Costs for D&O insurance for SPAC IPOs have been rising. It’s worth understanding why this has happened as a step toward learning what can be done to lower the premium paid for a SPAC IPO D&O insurance policy.
A critical step is to enter the D&O insurance market early and take a sophisticated approach. Our Guide to D&O Insurance for SPAC IPOs can help you do just that.
Why Have Rates Skyrocketed?
The basic law of supply and demand has played a big part in the skyrocketing of premiums. The surge of SPAC IPOs in the face of a D&O insurance market that is not seeing new carriers means, inevitably, that the price of this insurance is going up.
The D&O insurance market is a pretty closed system in the short run. The insurance carriers that are being asked to write D&O insurance policies for SPAC IPOs are the same carriers who are writing D&O insurance for existing public companies as well as private companies seeking to go public through a traditional IPO, direct listing, or business combination with a SPAC (aka a “de-SPAC transaction”). Carriers do not maximize profits for their own shareholders by undercharging premiums compared to what the market will bear.
In addition to the supply question in the face of overwhelming demand, consider that the D&O insurance market is currently a distressed one.
On the exposure front, as we reported in our recent DataBox 2020 Year-End Report, while the rate at which public companies were sued in 2020 was down compared to 2019, the rate of litigation is still elevated.
Securities Class Action Lawsuits, Woodruff Sawyer DataBox 2020 Year-End Report
More troubling is the all-time high in the number of open, unresolved cases carriers are facing. These claims are all against policies for which the carriers charged lower premiums in earlier years. Carriers are concerned about how these losses will impact them and are pricing their new D&O insurance policies accordingly.
As prices have gone up, the amount of D&O insurance most SPACs will purchase has gone down, but it would be 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.
D&O insurance carriers are also understandably uncertain about what the potential track record for SPAC IPOs ultimately will be. Sheer volume is a concern, as I noted in an earlier piece published by the ABA: More SPACs Will Lead to More Litigation.
In addition, the Securities and Exchange Commission has indicated that it may be sharpening its focus on SPACs.
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 my colleague Andrew Silva in a recent article about D&O insurance underwriting factors, 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|
|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
My 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.
Consider, however, that 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 very 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, the main risk to SPAC directors and officers is at the time of the de-SPAC transaction.
However, there will certainly be some independent directors and officers who are uncomfortable with the idea of purchasing only $2.5 million of D&O insurance—an amount that any defense lawyer would be able to go 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 has gained popularity recently 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, vet and close a deal in under one year, and who is not also overly concerned that market dynamics will change in the shorter run.
Indeed, my colleague Yelena Dunaevsky has written about how the average time between SPAC IPOs and completing their de-SPAC transactions is getting shorter.
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. As a reminder, SPACs are not allowed to have secured an undisclosed deal at the time of their IPOs. In addition, we have seen the market start to turn away from offering one-year policies for most SPAC IPOs.
More in Tail, Less in Initial SPAC Policy
Still 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 can be paid by the target company. In the current market, however, the discount for pushing even more premium into an already fully priced tail policy may be limited, particularly if you are unwilling to fully commit to purchasing the tail policy from the carrier that is writing the D&O insurance for your SPAC IPO.
Writing Smaller Layers
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. 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.
Visit our SPACs industries page for more insights and resources related to Special Purpose Acquisition Companies.
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