Another financial crisis is inevitable, the only question is what will ignite it...

My candidate for the most unperceived threat is the rapidly escalating use in mergers and acquisitions of insurance that offers both buyers and sellers protection against unexpected or hidden liabilities after deals close. This “reps and warranties insurance” is one of the hottest financial products of the year. It has created a gold mine of premiums for insurers and given deal makers the ability to get deals done more quickly with less to worry about something going awry after closing because that liability rests with the insurance company. Or so the theory goes; getting insurance companies to pay up has always been a challenge.

In an April 29 note to its clients, the international law firm Haynes and Boone reported a drastic increase in the use of the insurance over the last few years, coinciding with the surge in M.&A. activity. It’s the talk of Wall Street. George H. Wang, a lawyer at the firm, wrote that although the insurance has been around since the 1990s, its cost has dropped sharply and its use has increased accordingly. Mr. Wang observed that insurance policies with aggregate limits of $10 billion were issued in 2012, $15 billion in 2013 “and the estimates for 2014, while not yet in, are expected to show another substantial increase."

... He cited several reasons for the increased use of the insurance: the growing number of private company, midmarket deals where protections for buyers are fewer and the unknowns greater; the desire of private equity firms to limit the proceeds held back or put in escrow after the sale of portfolio companies; the search among buyers for a competitive advantage in a contested auction; and an appetite to mitigate risks in cross-border transactions where buyers and sellers may have different customs and interpretations about what constitutes a breach of a representation or warranty.

Excerpted from The New York Times Dealbook blog. To read the full article, click here.