Often grouped under the umbrella of Representations and Warranties Insurance, these policies aim to help sellers avoid tying up the typical escrow payment of 10 percent of the purchase price for years if a dispute arises.
“Any place where you may use an escrow to take care of some uncertainty in the transaction, you can often use an insurance product,” Ehrlich said in an interview.
The insurance also may help general partners more quickly share the benefits of a portfolio company sale with their limited partners, by not locking up capital for an escrow payment and instead letting it boost the return on an investment and in turn, lift the IRR performance of a fund.
“If you’re in a capital raising environment, the money saved for an escrow payment could be a world of difference between having an IRR that puts you in the top quartile and one that barely puts you in the second quartile,” Ehrlich said.
Carriers such as AIG, Beazley and Ambridge Partners have stepped up their efforts to promote Representations and Warranties Insurance. In the case of AIG, it typically offers limits of up to $50 million for any one transaction, but larger programs may be set up on a case-by-case basis, according to the firm’s website. Premiums range from 2 percent to 5 percent of the limit of liability purchased, with deductibles amounting to 1 percent to 3 percent of the transaction value.
Ilan Nissan, partner, and James Lee, associate, at law firm Goodwin Procter, said these types of insurance products were used only for very specific issues in the past, as when a fund wanted to dissolve and could not leave an escrow behind.
“Now in competitive situations, public-style, no-indemnity approaches are common, and wholesale rep and warranty insurance is becoming more and more the way people are going to protect themselves,” Nissan said in an email to Buyouts.
Ehrlich said he first noticed use of Representations and Warranties Insurance in the 1990s in England, and then in the United States starting in the late 1990s. It has taken since then for the product line to gain traction as pricing came down. “At first, people just weren’t used to it,” Ehrlich said.”Now it’s kind of growing in popularity in an exponential way.”