Rep and Warranty Insurance - A Seller's Guide to Risk Transfer

You’ve built a company worth $15 million, negotiated a purchase price based on competitive market multiples, and the buyer’s due diligence is nearly complete. Then the deal team drops a bombshell: the buyer wants to hold back 15% of the purchase price in escrow for two years to cover potential breaches of your representations and warranties. Suddenly, $2.25 million of your proceeds sits in limbo, exposed to claims you may never see coming. There’s a better way—and for transactions above certain thresholds, it’s becoming a common option for protecting exit proceeds.

Executive Summary

Rep and warranty insurance (RWI) has evolved from a niche product used primarily in billion-dollar transactions to a risk management tool accessible for middle-market deals, particularly those with purchase prices above $10 million. For sellers of businesses considering an exit, understanding RWI mechanics can help you evaluate whether this tool belongs in your transaction structure.

This guide examines how rep and warranty insurance works, when it makes strategic sense for sellers, and how to evaluate the economics of coverage for your specific situation. We examine premium costs, the claims process, implementation requirements, and the negotiating dynamics that RWI introduces between buyers and sellers.

The core value proposition is straightforward: RWI allows sellers to transfer the financial risk of certain representation and warranty breaches to an insurance carrier, potentially reducing escrow holdbacks, shortening indemnification periods, and providing deal certainty that benefits both parties. But this transfer applies only to covered breaches within policy limits, subject to exclusions and the retention amount. RWI isn’t appropriate for every transaction. The economics become compelling only when escrow holdbacks are substantial enough to justify premium costs, and coverage value depends heavily on what exclusions carriers require.

By the end of this article, you’ll have a framework for evaluating RWI in your own transaction, questions to ask your deal team, and realistic expectations about costs, coverage limitations, and the claims process.

Introduction

The representations and warranties section of any acquisition agreement represents one of the most consequential—and often least understood—elements of the deal. When you sell your business, you make dozens of formal statements about everything from financial accuracy and tax compliance to environmental matters and intellectual property ownership. These representations survive closing, meaning buyers can pursue claims against you for months or years if they discover breaches.

Traditionally, sellers protected themselves through negotiation: fighting for lower escrows, shorter survival periods, and higher claim thresholds. Buyers pushed back, demanding protection commensurate with their risk. This adversarial dynamic often consumed weeks of negotiation time and created deal friction that occasionally killed transactions.

Rep and warranty insurance changes this dynamic. Instead of sellers providing the financial backstop for their representations, an insurance policy assumes that role. The buyer files claims against the policy rather than against the seller directly, and the insurance carrier pays covered losses up to the policy limits.

The RWI market has expanded over the past decade. Premium costs have generally declined from earlier periods, policy terms have become more standardized, and carriers have developed expertise in middle-market transactions. According to major RWI brokers including Aon and Marsh, transactions with purchase prices as low as $10 million can access RWI coverage, though the economics become more compelling as deal size grows. For transactions below $10 million, premium costs often consume most or all of the escrow reduction benefit.

For sellers preparing an exit in the next two to seven years, understanding RWI before entering negotiations provides strategic optionality that can improve your outcome, provided the economics work for your specific transaction size and structure.

How Rep and Warranty Insurance Works

The Basic Mechanics of RWI Coverage

Rep and warranty insurance is a specialized M&A insurance product that provides coverage for financial losses arising from breaches of representations and warranties in acquisition agreements. When a buyer discovers that a seller’s representation was inaccurate—for example, that undisclosed litigation existed or that financial statements contained material errors—the buyer can file a claim against the RWI policy rather than pursuing the seller directly.

Policies are typically written on a “buyer-side” basis, meaning the buyer is the named insured and the beneficiary of coverage. This structure has become dominant because it provides buyers with a creditworthy counterparty (the insurance carrier) for claims, generally eliminates the need to pursue former owners who may be difficult to locate or lack resources, and can simplify the claims process.

For purposes of this discussion, enterprise value refers to the purchase price paid at closing. RWI coverage typically ranges from 10% to 30% of this purchase price, though policies can be structured for higher limits when warranted. Policy terms generally mirror the survival periods in the acquisition agreement, commonly 12 to 36 months for general representations and longer periods for fundamental representations like tax and title.

Understanding the Retention Structure

Every RWI policy includes a retention, essentially a deductible, that represents losses the buyer must absorb before insurance coverage begins. Market retentions typically range from 0.5% to 1% of enterprise value, though they can vary based on transaction characteristics, industry risk profile, and underwriting factors.

The retention structure creates an important negotiating point: who bears the retention amount? In many transactions, sellers remain responsible for losses within the retention through a small escrow or indemnity obligation. This structure gives buyers confidence that sellers have “skin in the game” regarding their representations while still limiting seller exposure compared to traditional escrow arrangements.

Some sellers negotiate for modified retention structures. Options may include having the retention reduce to a lower amount after a specified period, sharing the retention with the buyer, or eliminating seller responsibility for the retention entirely in exchange for other deal terms. But the availability of these structures depends on carrier appetite and transaction specifics. Discuss with your RWI broker early whether carriers are currently offering these features in your industry segment before building them into your expected deal structure.

Premium Costs and Economic Considerations

Based on market reports from major RWI brokers such as Aon, Marsh, and Lockton, premiums typically fall in the range of 2% to 4% of coverage limits, though individual quotes depend heavily on transaction characteristics including industry, deal complexity, and carrier competition. For a $15 million transaction with $3 million in coverage, this suggests premiums in the $60,000 to $120,000 range, plus underwriting fees and broker costs that can add another $25,000 to $50,000.

Total RWI costs typically include:

• Broker fees and underwriting fees: $25,000 to $50,000
• Insurance premiums: $60,000 to $120,000 for mid-sized transactions
• M&A attorney time for policy negotiation and integration: $15,000 to $30,000
• Management time for underwriting process: Estimated $10,000 to $20,000 in salary equivalent

Full costs may reach $150,000 to $250,000 depending on transaction complexity.

The critical question becomes: who pays? While buyers are the named insureds, sellers often pay the premium as part of the transaction economics. From the seller’s perspective, this makes sense when the premium cost is materially less than the value of escrow reduction and liability limitation. But the calculation requires careful analysis of your specific situation.

Evaluating the RWI Economic Trade-Off

Understanding When RWI Creates Value

RWI economics typically favor transactions with purchase prices above $10 million. Below that threshold, premium costs often approach or exceed the value of escrow reduction. For transactions in the $5 million to $10 million range, carefully model whether RWI premiums are justified by your escrow reduction—the math often doesn’t work.

To evaluate whether RWI makes sense for your transaction, work through the following framework with your advisors:

Step 1: Calculate Escrow Access Benefit Escrow benefit = (Escrow reduction amount × holding period in years × assumed return rate on cash)

Example: $1.5 million escrow reduction × 2 years × 5% return = $150,000 benefit from earlier access to funds

Step 2: Calculate Total RWI Costs Include premiums, underwriting fees, broker costs, and attorney time for policy integration.

Example: $100,000 premium + $40,000 fees = $140,000 total cost

Step 3: Consider Claim Probability Claims experience varies by transaction type and industry. Your broker should provide information about claim frequency in your industry segment. According to broker claims studies from firms like AIG and Euclid Transactional, approximately 15% to 25% of RWI policies experience some form of claim notification, though actual paid claims are lower. Don’t assume claims never happen.

Step 4: Net Assessment Compare total costs against the escrow access benefit, factoring in the value of liability limitation beyond escrow reduction.

Consider the following comparison for a $12 million transaction, with important caveats about assumptions:

Important assumptions in this example:

• Retention negotiated to 1% (low end of market range)
• Buyer agrees to reduce escrow from 15% to 1% (requires successful negotiation—not guaranteed)
• Escrow period reduction from 24 to 12 months (varies by buyer)
• Premium and fees at mid-range estimates
• Does not factor in probability-weighted claim costs
• Does not account for seller tax position on escrow timing

Actual economics will vary significantly based on your transaction specifics, buyer preferences, carrier underwriting, and claim probability in your industry.

Critical caveat: Escrow reduction requires buyer agreement and negotiation. Purchasing RWI does not automatically entitle you to lower escrow. Some buyers will insist on traditional escrow amounts regardless of RWI coverage, particularly if they’re unfamiliar with the product or prefer conventional deal structures.

Liability Limitation Beyond Escrow

Beyond potential escrow reduction, RWI can limit seller liability to defined amounts. In a traditional transaction, sellers may face indemnification obligations equal to a significant portion of the purchase price—sometimes up to the full amount for fundamental representations. A single material breach could claw back years of entrepreneurial value creation.

With properly structured RWI, seller liability typically caps at the retention amount plus any uncovered matters. For a $15 million transaction, this might mean exposure of $75,000 to $150,000 rather than $1.5 million or more—but sellers retain exposure for losses within the retention and any excluded or uncovered breaches.

This protection becomes particularly valuable when sellers must make representations about matters outside their direct control or knowledge. Environmental conditions, intellectual property clearance, and employee benefit plan compliance are areas where unknown issues can surface despite good-faith representations.

But RWI limits but doesn’t eliminate seller liability. Sellers remain exposed to claims within the retention, claims falling under policy exclusions, claims that exceed policy limits, and representation breaches discovered after the policy expires. Budget for potential exposure at least equal to the retention amount.

When RWI Makes Strategic Sense

Transaction Characteristics Favoring RWI

Rep and warranty insurance delivers value in specific transaction contexts. Understanding these circumstances helps sellers evaluate whether to pursue RWI early in the deal process.

Multiple Sellers or Complex Ownership Structures: When several shareholders are selling, RWI can simplify the post-close dynamic. Without insurance, buyers must pursue individual sellers for breaches, potentially creating contribution disputes among former owners. RWI can eliminate this complexity and allow sellers to exit without ongoing obligations to each other.

Sellers Seeking Limited Liability Exit: Owners who want to retire, pursue new ventures, or limit ongoing deal-related exposure benefit from the liability ceiling RWI provides. The alternative, remaining potentially liable for years after closing, creates ongoing uncertainty that many sellers find burdensome.

Competitive Auction Processes: In situations with multiple bidders, offering RWI as part of the deal structure can differentiate your transaction. Buyers value the protection RWI provides and may view it favorably in competitive situations—though this still requires buyer willingness to adjust escrow terms accordingly.

Private Equity Buyers: Financial sponsors are often sophisticated RWI users who understand the product’s value. When selling to private equity, RWI may be a familiar element of deal structure rather than a novel concept requiring education.

When RWI May Not Work

RWI creates complications in certain situations:

Smaller Transactions: For purchase prices below $10 million, premium costs often consume most of the escrow benefit. A $6 million transaction might see only $300,000 in escrow reduction but face $80,000 or more in RWI costs.

High-Risk Industries: Environmental, heavily regulated, or litigation-prone industries may face extensive exclusions that reduce coverage value. If carriers exclude your primary risk areas, you’re paying for coverage that doesn’t address your actual exposure.

Strategic Buyers with Integration Focus: Some strategic buyers focus on operational integration risk rather than financial statement accuracy. RWI may not address their primary concerns, making them less willing to reduce escrow in exchange for insurance.

Underwriting Timeline Pressure: If your transaction is on an accelerated timeline, RWI underwriting can create delays. Carriers typically need 4 to 8 weeks for full underwriting, and complex transactions may require longer.

Buyer Sophistication or Resistance: Some experienced buyers with their own insurance programs may resist seller-proposed RWI if they prefer their existing deal structures. Others simply prefer traditional escrow arrangements regardless of RWI availability.

Comparing Alternatives to RWI

Before pursuing RWI, consider whether simpler alternatives might achieve similar results:

Traditional Negotiation: Push for lower escrow percentage (10% instead of 15%), shorter escrow period (12 months instead of 24), higher claim thresholds, or caps on post-close indemnification. Many sellers successfully reduce escrow through negotiation without insurance costs.

Seller’s Note Structure: Some transactions replace part of the escrow with a seller’s note payable over time. This keeps capital in the deal while providing the buyer some credit protection. The seller accepts credit risk on the note rather than the buyer holding escrow.

Hybrid Approaches: Combine reduced escrow (perhaps 8%) with RWI covering the difference. This moderates premium costs while still providing protection.

Partial RWI: Cover only highest-risk representations (tax, title, fundamental matters) rather than full coverage. This reduces premiums while addressing the areas of greatest concern.

Each approach has different economics. Work with your M&A advisor to model which creates the most value in your specific transaction before assuming RWI is the optimal solution.

Implementing RWI in Your Transaction

The Underwriting Process and Timeline

Successfully incorporating RWI requires planning and coordination with your deal team. Based on broker experience, underwriting typically takes 4 to 6 weeks from initiation to policy binding for routine transactions, though complex deals may require 8 to 12 weeks. Factors affecting timeline include carrier workload, transaction complexity, industry risk profile, and speed of seller response to underwriting requests.

Plan for the longer timeline to avoid closing pressure. Many transactions experience extensions due to carrier questions, issue discovery, or workload delays. If underwriting isn’t complete by your target closing date, you’ll face pressure to accept suboptimal coverage terms or delay closing.

The process begins with engaging an RWI broker who understands middle-market transactions. The broker markets your deal to carriers, obtains competing quotes, and helps negotiate policy terms. Expect to provide carriers with access to the data room, draft acquisition agreements, and deal team calls to discuss transaction specifics.

Carriers conduct their own underwriting review, focusing on areas of elevated risk based on industry, transaction characteristics, and the representations being covered. They’ll identify exclusions—matters that won’t be covered—and negotiate coverage terms with your broker.

Plan to engage an RWI broker early, ideally during LOI negotiations or within a week of LOI signing. If you haven’t engaged a broker by week two after LOI, your underwriting timeline will be compressed, potentially forcing suboptimal coverage terms or closing delays.

Negotiating Policy Terms and Exclusions

Not all RWI policies are created equal. Sophisticated sellers work with experienced brokers to negotiate coverage terms that maximize protection.

Key negotiating points include:

Exclusion Scope: Carriers will exclude known issues identified during due diligence. The negotiation centers on how narrowly these exclusions are drafted. Work carefully with your attorney to understand what’s NOT covered, not just what is covered. Carriers may interpret exclusions broadly, so don’t assume “related unknown matters” are covered without explicit carrier clarification.

Knowledge Scrape: Policies exclude breaches known to the deal team at signing. The definition of “knowledge” and the universe of people whose knowledge counts matters significantly. Limiting the knowledge group to senior deal team members protects against broad constructive knowledge arguments.

Coverage Extensions: Some policies can extend to cover pre-closing tax matters, specific indemnity obligations, or purchase price adjustment disputes. These extensions add value but require specific negotiation and typically add premium cost.

Coordination Requirements

RWI implementation creates a distinct workstream requiring management attention. You’ll coordinate with:

• RWI broker (market coverage and negotiate terms)
• M&A counsel (integrate policy with acquisition agreement)
• Potentially RWI-specialist counsel (policy-specific language review)
• Accountant (support underwriting questions about financials)
• Multiple carriers (evaluate competing quotes)

Expect 10 to 20 hours of management time and $40,000 to $80,000 in professional fees for this workstream, in addition to premium costs. Factor this into your deal timeline and budget when deciding whether RWI is worth pursuing.

Industry Considerations

RWI value varies significantly by industry. Industries with predictable financial records and fewer environmental or compliance risks—such as software, professional services, and recurring revenue businesses—typically benefit most from RWI because coverage exclusions are narrower.

Industries with significant environmental exposure, heavy regulatory requirements, or complex intellectual property situations should carefully evaluate whether RWI exclusions make the coverage less valuable than traditional escrow and indemnification negotiation.

For example, a manufacturing business with environmental remediation history may find that carriers exclude environmental matters entirely, leaving the seller exposed for the area of greatest risk while still paying substantial premiums. Similarly, healthcare businesses with complex regulatory compliance may face exclusions around billing practices or licensure issues that represent their primary liability concerns.

Conversely, SaaS companies with clean financial histories, straightforward IP ownership, and minimal regulatory exposure often find RWI coverage broad with narrow exclusions, making the economics particularly attractive.

Work with your broker to understand what’s actually covered in your industry segment before committing to the RWI process. Request sample exclusion language from recent transactions in your industry to calibrate expectations.

Prerequisites for Pursuing RWI

Before investing time and resources in RWI, confirm you meet these prerequisites:

Active Transaction: You must have a committed buyer in active negotiations. RWI is not a pre-LOI planning tool—it requires buyer participation and negotiation.

Buyer Willingness: The buyer must be willing to negotiate escrow reduction in exchange for RWI. Some buyers prefer traditional escrow structures regardless of insurance availability. Gauge buyer receptivity early, before incurring broker and underwriting costs.

Premium Budget: You must be willing to pay premiums (or successfully negotiate for buyer to pay). Total costs of $100,000 to $200,000 are typical for mid-sized transactions.

Adequate Transaction Size: Your transaction complexity must justify underwriting costs. For purchase prices below $10 million, RWI rarely makes economic sense.

Timeline Flexibility: You need 4 to 8 weeks of timeline flexibility for underwriting, or risk closing delays.

Actionable Takeaways

Right-Size Your Expectations: RWI typically makes economic sense for transactions with purchase prices above $10 million. For smaller transactions, premium costs often exceed escrow reduction benefits. Model your specific economics before pursuing RWI.

Confirm Buyer Willingness Early: Escrow reduction requires buyer agreement—it’s not automatic with RWI purchase. Before investing in the RWI process, confirm your buyer will actually reduce escrow in exchange for insurance coverage. If they won’t, RWI may not deliver value.

Start Early: If you determine RWI may benefit your transaction, initiate discussions when you engage transaction advisors. Early planning provides maximum optionality and prevents timeline pressure from compromising coverage terms.

Quantify the Full Trade-Off: Work with your advisors to model the complete economics—not just escrow reduction versus premium, but including all costs, time value of money, claim probability, and the value of liability limitation. Multiple scenarios showing different outcomes help you understand the range of possible results.

Engage Specialized Brokers: RWI is a specialized product requiring specialized expertise. Work with brokers who focus on M&A insurance and have carrier relationships for middle-market transactions. Major firms with dedicated RWI practices include Aon, Marsh, and Lockton.

Understand Exclusions Thoroughly: The value of RWI depends entirely on what it covers. Work with your broker and attorney to understand exclusions, negotiate narrower drafting where possible, and ensure coverage aligns with your actual risks. Request carrier clarification on specific exclusions before binding.

Consider Alternatives First: Before committing to RWI costs, evaluate whether traditional negotiation, seller’s note structures, or hybrid approaches might achieve similar outcomes at lower cost.

Conclusion

Rep and warranty insurance has expanded from a specialized tool for large transactions into an option for middle-market sellers, particularly those with purchase prices above $10 million. For qualifying transactions, RWI offers a mechanism to potentially reduce escrows, limit defined post-close liability, and transfer certain risks to an insurance carrier.

The decision to pursue RWI requires careful analysis of transaction size, industry characteristics, buyer dynamics, and economic trade-offs. Not every deal warrants the cost and complexity of insurance coverage, and simpler alternatives may achieve similar results. But sellers who understand the product and evaluate it thoughtfully gain negotiating optionality that can improve their outcomes when the economics work.

RWI is becoming common in PE-sponsored and larger middle-market deals, but it’s not standard or necessary in all transactions. Evaluate whether RWI benefits your specific deal rather than assuming it’s required, and remember that escrow reduction requires buyer agreement, not just policy purchase. The difference between leaving money in escrow for two years and achieving a limited-liability exit often comes down to knowing your options, understanding the economics, and working with experienced advisors who can help you choose the right structure for your situation.