The Rise of W&I Insurance in the Context of Continuation Funds

With the slowdown in traditional M&A transactions since 2023, private equity players have been looking to innovate and set up solutions enabling them to continue to hold assets held by funds reaching the end of their life. One solution increasingly being used is continuation funds.
A continuation fund provides benefits to both the sponsor (General Partner) and the investors (Limited Partners).  It enables the sponsor to retain one or more high-performing assets while continuing to maximize their value and without having to divest to competitors. The ultimate aim of a continuation fund is to provide liquidity to investors in a fund that is reaching maturity, but in which one or more attractive assets remain and the sponsor wishes to keep in its portfolio.

Existing limited partners or investors have the choice of realizing their investment or reinvesting some or all of their proceeds in the new continuation fund. New limited partners or investors are given access to known, high performing assets, unlike investing in a new fund without knowing precisely what future assets will be financed.

As the popularity of continuation funds continues to grow in the USA and Europe, so does the use of W&I insurance. Although traditionally used in transactions between two different general partners or sponsors, W&I insurance can also be used in a continuation fund as a risk mitigation tool for all stakeholders. The sponsor, new investors, reinvesting or selling investors all benefit from the use of W&I insurance. The protection offered is similar to the one offered by insurance to buyers and sellers in traditional exit operations, with a few specific features tailored to the particular structure of a continuation fund.
Transferring the seller’s liability for the warranties and indemnities under the share purchase agreement to an insurer helps to facilitate the sometimes-tense negotiations between the seller and buyer, enabling parties to concentrate on other important issues surrounding the transaction. W&I insurance can also help to reduce post-closing conflicts between the sponsor and investors, preserving relationships that are required to work together going forward.

For the sell-side, the insurance provides a clean exit after the fund's liquidation, save in cases of fraud or deceit. By offering this solution to future investors, the sponsor will also make the continuation fund more appealing, by attracting new investors who are generally cautious and wish to take on as little historical risk as possible.
On the buy-side, the introduction of W&I insurance makes it possible to obtain longer protection periods, higher indemnity amounts and a broader suite of warranties. In short, W&I insurance can provide better protection than would be the case if the seller was liable for the warranties and indemnities. By outsourcing risk towards the insurer, the new investors are reassured that their coverage is as broad as possible and the historical risk exposure is minimal, making it easier for them to approve the transaction.

Now that we have discussed the advantages of W&I insurance for all transaction parties, it is worth looking at the insurance cover itself and how to maximize it.

The coverage of a W&I insurance policy in a continuation fund will be linked to the due diligence conducted by the sponsor and/or the investor and the structure of the transaction i.e. does the transfer concern one or multiple assets and the level of due diligence available, depending on these two factors, the scope of coverage will vary.

In principle without due diligence, there is little to no W&I insurance cover available. Even if this point needs to be qualified in certain respects, it is important to bear in mind that the insurers largely obtain comfort from adequately scoped external third-party due diligence reports, a comprehensive seller disclosure exercise and through discussions with the buyer and/or the buyers advisors. The broader and more comprehensible the scope of the due diligence, the more likely it is that insurers will be able to offer satisfactory cover for the insured.

When a single asset is transferred, it is typical for the acquisition agreement to include broad title, tax and business warranties similar to those usually found in a typical M&A transaction. Insurers are prepared to offer extensive warranty coverage if certain conditions are met. The insurer underwriting the deal expects management to be involved in the disclosure process, and the buyer to have carried out a comprehensive due diligence exercise (legal, tax, financial, insurance, etc.) with a scope similar to that of the warranties given. Otherwise, the scope of coverage will be limited. Where only sell-side due diligence is available (and not buy-side due diligence), insurers will be able to offer coverage, albeit on a more limited basis, including many qualified warranties to the knowledge of the seller-side sponsor's transaction team.

In a multi-asset portfolio transaction, it is customary for warranties to focus mainly on securities, transferability and a few warranties on the underlying assets. It is also customary for only sell-side due diligence to be available. In this context, insurers will offer limited coverage for underlying asset warranties by qualifying them to the knowledge of the sponsors transaction team advising the sell side.

In addition to the warranty and indemnity coverage, W&I insurance can extend to cover Excluded Obligations. Excluded Obligations are sell-side commitments for which the parties agree in the acquisition agreement will remain the seller's responsibility once the transaction is finalized. These often include matters such as tax liabilities, losses caused by acts or omissions of the seller, and other limited partner clawbacks. These commitments are varied, but some insurers are able to cover most standard Excluded Obligations for an additional premium of circa 7%-10%.

To cover these commitments, insurers will look at the performance of the original fund and ask questions about clawback clauses. They will also look at the structure of the original fund from a tax point of view.

In the absence of Excluded Obligations negotiated into acquisition agreement, some insurers are even able to offer synthetic cover for this type of commitment. The additional premium will be higher, but it can be a simple way of resolving a tension between parties on this point.

Now that we have discussed the scope of coverage available under a W&I insurance policy, it's interesting to understand who the beneficiary of such policy can be, for how long, and what the policy's coverage limits are.

As far as the beneficiary of the policy, and therefore the insured, is concerned, there are two possible options. The insured is either solely the new investor, or the insured can be the continuation fund, this will include all those with an interest in the continuation fund, i.e. the new investor, the reinvesting investors and the sponsor. The nature of the insured will have an impact on the loss payable, the premium and the deductible applicable to the policy.

If the insured is the new investor alone, the loss payable, premium and deductible will be based on the new investors’ proportionate ownership in the fund e.g. if the fund's Net Asset Value is 200M and the new investor contributes 100M, the loss, premium and the deductible will be calculated pro-rata to reflect the fact that the investor has invested 50% and not 100%.

If the insured is the continuation fund, the loss payable, premium and deductible will be based on the full Net Asset Value of the continuation fund.
The duration of cover will depend on the type of warranties. Fundamental and tax warranties will be covered for up to 7 years after completion of the transaction, while social and environmental warranties will be covered for up to 5 years. The remaining warranties will be covered for 3 years. 
As far as the insurance limit of liability is concerned, it is a commercial decision for the insured to choose the amount to be covered. Depending on the limit, one or more insurers will need to be involved in providing insurance capacity. As of September 2024, there is in excess of a billion euros of insurance capacity available in the market for a single risk. The size and range of insurable transactions is therefore vast.