Gaps in W&I insurance coverage
Gaps in W&I insurance coverage
Warranty and Indemnity (W&I) insurance has become an established feature of Finnish transactions in recent years. It is a customized insurance product through which the parties to a transaction transfer deal-related risks to an insurer. At its best, W&I insurance serves both the buyer and the seller, but in practice, its coverage is often understood to be broader than it actually is. This article examines what W&I insurance is all about and what its typical coverage gaps are.
What is W&I insurance?
In a transaction, the seller typically provides a broad set of warranties regarding the state of the target company. These are recorded in the sale and purchase agreement as so-called representations and warranties, in which the seller guarantees that the information provided about the target company is accurate and that it is in the condition the seller has represented it to be.
Through W&I insurance, the parties transfer liability for any breach of these representations and warranties to the insurer. In practice, this means that the buyer claims from the insurer rather than the seller. The W&I insurance provides the buyer with the same protection as the sale and purchase agreement, but through a different recovery channel.
The parties may take out the insurance in the name of wither the seller of the buyer, but market practice has shifted clearly towards buyer-side policies. The reason is practical: the buyer can claim directly against the insurer without first having to pursue the seller. This eliminates the risk of the seller being insolvent at the time a claim is made. The parties can negotiate the allocation of costs as part of the overall terms of the transaction. In practice, the buyer typically bears the cost, although the seller may contribute through pricing adjustments.
Benefits of W&I insurance for the seller and buyer
From the seller’s perspective, the key benefit of W&I insurance is a clean exit: the seller receives the full purchase price and walks away from the target company without significant residual risks or warranty liabilities. For the buyer, the benefit is more straightforward. An insurer is a more reliable counterparty than the seller, making it more likely that any claim will actually be paid.
W&I insurance can also protect the shared interest of the parties in situations where they continue to work together after closing. This is the case, for example, when the seller remains in the management of the company after the transaction and the parties want to avoid potential disputes.
Five typical gaps in insurance coverage
The practical challenges of W&I insurance rarely stem from a poorly drafted insurance policy. The more common problem is usually that buyers overestimate the scope of coverage. Below are five typical situations in which insurance coverage does not materialize as expected.
1. The risk was “known” in one way or another
W&I insurance covers only unknown risks. If the buyer knew or should have known about a certain matter before signing, the insurance will not cover the loss arising from it. This also applies to findings identified during due diligence review. In such cases, the parties must agree separately on the allocation of liability.
In practice, the threshold for a risk being deemed known to the buyer is relatively low. The insurer may subsequently take the position that a risk was known, even if the buyer did not consider the matter significant at the time. Buyers should address this risk already at the deal stage. Practical options include recording specific seller undertakings in the sale and purchase agreement and agreeing on how the seller will be responsible for related costs. Alternatively, the buyer may seek a reduction in the purchase price reflecting the identified risk.
2. The risk relates to the future, not a past breach
W&I insurance covers only existing conditions and past breaches related to the seller’s warranties. This limitation is frequently misunderstood. Buyers sometimes assume the insurance will respond where the target company’s business fails to develop as expected, but this is not the case. The insurance is not a guarantee of future business performance, nor does it cover reputational damage or a decline in share value. It provides coverage only in situations where the information provided by the seller regarding the state of the target company was incorrect at the time of signing.
3. Certain risk categories are systematically excluded
W&I insurance policies almost always contain standard exclusions that remove certain categories of risk from coverage, either entirely or in part. These typically include certain tax risks, environmental liabilities, pension liabilities, and various regulatory and compliance risks.
In practice, the parties may record these matters as seller warranties in the sale and purchase agreement, only to find that the W&I insurance does not cover them. The risk is covered on paper but not in practice. This creates a gap that the buyer must bear.
However, there are ways to address this. The parties can agree on separate risk allocation mechanisms, such as purchase price adjustment reflecting a specific risk, or obtain separate insurance for the risk in question.
4. The due diligence was not sufficiently thorough
W&I insurance is not a standalone risk management tool. It is always based on the due diligence review conducted by the buyer. The quality and scope of the due diligence directly affects the coverage the insurer is willing to provide. The more thoroughly the due diligence has been conducted and documented, the wider the coverage the insurer will grant. If the due diligence was rushed, limited in scope, or poorly documented, the insurer may exclude certain risks entirely or significantly narrow the available coverage.
A common practical problem is that the scope of due diligence is often compromised for cost or scheduling reasons precisely in those transactions where W&I insurance is expected to compensate for that shortcut. The logic, however, runs in the opposite direction, because the insurance does not substitute for thorough preparation; rather, it requires it.
5. Proving the loss is not straightforward
Even when W&I insurance is in principle in force, obtaining a payment requires the buyer to demonstrate the loss, its extent, and the causal link to the seller’s breach of warranty. Questions regarding how the loss is defined, how the diminution value is calculated, and how causation is established can lead to significant disputes with the insurer. The outcome may fall well short of expectations, even where the existence of a loss is not in dispute.
How to address coverage gaps?
W&I insurance is an effective risk management tool, but only when its limits are understood. The most common practical problem is not a single exclusion clause but the overall structure. The buyer assumes it has transferred the risk to the insurer, the seller assumes they have been released from liability, and in reality some risks fall between these assumptions, often going unnoticed until a loss has already materialised.
Coverage gaps are not inevitable. They typically arise when insufficient attention is paid to aligning the insurance policy terms, the sale and purchase agreement, and the due diligence findings before the transaction closes. This requires treating the W&I insurance not as a standalone product but as an integral part of the overall deal structure from the moment the decision to obtain coverage is first considered. Early legal advice plays a crucial role here. It ensures that the insurance provides coverage where it is expected to do so and that remaining risks are addressed through other means.
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