Insurance claims and recovery
March 2024 | TALKINGPOINT | RISK MANAGEMENT
Financier Worldwide Magazine
March 2024 Issue
FW discusses insurance claims and recovery with Marc B. Sherman and John P. Galdi at Alvarez & Marsal.
FW: Could you provide an overview of key developments in the representations and warranties (R&W) and warranty and indemnity (W&I) insurance claims and recovery space? What overarching trends would you highlight?
Sherman: Representations and warranties (R&W) and warranty and indemnity (W&I) insurance coverage continues to be a popular risk transfer component of the current M&A marketplace. From a claims timing perspective, claims relating to acquisitions through 2019 are largely completed and settled. A significant number of active claims relate to the high-volume M&A activity of late 2020 through early 2022, and we are beginning to see claims from early 2022 and later, even though M&A volume slowed down after early 2022. Over time, claim statistics have remained relatively consistent. We continue to see a mix of private equity and strategic buyers in the claims and recovery space and other trends from the past continue into the present. Claims filed as a percentage of policies issued still hover on either side of 20 percent, although larger value losses have been paid in more recent years, consistent with larger deals and higher policy limits. Overall, the claims process, intended to be a collaborative process, is working well. Across the market, only 3 percent or so of claims filed have been denied and only about 0.5 percent of claims filed have required arbitration or litigation to reach resolution.
FW: Drilling down, what are some of the common types of claims you are seeing in today’s R&W and W&I insurance market?
Galdi: Financial statements and tax claims continue to be the most frequent type of claim. A greater portion of the common financial statements claims, and most significant losses, relate to revenue recognition. Also, over the past year we have seen a disproportionate uptick in the number of revenue recognition claims in connection with acquisitions of software companies. This is not surprising given the seeming increase in the number of acquisitions of software companies over the past few years, combined with the change in the revenue recognition accounting standard that has an outsized impact on software companies. Other, recent and more common financial statements claims include various problems affecting accounts receivable and accounting for inventory and inventory value, which leads to costs of goods sold issues. We continue to see an outsized percentage of financial statements claims on carve out transactions and would encourage acquirers to pay special attention to the financial and accounting details of carve outs. Lastly, condition of assets and material customers and contracts claims are making a resurgence since late 2022 and early 2023.
“Most, if not all, claims involve technical aspects, often from legal, accounting, valuation and subject matter perspectives.”
FW: What initial steps do insurers take when an insured has lodged a claim for breach and loss under an R&W or W&I insurance policy? Could you describe the process of how such claims are typically quantified and substantiated?
Sherman: Insurers enter a claim with limited knowledge about the business and no knowledge about the problems encountered, other than what the claim notice recites. At the beginning of the claim process, and throughout the process, insurers endeavour to reduce this ‘information deficit’ by obtaining all relevant information and documents supporting the claim as efficiently and expeditiously as possible, through conversations with the insured and information requests. These discussions allow insurers to understand the basis for the claim, how the matter was discovered, and what categories of supporting documentation may exist. Once the insured understands what the insurer requires to support the claim, a cooperative and iterative process follows where the insured provides substantiation of the claim, and they work together to reach resolution. Claims are quantified and substantiated on a case by case basis. While claims may have sets of facts similar to prior claims, each claim requires its own assessment and validation based on the underlying facts, the policy terms, the economics of the acquisition and the relevant representations.
FW: What are the advantages of outsourcing the claim investigation to dedicated insurance claims recovery professionals?
Galdi: It is common for insurers to rely on legal counsel and advisers to assist and advise them on the claim investigation. Dedicated and experienced advisers are knowledgeable and efficient with the claims process and understand what information is needed to validate the claim, resulting in a more efficient process for all parties involved. Most, if not all, claims involve technical aspects, often from legal, accounting, valuation and subject matter perspectives. Especially for larger or more complicated claims analysis and validation, insurers hiring professionals with relevant experience and expertise is beneficial to the insured, the insurer and the process. As an example, with regard to financial statements claims, financial and accounting advisers with R&W or W&I claims experience benefit both the insurer and policyholder by translating accounting records and information, analysing relevant accounting standards, evaluating the impact of the breach, and collaborating with the policyholder’s advisers.
“The formula that drives the most successful claims and recovery processes is based on a high-level of communication and cooperation among the insured, the insurer and their advisers.”
FW: In your experience, what factors are essential to maximise the success of the claims and recovery process?
Sherman: The formula that drives the most successful claims and recovery processes is based on a high-level of communication and cooperation among the insured, the insurer and their advisers. That formula is best accomplished when the insured retains advisers that are of the same mindset. It is helpful for the insurer and the insured to have discussions upfront, as well as throughout the claims process, in order to have reasonable expectations regarding the anticipated scope and timeline of the claims and recovery process. It is in the policyholder’s best interest to ask questions about the process and provide all relevant information to the insurer upfront and throughout the process, regardless of whether it supports or cuts against the claim, to allow the insurer to understand the facts and validate the claim efficiently. Claim handlers have an obligation to obtain complete substantiation to fully validate the occurrence of a breach and the resulting amount of the incurred loss in order to obtain approval to write a big cheque to the policyholder. Insureds’ efforts to guide the investigation typically result in delays and discontent. Experience shows that the process is most successful and efficient when the insurer is able to receive all of the information they believe is needed to substantiate and validate the claim. At times, that may be more information than the insured may expect, but a cooperative working partnership will pay dividends. Also, the process is not meant to be an adversarial or dispute process. Indeed, when the players or their advisers act like it is, the process has the tendency to become extended and often more burdensome to the insured and the insurer, without any meaningfully better results. Recent experience has seen some new advisers that tend to take a more adversarial approach, which has proven to extend the time to resolution by as much as three times, resulting in unnecessary delays and no better results.
FW: Looking ahead, how do you expect the claims handling process to evolve? Are developments in the R&W and W&I insurance industry set to increase policyholder satisfaction?
Galdi: Discussions with policyholders brings greater satisfaction and communication and process efficiency. Both insureds and insurers should strive for both. Looking to the future, even though billions of dollars have been paid out in claims to date, R&W and W&I insurance, and their related claims and claim processes, are relatively young. No doubt as the product matures further, both insurers and insureds will gain experience that will help fine tune efficiency and satisfaction, and the claims handling process will evolve in a positive way.
Marc Sherman is a managing director and partner with Alvarez & Marsal, resident in Washington, DC. He specialises in forensic accounting and corporate restructuring with a focus on representations & warranty and warranty & indemnity insurance, M&A, economic loss and business value and has frequently served as an arbitrator in post-acquisition M&A disputes. He can be contacted on +1 (202) 729 2129 or by email: msherman@alvarezandmarsal.com.
John Galdi is a director at Alvarez & Marsal in Washington, DC. He is a certified public accountant and certified fraud examiner who specialises in helping clients navigate complex accounting, valuation and damages related matters. Mr Galdi has advised clients on hundreds of representations and warranties matters. He can be contacted on +1 (202) 494 6876 or by email: jgaldi@alvarezandmarsal.com.
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