Costs for D&O insurance for SPAC IPOs rose dramatically between 2020 and the end of 2021.
In 2022, we are unlikely to see significant decreases in pricing due to the quickly developing SPAC litigation environment. This litigation, as well as the SEC’s active interest in the SPAC sector, also means that coverage terms are unlikely to improve.
This is not to say that it is impossible to save money on D&O insurance, however. The keys to obtaining more affordable D&O insurance that includes meaningful coverage are entering the market with correct information, guidance from experienced SPAC insurance broker, and advanced planning.
Our 2022 Guide to D&O Insurance for SPAC IPOs can help.
Why Have Rates Skyrocketed?
The basic law of supply and demand has played a big part in the skyrocketing of premiums. And—as always when it comes to supply and demand—the potential entrance in the D&O insurance marketplace of more carriers willing to write D&O insurance for SPAC IPOs is the key to bringing down prices.
In 2021, however, the surge of SPAC IPOs and SPAC business combinations (aka “de-SPACs”) in the face of a D&O insurance market that was not seeing a similarly large influx of new carriers means, inevitably, that the price of this insurance did not decrease.
In addition to limited supply in the face of overwhelming demand, carries are now dealing with significant SPAC-related litigation. For example, according to the data collected by Woodruff Sawyer, securities class actions filed in connection with SPAC-related transactions in 2021 jumped by 520% compared to 2020. Many of these cases have not yet been resolved. Carriers are concerned about the potential severity of current litigation and the volumes of litigation that is yet to come in 2022 and 2023.
Number of SPAC and de-SPAC related Securities Class Actions, Source: Woodruff Sawyer
Some SPACs have also paid hefty regulatory fines in 2021. Furthermore, the US Securities and Exchange Commission (“SEC) has been extremely vocal throughout 2021, issuing statements and speaking out against insufficient disclosure and questionable marketing and diligence efforts adopted by some SPACs. Additional regulations aimed at SPACs are very likely in 2022, and rule amendments related to SPACs are on the SEC’s agenda for April of 2022.
In the face of what could be heavy future losses from litigation and enforcement actions, insurance carriers pricing their new D&O insurance policies are charging higher premiums for SPAC-related policies versus policies for established public companies or companies going public through a traditional IPO. All of this, coupled with the general distressed state of the D&O insurance market over the last few years, makes it difficult for SPAC teams to procure desired levels of coverage at budget-friendly prices.
How Much D&O Insurance Are SPACs Buying?
Most SPACs team now purchase, and in 2022 will likely continue to purchase, lower policy limits than they did at the beginning of 2020. However, it is still unusual for independent directors to agree to serve on the board of a SPAC without any D&O insurance at all. The issue for the directors is that they are agreeing to be responsible for the oversight of a public company in which its major financial assets—the money raised in the SPAC IPO—sits in a trust that typically cannot be used to indemnify them, should litigation arise.
To be sure, the SPAC will have some working capital, but it is usually a relatively low amount. Once it is gone, if there is any litigation or an SEC inquiry, either D&O insurance responds or directors are paying their legal fees out of their own pockets.
Most D&O insurance carriers have seen financial bubbles in the past and have learned from these experiences. As a result, insurers want to be compensated today for taking the risk that their capital will be called on to pay for litigation in the future should the market take a turn for the worse.
What Makes SPACs More or Less Attractive to D&O Insurance Underwriters?
As discussed at length by Yelena Dunaevsky and Andrew Silva in their articles about D&O insurance underwriting factors and how carriers view recent SPAC market shifts, there are certain characteristics that make a SPAC more or less attractive to insurance carriers.
If you are in a position to make a choice when it comes to structuring your SPAC, consider making choices that help keep you in the “favorable” column, below. The “less favorable” is not bad; it is just more expensive when it comes to D&O insurance for SPAC IPOs.
SPAC IPOs and Insurance Carrier D&O Risk Appetite
|US address||Non-US address|
|Successful serial SPACer||Novice|
|Steady cadence||Simultaneous high volume|
Size of IPO Raise
|Moderate||Very high or low|
|Familiar jurisdictions||Less familiar jurisdictions|
Deal and Diligence Report
|Institutional support||Small team|
|Well-known lawyers and bankers||Less well-known|
Federal Forum Provisions
|Included in charter documents||Not included|
Projected Investment Period
Backup Plan for High Redemptions
|In place||Does not exist|
|Not socially controversial||Socially controversial|
|Correlated w/ management expertise||Not correlated|
|More specific||Less specific|
|Comfortable business model||Unusual business model|
|Saturated market||Blue ocean|
SPAC IPOs and Insurance Carrier D&O Risk Appetite, Woodruff Sawyer
Once you have taken advantage of all the favorable factors you can, it may be time to consider other ideas to reduce cost.
Saving Money on Premiums
Our partner Dan Berry always asks clients: “What is your goal for the D&O insurance coverage you are purchasing?” It’s the right question.
Are you in a situation when only platinum levels of protection and policy terms will do? If this is the case, the cost to purchase the insurance will certainly be higher than if you are more flexible.
By contrast, are you in a situation where your independent directors are more risk-tolerant if not actually risk-loving? In that case, you will have a lot more options when it comes to saving on D&O insurance premiums.
However, if someone is telling you they will save you 50%, the next question should be: “What am I giving up for this great deal?”
The D&O insurance market is a robust one, so the chances are low that one broker has sustainably better pricing than another broker who also transacts a lot of SPAC IPO business.
This goes double if the broker offering the deal in question either does not work with a lot of SPAC IPOs or is using a wholesaler. (You want to use a broker who has direct relationships with the relevant insurance carriers, not a broker that is largely or even exclusively using a wholesaler to obtain the D&O insurance for your SPAC IPO.)
However, it is not all doom and gloom. While one could just buy less in D&O insurance, there are also other innovative ideas that can save you money in the D&O insurance marketplace.
SPAC Boards with Almost No D&O Limit
For example, there are some SPAC boards that might be very comfortable with having almost no D&O insurance limit at the time of the IPO so long as a carrier is willing to guarantee coverage for future claims as or after a de-SPAC transaction has closed. “After all,” goes the common refrain, “the main risk to SPAC directors and officers is at the time of the de-SPAC transaction.”
In 2021, however, we saw that this is not, unfortunately, true for all SPACs. Two of the 31 SPAC-related securities class actions filed in 2021 (the Lucid Motors case and the Stable Road/Momentus case) were filed prior to the merger. The December 2021 lawsuit brought against the CEO of Digital World Acquisition Corporation, which has plans to merge with Trump Media and Technology Group, was not a securities class action but was also brought prior to the proposed merger.
So while some independent directors may be sure that their SPACs will have nothing to fear until they reach their business combination, other independent directors and officers will be uncomfortable with the idea of purchasing only $2.5 million of D&O insurance—an amount that any defense lawyer would burn through fairly quickly. You will want to get the input of your independent directors before pursuing this option.
One-Year Policy Option
Another idea that we often discuss with our clients is the concept of placing a one-year policy instead of the standard two-year policy that most SPACs purchase. The idea here is to avoid paying for two years of coverage at the time of the SPAC IPO if the SPAC sponsors are fairly certain that they can wrap-up their de-SPAC transaction within the first year.
This might be an option for a serial SPAC-er that has a high degree of confidence that the SPAC can source, diligence and close a deal in under one year—a level of confidence that might, arguably, be diminished in light of the longer time periods the SEC has recently been taking to approve S-4 registration statements that are needed to close a de-SPAC deal.
True, at the beginning of 2021 Yelena Dunaevsky wrote that the average time between SPAC IPOs and their mergers was getting shorter. However, by the end of 2021, we heard frequent complaints from SPAC teams that backlogs at the SEC and service providers were forcing them to extend their projected closing dates months beyond what they had originally anticipated. In addition, the number of deal terminations whether prior to or post deal announcement also increased at the end of 2021 and is likely to continue into 2022 as many SPAC teams determine that some targets are not a great fit or ready for public company status.
The risk, of course, is that if the SPAC cannot close its deal in one year, the D&O insurance carriers are under no obligation to offer similar renewal terms, or renewal terms at all. Although we have been able to secure renewal options for our clients that purchased one-year policies thus far, it is very far from certain that those options will be available in 2022.
Finally, it is worth noting that although insurers have been willing to offer coverage for 15-month and 18-month policies, those policies don’t necessarily come with a lower premium.
More in Tail, Less in Initial SPAC Policy
Another idea that has gained popularity is the idea of putting more premium in the tail policy and less in the initial SPAC IPO policy.
Remember that at the time a broker is placing a D&O insurance policy for a SPAC IPO, the broker is also negotiating the price of the six-year tail (the policy extension that allows the policy to respond to claims that arise after the de-SPAC transaction closes).
This tail premium is paid at the time of the de-SPAC transaction and is typically paid by the target company, which helps the SPAC’s cashflow. It is not, however, an over-all money-saving strategy. In the current market, the discount for pushing even more premium into an already fully priced tail policy is generally limited. Relatedly, we have also seen some target companies push back on the cost of the tail, or at least take it into serious consideration when choosing among SPAC merger offers. This should not be surprising given that the cost of a SPAC IPO tail policy can amount to millions of dollars.
Writing Smaller Layers/Higher SIRs/Side-A Only
Finally, there is the normal bag of tricks: Writing smaller layers with each carrier, taking a higher self-insurance retention, or purchasing a side A-only policy as Priya Cherian Huskins explains in her Side A Insurance Overview for Directors & Officers. In the right circumstances, these methods may be worth pursuing.
Timing and Next Steps for SPAC IPOs
Given how crowded the D&O insurance market has become for SPAC IPOs, you will want to choose your expert D&O insurance broker sooner rather than later so that you can get into the market as efficiently as possible.
It is also a good idea to talk to an experienced broker to get a sense of how much you will need to budget for D&O insurance in the current market. Remember that what you see in the expenses section of S-1 registration statements are often lagging indicators of pricing, particularly in the current market given how dynamic it has been.
Download Woodruff Sawyer’s Guide to D&O Insurance for Your IPO for a briefing on things like the D&O insurance timeline, how to choose the right D&O insurance broker, and more.