Bermuda Captives: Reps and Warranties Coverage

Representations usually refer to the past and present, and warranties to the future.

R&Ws relate to aspects of a seller’s business and/or standing and are included in contracts to provide counterparties with certainty and comfort around the target in an acquisition context.

A simplified example of an R&W is where a seller provides that there will be no material impact to the revenues generated by the target during the period of time leading up to the sale and in the first year of operations following the sale.

R&Ws are heavily negotiated as part of a typical acquisition and are tailored to be deal-specific in many instances.

R&W insurance is transactional protection typically purchased by the buyer in a given transaction, giving rise to a claim where the seller breaches a covered representation and/or warranty.

The coverage is attractive to both parties as the seller can exit the deal without, or with fewer, strings attached.

For example, in transactions without R&W coverage some deals are structured such that a percentage of the purchase price is withheld for a set period of time, for example one year, and until certain R&W periods have come to an end.

This is less attractive to a seller who does not get a clean break and may also have to provide a seller indemnity.

Alternatively, where R&W coverage is in place, the seller walks away with full payment at the time of closing and the buyer has recourse to the R&W insurer for compensation where the target breaches a R&W, which limits its exposure to any breach.

R&W coverage can be obtained on the open market, typically using a broker to source quotes and relay relevant information to and from the insured – and in relation to the target – before pricing can be considered.

As the buyer, and/or buyer’s counsel, is carrying out due diligence on the target, the prospective insurer, via the broker, will be doing a similar exercise – evaluating the risks associated with the transaction, seeking to mitigate those risks using R&Ws, and ultimately agreeing to insure against breach of those R&Ws.

For companies or groups who are particularly acquisitive, the process of going to market to obtain coverage in each instance may become overly time consuming and/or costly.

In some instances, using a captive insurer to cover some or all of the R&W risks makes a compelling economic case.

This is especially true where claims are historically low, and processes for assessing targets are well-honed.

Bermuda captives are well-suited to such risks. The island’s insurance regulator, the Bermuda Monetary Authority, has tended to a highly-regarded and world leading captive market for many decades.

As such, the BMA is well-placed to expediently consider and approve of R&W business, written through an existing Bermuda captive or through a new Bermuda captive.

In the former example, an existing captive can expand the footprint of its business plan to include R&W risks by submitting an application to the BMA’s Assessment and Licensing Committee for approval.

In the latter scenario, where a company or group is seeking to form a new captive, incorporation of a new Bermuda company can run concurrently with the preparation of BMA application materials for efficiency.

As with the existing captives, application for a new captive license goes to the BMA’s ALC and a response is usually received in the same week as the submission of the application.

Utilising a Bermuda captive for R&W risks has a number of advantages.

For example, transactional efficiency – a reduction in the time to closing given the target familiarity.

Other advantages include a reduction of intermediary fees, lower volatility in pricing, ready-to-deploy capacity, generation of premium as a source of revenue over time, and diversity in risk management tools.

Of course, there are costs associated with the set-up and ongoing operation of a captive, however in several recent examples, the benefits significantly outweighed these costs.

Additionally, Bermuda captives can be used to cover other lines of business such as worker compensation, employee benefits, or other risks that a company or group may face.

In addition to those regulatory benefits, Bermuda offers a number of other attractive features.

Bermuda is proximate to major insurance markets in the gateway cities of New York and London, and it is, in itself, a leading reinsurance domicile affording proximate access to a well-established reinsurance market.

The island also has a wide array of experienced and well-equipped service providers who can help to bring a captive online in a cost-efficient and expedient manner.

We hear of cyber and ESG-related risks as being emerging in the captive context, but the island may well see R&Ws coverage as another growing risk category for Bermuda captives going forward.

First Published in The Royal Gazette, Legally Speaking column, September 2023