Origin and Nature of W&I Insurance Policies
W&I (Warranty and Indemnity) insurance policies have become an increasingly common tool in share purchase transactions in Italy. Originally developed in the UK market, they later expanded to the United States and, in recent years, have become a frequently used insurance product in Italian M&A deals.
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These policies allow parties involved in an extraordinary transaction to reallocate the risks arising from a breach of the so-called representations and warranties (R&W) provided by the seller in a share purchase agreement (SPA). When signing an SPA, the seller guarantees to the buyer certain facts and circumstances regarding, among other things, the legal, economic, financial, commercial, and tax situation of the target company. By means of a W&I policy, in the event of a breach of these representations and warranties, the obligation to indemnify falls on a third party—the insurance company—rather than on the seller. Naturally, as with any insurance product, coverage is subject to the payment of an annual premium by the insured party.
The Validity of W&I Policies under Italian Law: IVASS Regulation 29/2009 and the Clarification of July 25, 2019
Initially, the legitimacy of W&I policies under Italian law was uncertain. Article 4, paragraph 2, of IVASS Regulation No. 29/2009 prohibited “insurance coverage intended to guarantee reimbursement of contingent liabilities or capital losses on assets resulting from valuations following extraordinary corporate transactions.” This wording appeared to prohibit the issuance of W&I policies in the Italian market, despite their growing popularity.
To address market concerns, IVASS issued a clarification on July 25, 2019, confirming that W&I policies do not fall within the scope of the prohibition in Article 4, paragraph 2 of Regulation No. 29/2009, provided that:
- If taken out by the seller, they are intended to insure the seller’s indemnification obligations in the event of a breach of specific representations and warranties given to the buyer in an extraordinary corporate transaction.
- If taken out by the buyer, they must be based on clearly defined and identifiable commitments, not resulting from asset valuations, capable of adequate actuarial risk assessment, and leading to indemnifications that do not coincide with the purchase price of the transaction.
Despite this clarification, the initial regulatory uncertainty has led to foreign insurance companies frequently underwriting W&I policies in Italy, a practice that continues today.
Buy-Side vs. Sell-Side W&I Policies
W&I policies can be taken out by either the buyer (buy-side policies) or the seller (sell-side policies).
- Buy-side policies: The insured party is the buyer acquiring the target company, who seeks assurance that, in the event of untrue representations and warranties, they will receive fair compensation for the devaluation of the acquired company.
- Sell-side policies: The insured party is the seller of the shares, who ensures that, if a claim arises regarding the representations and warranties, the indemnification will be covered by the insurance rather than directly by them.
In both cases, the insured risk is the same: a breach of R&W.
In practice, buy-side W&I policies are far more common than sell-side policies. This means that in most transactions, the buyer bears the cost of the insurance premium. Often, the SPA itself regulates the mechanism through which, in case of a breach of R&W, the insurance indemnification is activated in favor of the buyer. The policy may cover either the full amount of the seller’s indemnification obligation or only a portion of it. In the former case, the seller has no further indemnification obligations beyond the insurance coverage, making the policy the buyer’s sole recourse.
An Additional Type of W&I Policy: The Sell-Side Flip Policy
As with most insurance products, W&I policies continue to evolve in response to the changing needs of the M&A market. In addition to buy-side and sell-side policies, a hybrid structure has emerged: the sell-side flip policy.
This type of policy involves the seller and the insurance company as contracting parties, but the ultimate beneficiary is the buyer. In this case, the seller pays the insurance premium, but any indemnification for breaches of representations and warranties is paid directly to the buyer. This structure can have implications for the purchase price, as a buyer may be willing to pay a premium knowing that the seller has secured insurance coverage for their representations and warranties under the SPA.
