Quick answer: Representations and warranties insurance is a policy the buyer purchases to cover losses from breaches of the seller’s statements about the business that surface after closing. The insurer pays the buyer above a retention, up to a limit, and excludes problems the buyer already knew about and areas its diligence did not cover. Because the insurer pays most covered losses, the seller’s indemnity escrow can shrink, but fraud and excluded matters generally stay with the seller.
Key points
- The buyer buys the policy and is the insured. The insurer pays covered loss above a retention and up to a limit, so the buyer’s main recourse shifts from the seller to the insurer.
- Coverage follows the buyer’s diligence. Insurers read the buyer’s financial, legal and other reports, and an area with no report behind it is narrowed or excluded.
- Known problems are excluded. A matter the buyer’s team knew about before signing is outside the policy, and the buyer usually asks the seller for a specific indemnity instead.
- A policy shrinks the seller’s exposure but does not end it. Fraud, excluded matters, price adjustments and any seller-funded share of the retention generally remain.
What a buy-side policy is and who it protects
A representations and warranties policy, called R&W insurance or RWI, is an insurance contract the buyer purchases when it signs the purchase agreement. The buyer is the insured. If a representation the seller made proves untrue and the buyer suffers a loss, the insurer reimburses covered loss above a retention, which is the first slice of loss the insured bears, up to a limit. This guide covers the buyer’s policy.
A seller gives the same statements with or without a policy. What changes is who stands behind them. In a traditional deal the buyer recovers from the seller’s indemnity, usually backed by an escrow, as the guide to representations, warranties, indemnification and escrows explains. With a policy the insurer becomes the main source of recovery for ordinary breaches, and the negotiation shifts to what the insurer will cover and what is left for the seller. The disclosure schedule matters as much as before, because an item disclosed against a statement is not a breach and an item the buyer already knew about is not insured.
From first quote to a bound policy
A policy is underwritten in a fixed sequence that runs beside diligence and the drafting of the purchase agreement.
- Decide to use a policy. A bidder proposes one in its offer, or the seller’s advisor asks bidders whether they would use one. The agreement is then drafted around a smaller seller indemnity.
- Collect quotes. The buyer’s insurance broker sends a deal summary and the draft agreement to several insurers, each of which returns a non-binding quote with a retention, limit, premium and expected exclusions.
- Underwrite. The chosen insurer reads the draft agreement, the data room and the buyer’s diligence reports, then questions the buyer’s team and advisors on the work behind each representation.
- Negotiate the policy. The insurer issues a draft with its exclusions, the buyer negotiates the wording, and the seller’s counsel checks that the policy and the agreement treat knowledge and fraud alike.
- Bind at signing. The policy takes effect when the agreement is signed, and the buyer states in writing that its deal team knows of no breach.
- Confirm at closing. The buyer repeats that statement, and a breach it learns of between signing and closing is generally excluded.
- Claim after closing. The buyer gives notice, the insurer investigates and pays covered loss above the retention, and the seller is usually asked to cooperate with records.
Underwriting usually begins once the letter of intent is signed, so a policy adds a work stream to weeks in which the seller is already answering diligence requests. The guide to how long a sale takes covers that stretch.
What underwriters read and what they exclude
An insurer prices a policy from the buyer’s diligence. It does not repeat the work but checks that it was done and reads the result, and an area with no report behind it is usually narrowed or excluded. The financial row rests on the buyer’s quality of earnings report.
| Seller statements | What the insurer expects to read | If the work is missing |
|---|---|---|
| Financial statements and undisclosed liabilities | A buy-side quality of earnings report with a working capital analysis | Cover narrowed or excluded for the financial statements |
| Taxes | A report from the buyer’s tax advisor | Cover limited to the items reviewed |
| Contracts, intellectual property, litigation and permits | Buyer counsel’s legal diligence report | Exclusion for the topics not reviewed |
| Employees and benefits | Findings on worker classification, pay practices and plans | Exclusion or narrow cover |
| Owned or leased real estate and environmental condition | Title and survey work and, where relevant, a site assessment | Environmental cover often excluded |
The standard exclusions complete the picture.
- Known matters. Anything the buyer’s deal team knew before signing or learns before closing.
- Price mechanics. Purchase price and working capital adjustments, which have their own settlement process.
- Projections. Forward-looking statements, including forecasts in the information memorandum.
- Covenants. Promises about conduct, as distinct from statements of fact.
- Higher-risk topics. Subjects the insurer treats as risky for the industry or the company.
Every exclusion is a place where the buyer, who still wants protection, turns back to the seller. The legal diligence overview shows what buyer counsel’s report examines, and environmental diligence and Phase I assessments covers the site work for real estate.
How the policy changes the seller’s exposure
A policy changes who recovers first, how large the seller’s escrow is and what the seller can still be asked to pay. The example follows one loss through a traditional deal and two ways of structuring a policy.
Illustrative example: The same loss under three structures
A buyer pays $24,000,000 for a company and soon finds unrecorded customer rebates and a missed contract term that together cause a loss of $1,500,000. Neither was known at signing. A separate customer dispute of $400,000 was disclosed in diligence, so a policy excludes it and the buyer takes a specific indemnity from the seller in every structure. In the escrow-only deal the seller’s liability for general breaches is capped at a $1,200,000 escrow. In the second structure a policy has a $240,000 retention split equally, with the seller’s half in escrow. In the third the buyer bears the whole retention. The policy limit exceeds the loss.
| Item | Escrow only | Policy, shared retention | Policy, buyer retention |
|---|---|---|---|
| Indemnity escrow funded from the price | $1,200,000 | $120,000 | $0 |
| Specific escrow for the disclosed dispute | $400,000 | $400,000 | $400,000 |
| Held back from the seller at closing | $1,600,000 | $520,000 | $400,000 |
| Loss of $1,500,000 paid by the seller | $1,200,000 | $120,000 | $0 |
| Loss of $1,500,000 absorbed by the buyer | $300,000 | $120,000 | $240,000 |
| Loss of $1,500,000 paid by the insurer | $0 | $1,260,000 | $1,260,000 |
| Dispute loss of $400,000 paid by the seller | $400,000 | $400,000 | $400,000 |
| Total paid by the seller on both items | $1,600,000 | $520,000 | $400,000 |
The policy moves most of the larger loss to the insurer, but the disclosed dispute still comes out of the seller’s proceeds, because an insurer excludes what the buyer already knew. The amounts are invented to show the mechanics and are not benchmarks, and premiums and fees are left out.
Two drafting points keep the policy from working against the seller. A draft that adds a policy but keeps the traditional seller indemnity gives the buyer both, so the agreement should make the policy the buyer’s only recourse for ordinary breaches, apart from fraud and named items. And an insurer that pays a claim ordinarily may pursue whoever caused the loss, so the seller’s counsel should confirm that the policy waives that right against the seller except for fraud, and that fraud is defined narrowly, as a deliberate false statement.
Advantages and drawbacks for each side
| Advantages | Drawbacks | |
|---|---|---|
| Seller | More of the price is paid at closing instead of held back. Claims afterward are fewer and smaller, which suits an owner who wants a clean exit or has co-owners to pay. | Extra work and questions before signing. Known problems return as specific indemnities. The seller may share the cost or part of the retention. Thin buyer diligence widens the exclusions. |
| Buyer | A second source of recovery with its own credit, useful when the seller will distribute the proceeds or stays on as a partner. | Cost, a retention and a limit. Exclusions leave gaps. Claims go through an insurer’s investigation. Diligence must satisfy underwriters. |
When a policy tends to appear
Policies tend to appear where the buyer wants recourse beyond the seller and the seller wants a clean exit: an advisor-run process with several bidders, a financial buyer with investors and lenders to answer to, a seller group with many owners, or a deal in which the owner stays on or rolls equity, because a buyer would rather not sue a partner. In many smaller transactions the cost of a policy and underwriting does not fit, and the buyer relies on an escrow or holdback instead.
A seller can raise the question in the bid instructions by asking each bidder whether it intends to use a policy and what indemnity it would then expect. The answers belong in the comparison of first-round offers, because bids at the same price can leave very different amounts held back.
Points to settle before the agreement is drafted
These questions are for the seller’s attorney, ideally before the first draft.
- Does the agreement make the policy the buyer’s only recourse for ordinary breaches, apart from fraud and named items?
- What share of the retention does the seller fund, how is it held and when is it released?
- Does the policy waive recovery against the seller except for fraud, and how is fraud defined?
- Who pays the premium and fees, and is any seller share capped?
- Which matters has the insurer excluded, and does the buyer expect a specific indemnity for each?
- If the policy is not issued before closing, does the seller’s indemnity revert to a traditional structure?
The terms sit inside the contract described in the guide to purchase agreement key terms, and the guide to how to sell a business shows where insurance falls among the other stages. This guide is general education and not legal or insurance advice.
Frequently asked questions
What does R&W insurance cover in an acquisition?
It covers the buyer’s loss when a seller’s representation in the purchase agreement proves untrue and the buyer did not know it at signing, such as an unrecorded liability or an undisclosed contract term. The policy pays above a retention, up to a limit. It does not cover known issues, purchase price adjustments or areas the insurer excluded.
Who pays for the policy?
The buyer buys the policy, but who bears its cost is negotiated. Some agreements leave it with the buyer, some split it and some reflect it in the price. A seller should ask what is offered in exchange, such as a smaller escrow, and check how any seller share of the cost is defined and capped.
Does R&W insurance mean the seller has no liability after closing?
No. The policy reduces the seller’s exposure for ordinary breaches, and many agreements then limit the seller to a small escrow or none. Fraud, excluded matters that the buyer asks the seller to indemnify, breaches of the seller’s own covenants and the price adjustment mechanism generally stay with the seller.
Will the policy cover a problem found during diligence?
No. Insurers exclude matters the buyer’s deal team knew about before signing, and the buyer typically confirms in writing at closing that it knows of no breach. A problem found in diligence is handled in the deal itself, through price, a specific indemnity from the seller, an escrow or a fix before closing.
Thinking about a sale or an acquisition?
The Impetus Group provides sell-side and buy-side M&A advisory, from preparation and buyer outreach to negotiation and closing. A transactional valuation is often the first step, scoped and priced separately.
Related guides
- Reps and Warranties, Indemnification and Escrows in a Business Sale: A Seller’s Glossary: How reps and warranties, indemnification, baskets, caps, survival periods and escrows work in a business sale, and how a claim moves from notice to payment.
- The Purchase Agreement: Key Terms Sellers Should Understand Before Signing: The purchase agreement is the binding contract in a business sale. See its key terms, from price adjustments to indemnification, and the questions to ask counsel.
- Quality of Earnings Report: What It Is and What Buyers Test: A quality of earnings report tests whether a company’s reported profit is real and repeatable. See what buyers examine, how it affects price and how sellers prepare.
- Legal Due Diligence Checklist for a Business Sale: Contracts, IP, Litigation and Records: What buyer counsel reviews in a sale: ownership records, change-of-control clauses, IP assignments, permits, litigation and insurance, plus a seller clean-up list.
- How Long Does It Take to Sell a Business? Phase by Phase: How long a business sale takes depends on its slowest phase. See what controls each stage, where delays occur and what shortens the path.
- Buyer Outreach in a Sale Process: Reaching Buyers Without Breaking Confidentiality: How a confidential sale reaches buyers: blind teasers, NDAs, call sequencing, contact logs, broad versus targeted outreach and what to do if word leaks.
This guide is general education. It is not a valuation opinion, appraisal, investment advice, or legal or tax advice. How these guides are made.