Health care transactions can be complex, given the regulatory maze of health care laws and regulations applicable to the entities involved. One way to help mitigate the risks inherent in such transactions is through representations and warranties insurance (“R&W insurance”), which can be purchased by a buyer or seller. R&W insurance is becoming more common in health care transactions as a means to provide buyer and seller more financial certainty in finalizing a deal.

In mergers and acquisition transactions, buyers and sellers traditionally provide each other with representations and warranties in the acquisition or merger agreement. The transaction agreement usually requires the seller to indemnify the buyer if the seller breaches a representation and warranty. To cover the possibility of a breach of a representation and warranty, a seller may be required to escrow part of the purchase price to cover potential indemnification obligations. R&W insurance coverage can supplement the seller’s indemnification requirement and thereby lessen or potentially even do away with the need for escrows or purchase price holdbacks. This also may make a buyer’s bid more competitive and encourage the seller to make greater representations and warranties than it would otherwise provide without R&W insurance coverage. The R&W insurer may indemnify the seller for its indemnification requirements or pay a buyer directly if there is a post-closing discovery of a breach of the seller’s representations and warranties.

The risks of a specific transaction impact the amount of the R&W insurance premium, which is generally a percentage of the policy or coverage limit. By contrast, the deductible or retention of the R&W insurance is usually based on a percentage of the transaction value. According to industry sources and the Harvard Law School Forum on Corporate Governance and Financial Regulation in the post “Representations and Warranties Insurance in M&A Transactions,” the R&W insurance premium can be about 3 percent of the policy limits, while the retention can be approximately 1 percent of the value of the transaction. It is important to note that not all R&W insurers provide coverage for health care transactions given the additional regulatory risks involved, or they may provide coverage but carve out certain health care regulatory risks. Buyers and sellers in the heavily regulated health care industry also may have to pay more for R&W insurance coverage to reflect this increased risk.

R&W insurance policies typically do not provide coverage where an insured party has actual knowledge of a fraud or breach pertaining to a representation and warranty — whether this knowledge is obtained through due diligence or otherwise. Thus, a party cannot have pre-closing knowledge that a representation and warranty is inaccurate and still expect coverage for that particular breach. Other exclusions from R&W insurance coverage include breach of covenants, purchase price adjustments and pension underfunding liabilities.

In general, R&W insurance can be an attractive option to consider in your next health care deal, as it can be used to reallocate some of the risk of the unknown. In addition to the normal buyer and seller due diligence, the R&W insurance underwriters will typically perform their own due diligence. While not a replacement for due diligence in a health care transaction, R&W insurance can benefit both buyer and seller by transferring some of the potential exposure of a breach of a representation or warranty to the insurer.