Transcripts/Transcript.aspx?TranscriptID=2636, last visited May 24, 2018.

[2] AIG, Claims Intelligence Series, M&A Insurance – The New Normal?, May 2018, available at https://www.aig.com/content/dam/aig/america-canada/us/documents/insights/aig-manda-claimsintelligence-2018-r-and-w.pdf, last visited May 24, 2018.

[3] Gallagher Market Conditions, January 2018, available at https://www.ajg.com/media/1701903/rw-market-conditions-2018.pdf, last visited May 24, 2018.

[4] AIG, Claims Intelligence Series, M&A Insurance – The New Normal?, May 2018, available at https://www.aig.com/content/dam/aig/america-canada/us/documents/insights/aig-manda-claimsintelligence-2018-r-and-w.pdf, last visited May 24, 2018.

[5] Id., Source of Reprinted Graphic.

[6] Ratajczak v. Beazley Solutions, Ltd., 870 F.3d 650 (7th Cir. 2017).

[7] See, JP Morgan’s 2018 Global M&A Outlook, available at https://www.jpmorgan.com/jpmpdf/1320744801603.pdf, last visited May 24, 2018, and Deloitte’s The State of the Deal, M&A Trends 2018, available at https://www2.deloitte.com/content/dam/Deloitte/us/Documents/mergers-acqisitions/us-mergers-acquisitions-2018-trends-report.pdf, last visited May 24, 2018, among other forecasters.

Duane Morris Partner Max Stern to Moderate Panel at the American Conference Institute’s National Forum on Insurance Allocation

Duane Morris partner Max H. Stern will be moderating a panel at the American Conference Institute’s (ACI) National Forum on Insurance Allocation on October 29, 2014 at the Carlton Hotel on Madison Avenue in New York. Mr. Stern’s session is titled, “In-House Roundtable: Counsel and Claims Professional Insights on New and Emerging Issues in Insurance Coverage and Allocation,” and will take place at 9:35 a.m.

For more information or to register for this event, please visit the American Conference Institute’s website.

Duane Morris Partner Dominica Anderson to Speak at the PIAA Corporate Counsel Workshop

Duane Morris partner Dominica C. Anderson will be speaking at the PIAA’s Corporate Counsel Workshop. Ms. Anderson’s session is titled, “ECO/XPL and the Mega-Verdict: Is This the New Normal?” and will begin at 2:45 p.m. on Thursday, October 16, 2014 at the Fairmont Hotel Vancouver.

For more information about this event, please visit our Duane Morris Events Page.

Six-Month Delay Bars Coverage in NJ Under Claims-Made Policy

For a claims-made policy, the policy holder is to provide notice of a claim: (1) during the same policy period in which the policyholder received the claim and (2) “as soon as practicable.” Otherwise, the claim may be denied because of late notice. New Jersey has determined that six months or more is not “as soon as practicable.”

Holding: The Superior Court of New Jersey, Appellate Division, held in Templo Fuente de Vida Corp. v. National Union Fire Insurance Company of Pittsburgh, P.A., that: (1) notice of a claim was not provided “as soon as practicable” when sent six months after service on the insured of the underlying complaint and (2) an insurer on a claims-made policy does not have to show that it was prejudiced by the late notice.

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California Court of Appeal Issues Ruling Regarding Attorney Fee Awards

A California Court of Appeal has affirmed the concept that a successful defendant who is entitled to an attorney fee award can seek an award which is greater than the fees actually billed by the insurance appointed defense counsel who represented the defendant.

In Syers Properties III, Inc. v. Ann Rankin et. al., 226 Cal.App.4th 69 (2014), defendants successfully obtained a judgment of nonsuit in a legal malpractice action. Defendants were entitled to attorney fees by reason of their fee agreement with the plaintiff which entitled the prevailing party to attorney fees. Defense counsel sought and successfully obtained an award of attorney fees which were not tied to the rates actually charged for the representation by presenting evidence to the trial court that a reasonable rate for the representation was actually higher than the rates charged. The court noted that the benchmark for a fee award is reasonableness and there is no requirement that the reasonable market rate mirror the actual rate billed. In concluding that a reasonable rate could exceed the actual rate billed, the court acknowledged that attorneys who do work for insurance companies often work at what are arguably below market rates (in part because of the volume of work). Thus, because counsel was able to convince the trial court that the skill, expertise and experience necessary to successfully litigate the case would reasonably have been charged at higher rates, the court of appeal concluded that the trial court was within its discretion in concluding that a higher rate was reasonable and justified.

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Third Circuit Issues Decision Concerning Medicare Secondary Payer Act in New Jersey

On July 29, 2014, the Third Circuit issued an interesting court decision concerning the Medicare Secondary Payer Act (MSP) that may provide guidance to the parties in tort litigation, particularly in New Jersey tort litigation, in a case styled Taransky v. United States. The Taransky case involved a slip and fall accident involving a settlement by a tortfeasor who tried to resolve the Medicare lien in the settlement process. The case pitted two statutes against each other, the Medicare Secondary Payer Act and a New Jersey statute prohibiting tort claimants from recovery twice under medical insurance and liability insurance. In the end, the Third Circuit found that the plaintiff had to reimburse Medicare from the tort settlement for medical bills incurred by Medicare. Continue reading Third Circuit Issues Decision Concerning Medicare Secondary Payer Act in New Jersey

Partner Terrance Evans Appointed Vice Chair of the ABA National Insurance Coverage Conference

Congratulations to partner Terrance Evans, of the San Francisco office, on his appointment as Vice Chair of the ABA National Insurance Coverage Conference, the largest insurance coverage conference in the country. Mr. Evans follows in the footsteps of partner Ray Wong, of the San Francisco office, who served as Chair and Vice Chair of the conference, and partner Dominica Anderson, of the Las Vegas office, who served as Vice Chair of the conference.

Duane Morris Chicago Office Adds Trial Partners Tomas M. Thompson and Mark A. Bradford

Duane Morris LLP is pleased to announce that Tomas M. Thompson and Mark A. Bradford have joined the firm’s Trial Practice Group as partners in the firm’s Chicago office. Thompson and Bradford, who join from DLA Piper, follow the addition in the firm’s Chicago office of partners Mark D. Belongia and Lisa T. Scruggs, associate David B. Shafer and associate Brian L. Dougherty.

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San Francisco Partner Paul Killion Receives National Legal Writing Award

Duane Morris is pleased to announce that partner Paul J. Killion of the firm’s San Francisco office will receive a Burton Award for Legal Achievement at a gala ceremony to be held on June 9, 2014, at the Library of Congress in Washington, D.C. This honor is given to only 30 authors selected from entries from the nation’s 1,000 largest law firms.

Killion was selected as a 2014 Distinguished Legal Writing Award winner for an article he wrote about how to use Internet sources in legal writing. “Warning: The Internet May Contain Traces of Nuts (Or, When and How to Cite to Internet Sources)” appeared in California Litigation: The Journal of the Litigation Section, State Bar of California, last spring.

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What I Tell You is Privileged and Protected From Discovery (Even if You Embrace It and Reiterate It to Your Insured)

Insurers often rely upon coverage counsel to advise them of their duties and obligations with respect to claims for coverage by their insureds and then take that advice and communicate it in whole or in part to their insureds. The expectation is that the advice of counsel is privileged even if it is thereafter embraced by the insurer and communicated to the insured. But is it? No, said a trial court in West Virginia, where an insured sought from coverage counsel for the insurer opinion letters the counsel had written to the insurer on similar claims (i.e., claims not involved in the litigation between the insured and the insurer). Continue reading What I Tell You is Privileged and Protected From Discovery (Even if You Embrace It and Reiterate It to Your Insured)