W&I insurance for larger deals: practical considerations for tower structures and claims in syndicated insurance programmes

W&I insurance continues to be particularly relevant on sizeable deals. According to several claims studies including our proprietary Howden M&A data,1 large deals generate a higher number of notifications than smaller deals. In light of this, an increasing number of W&I insurers have a preference to deploy smaller policy limits on transactions to actively manage potential exposures, thereby triggering a need to involve several insurers. This means that syndicated insurance programmes (so-called “Insurance Towers” or “Towers”) are becoming increasingly relevant in M&A practice. In this piece, we outline practical considerations for structuring towers and pursuing claims in syndicated insurance programmes.

1. What is a Tower?

Limited capacity of each insurer: The maximum amount W&I insurers can deploy on a single deal is limited.2 Where the insured requires a higher policy limit, at least one other W&I insurance provider will have to be involved to supplement the limit under the so-called “primary policy”. This is usually done by way of so-called “primary policy”. The primary policy (issued by the primary insurer) and the excess policies (issued by the excess insurers) together form a layered syndicated insurance programme (the “Tower”), with each policy sitting excess of the underlying policies: the first layer is the primary policy (which will respond to loss once the retention is eroded), the second layer is the first excess policy (which will respond to loss once the retention and, subsequently, the limit under the primary policy has been eroded), the third layer is the second excess policy and so forth. There is, in principle, no limit to the number of excess policies that can be issued on a single deal.

The level of capacity that insurers can deploy on a single deal is, of course, particularly relevant on large transactions (on which W&I insurance is especially relevant).3 In the current market environment, no W&I insurance provider could insure a transaction with a multi-billion euro transaction value on its own (assuming a policy limit of at least 10% of the transaction value).

Trends towards lower primary limits: W&I insurance providers increasingly prefer deploying smaller primary limits, while potentially offering additional capacity under an excess policy at the very top of the tower (“ventilated structure”). For example, the average limit of all policies issued in the DACH region by AIG has decreased from c. EUR 33m in 2019 to c. EUR 26m in 2021 (a decrease of c. 22%).4 We are also seeing some insurance providers take a more conservative approach to standalone insurance structures (i.e. they increasingly prefer to insure deals in a syndicated insurance program rather than on a standalone basis).

The driver behind this trend is the fact that W&I insurance policies are intended to protect the insured against risks that have a low chance of materialisation but potentially imply a very significant loss. Only c. 20% of large deals attract notifications5 and payments are made by the insurers in 57% of all notifications.6 Only a fraction of the payments will exceed EUR for 10m a single claim but large claims occur regularly.7 Given the premium levels in Europe and the US (and taking into consideration that a sizeable percentage of the premium charged by the insurer will be spent on overhead costs), the premium corresponds to a minuscule fraction of the limit, which means that a single large claim can wipe out a substantial part of the revenues generated by a W&I insurer in more than a year. The impact will be greater for insurance providers with a lower number of policies issued in a year and less (geographical) risk diversification.

So, a single material claim can “make or break” an insurer’s book. Considering this dynamic, W&I insurers in the US have already been implementing lower primary limits and fewer standalone policies for years. It is also common practice globally across other lines of insurance, such as directors and officers liability insurance.

2. What aspects should be considered when structuring a Tower?

Insurer Selection: When selecting insurers for the Tower, it should be ensured that the primary insurer is considered by other W&I insurers to be a reputable and experienced provider whose underwriting decisions they will have confidence following.

In selecting insurers for the Tower, brokers will prefer providers that understand the basic dynamic behind underwriting in a syndicated insurance programme (which is that the excess insurers rely heavily on the primary insurer’s underwriting) and can be expected to follow the primary insurer. In any event, before selecting the excess insurers, key indications received from the primary insurer at non-binding indications stage (i.e. before its appointment as primary insurer) should be discussed with the excess insurers to ensure maximum consistency in the policies across the Tower (see below under 3. — Excess policies). Key considerations include that (i) the excess insurers can insure all relevant jurisdictions, and that (ii) they can follow the primary insurer’s position with respect to key risk areas and key enhancements and policy terms.

Based on the nature of the provider, W&I insurance providers can be divided into two categories: They are either insurers or Managing General Agents (MGAs), i.e. non-insurers that have been authorized by insurers to write risks on their behalf (these insurers are called “carriers”). Some MGAs have also been delegated the authority to decide on claims on the carriers behalf. However, in case the insured does not agree with the decision of the MGA with respect to a claim and decides to initiate court or arbitration proceedings, the MGA’s claims authority will no longer be relevant.

To minimize the number of parties involved in the claims process, it is prudent to select MGAs that hold claims authority. It can also make sense to use MGAs on the Tower that only have one capacity provider, thereby reducing the number of insurers that could be involved in court or arbitration proceedings.

Costs: The total cost of a syndicated insurance programme should, in most cases, correspond approximately to the cost of a single policy with the same limit. In practice, the cost of the individual layers of the Tower is calculated as follows:

• As discussed above under 1. – Limited capacity of each insurer, the excess policies sit excess of each other, which means that, the higher up in the Tower an excess insurance provider sits, the lower the likelihood that it will have to make payments to the insured (in other words: the higher up in the Tower they sit, the further “away from the fire” they are). Considering this dynamic,8 “haircuts” can be agreed with the excess providers. This means that insurers will agree to a discount on the proportion of their premium relative to the limit of their layer (“rate-on-line”) as compared to the rate-on-line of the underlying layer.9

• However, excess insurers providing excess capacity at the very top of the Tower will not accept a rate-on-line below a certain minimum percentage.10 Also, excess insurers will expect that a reasonable pricing methodology has been applied consistently across the tower.11

• Alternatively, if the rate-on-line hits such a low level that it makes the risk unattractive to insurers, a “quota share” layer can be an option. A quota share policy is a policy jointly issued by two or more insurance providers. Loss insured under a quota share policy will be paid by the quota share insurers in the proportion agreed in the quota share policy.

For complex deals, the total cost of the Tower may prove to be lower than the cost of a standalone policy if a limited number of excess policies (two or three layers) is involved. This is due to the fact that insurers tend to be more cautious on complex deals in case they insure the deal on a standalone basis rather than a portion of the total limit (see above under 1. — Trends towards lower primary limits). Such cautiousness usually translates into higher pricing.12 By allocating risk to several insurers rather than one, each individual insurer’s maximum exposure is limited, which should, in theory, lead to a more efficient allocation of the risk. If an insured party is not concerned about the implications of several insurers in the Tower being involved in claims decisions (discussed below under 4. – Insurer claims participation and Settlement of disputed claims), this aspect can be used proactively to reduce the cost of the insurance programme.

3. How are processes involving several insurers different from processes with only one insurer?

Process: The process for placing a syndicated insurance programme is generally more complex and time-consuming than for a single policy. However, the additional complexity will be relatively limited, and it is possible to put in place Towers with up to six layers within challenging timelines.

Involvement of excess providers in underwriting: In almost all processes, the excess insurers will rely heavily on the underwriting of the primary insurer provided that the primary insurer is a reputable provider. Whilst the excess insurers will expect to be involved in the process (i.e. receive all relevant documentation including due diligence reports and answers to underwriting questions and listen to the underwriting call), excess insurers rarely ask underwriting questions of their own or deviate from the coverage position offered by the primary insurer. Generally, the degree to which a primary insurer’s underwriting is interrogated depends on how high the excess insurers sit in the Tower: The further an excess insurer is away from the primary risk, the less likely they will be to challenge or query the primary insurer.

In practice, the insured only must deal with the primary insurer in the underwriting process in most cases so that the underwriting process does not require more time or resources than in processes where only one policy is issued. In a process leading up to a tower structure, more administrative tasks will have to be done (non-reliance letters must be agreed with all excess insurers and access to the VDR provided to all), but this is something W&I brokers can handle.

Excess policies: The only part of a syndicate W&I insurance work stream that requires more attention from the insured’s advisors is the discussion on the interlocking of the excess policies. The W&I broker’s and the insured’s legal advisor’s objective is to limit any substantive differences between the primary policy and the excess policies, as well as between the excess policies to avoid gaps in cover and inconsistencies in policy terms between layers. Besides details specific to the layer (including the policy limit and the insurer’s details), excess policies largely adopt the cover position provided by the primary policy. The only provisions that are, in practice, negotiated are the dispute settlement provisions (see below under 4. – Settlement of disputed claims). The primary policy and each excess policy remain a separate contract between the insured and each W&I insurer as excess insurers do not delegate their claims authority to the primary insurer or any insurer sitting below them on the Tower. This means that each policy has to be reviewed, discussed and agreed separately.

4. What aspects should be considered with respect to claims and dispute settlement?

Notification: Typically, excess policies adopt the notification clauses of the primary policy. Excess policies should be drafted so that losses can be notified to all layers at the same time as notifying the primary regardless of potential quantum (as opposed to only allowing notification once the quantum of the primary limit is exceeded). This enables the notification to attach to all layers, which protects the insured from losing the ability to claim under excess layers if the loss exceeds the primary after the policy period expires.

Insurer claims participation: Typically, the primary takes the lead on insurer claims participation, until it is apparent that there is a risk that the loss is large enough to attract cover from the excess layers. When an excess layer is notified of a loss that is well within the primary policy limit, the excess providers rarely take an active role in the claim. We recommend adopting the claims participation language of the primary policy in the excess layer policies to streamline insurers’ involvement. Whilst each layer is a separate and distinct contract with the insured (with scope for disagreement), adopting consistent policy terms will limit inconsistencies in the policies with respect to obligations to which an insured must comply.

When a loss is larger than the primary limit triggering the excess layers, the excess insurers are likely to take an active role in the claim and usually conduct their own assessment of coverage, which is likely to involve instructing counsel and experts. This may lead to inconsistencies in interpretation of evidence submitted in support of the claim and the policy wording, and ultimately a difference in opinion as to policy response, or claim strategy, between the layers. Having a reputable lead insurer on the primary layer will assist in ensuring coverage restrictions and insurer participation starts off in the right direction. A strong primary should also reduce the risk of excess layers taking a different approach, as they should have confidence in following the primary’s course of enquiry. This is important when the subject matter of the claim is a third-party demand, and insurers will need to agree on the defence. The broker will be consistent across each layer and can assist with navigating any disagreement between the layers. An effective claims broker should communicate with each layer to understand any key differences and identify how best these can be resolved.

Settlement of disputed claims: A coverage dispute for a claim under a Tower can be complicated for an insured party because (i) excess policies only provide cover after the primary and any other underlying policies have paid their limit and (ii) each policy is a separate contract with the insured and there is no contract between each layer. This can cause several practical problems for resolving a cover dispute, including:

(i) If a claimed loss exceeds the primary and exhausts the first excess layer, and the primary and first excess insurers take different views on cover, any settlement with the primary for less than the primary limit could leave the insured exposed as excess insurers are not usually liable until the entire underlying layer is exhausted. The policy wording and any settlement agreement should be worded with this situation in mind so that an insured can pursue the excess insurer for loss beyond more than the primary limit.

(ii) If a claimed loss exceeds the limit of the Tower and all insurers dispute cover but are prepared to settle at a discount, there may be disagreement between the insurers as to their contribution. The insurers higher up the Tower may refuse to contribute to the settlement until the layers at the start of the Tower are fully exhausted. The layers at the lower level of the Tower may not agree to this as cover is disputed and any settlement is outside the policy terms. They may prefer that all insurers contribute prorata to their limit. The lack of contract between the layers makes it difficult to negotiate but insurers often adopt a practical approach and settle pro rata. Active involvement from the claims broker will help facilitate discussions between the layers.

(iii) A coverage dispute that cannot be resolved between the parties may need to be resolved in litigation or arbitration. W&I insurers typically favour arbitration. The primary and each excess policy should be worded to allow any disputes to be resolved in a composite arbitration to avoid an insured having to pursue a separate arbitration against each layer. This will save on time and cost and prevent inconsistent decisions in each arbitration.

5. Conclusion

Towers are set to be more commonplace in W&I practice. As insurers seek to avoid full limit losses, they increasingly prefer to deploy smaller primary limits and be more cautious about insuring deals on a standalone basis. For large deals where the total policy limit exceeds the relevant insurance provider’s maximum standalone limit, W&I insurance will in any case have to be structured as a Tower.

A Tower adds additional complexity to the W&I placement and claims processes. However, the additional complexity at the pre-inception stage is limited and, provided an accomplished broker is involved, can be dealt with under challenging timelines. Thinking of the claims process upfront, inserting appropriate language in the primary and excess policies (see above under 4. — (i) and (iii)) will reduce the additional complexities the insured faces in pursuing claims.

1 Howden M&A Claims Report 2021. 2 The insurance providers’ maximum limits are in a range between c. EUR 30m and c. EUR 100m. Some providers can deploy limits also in excess of EUR 100m on a standalone basis, but this is increasingly rare in practice... 3 CMS, European M&A Study 2021, p. 3: W&I insurance has been used on almost half of CMS’ large transactions (EUR 100m and more). 4 This includes primary policies and excess policies. Specific data for primary policies only is not available, but the decrease here can be expected to be even more pronounced. 5 Howden M&A, Claims Report 2021, p. 1: The notification rate for all deals is, on average, even significantly lower at roughly 12%. 6 Howden M&A, Claims Report 2021, p. 15: 57% result in a payment and 17% result in erosion of the retention when quantum is below the retention. 7 A prominent public example is the payment of EUR 50m to FSN Capital in 2019 for damages related to its acquisition of Gram Equipment from Procuritas.. 8 By way of example, on a EUR 1bn deal, the chance of a €1m claim is significantly higher than the chance of a EUR 100m claim. 9 For instance, assuming that the rate-on-line of the primary limit is 1.5% (in other words, the cost of a EUR 20m primary limit would be EUR 300k), the first excess insurer would agree to a discount on the 1.5% rate-on-line for the primary layer. A reasonable haircut could be 17.5% so that the rate-on-line of the first excess layer would be c. 1.24%. 10 A rate-on-line below 0.7% is very rare even at the very top of a tower. 11 The insurers sitting on a Tower do not communicate directly with one another. Communication between the broker and the various insurers is kept separate. However, the insurers will usually ask the broker structuring the policy to confirm the pricing applied throughout the Tower. 12 Howden M&A, Claims Report 2021, p. 7: “… large deals are more difficult to diligence and issues can be missed … Insurers have continued to price this into their models…”