Mach Millett, from Marsh, breaks down the current D&O insurance landscape for SPAC teams. Read on for an explainer for why costs have risen and what future teams need to be mindful of when launching a new SPAC.
By Mach Millet, Esq., Managing Director
Marsh SPAC Practice Leader
SPAC D&O Insurance – No, the Sky is Not Falling
It seems to have become quite popular lately to overstate the regulatory and litigation exposures of, exaggerate the risks inherent in, and predict the imminent downfall of the booming SPAC marketplace. Why all the negativity? Well, positive news doesn’t sell nearly as well as negative news, does it? And it certainly doesn’t sell legal, consulting and insurance services.
The reality of the SPAC D&O insurance market is far more straightforward – the tremendous growth in SPAC activity has generated significant attention from the media. This attention has in turn led to SEC announcements, plaintiff bar opportunism, and a small number of problematic situations.
There were a lot of SPAC IPOs launched in 2020. This is true – 248, with another 43 already in 2021, as of the writing of this article. The 2020 SPACs were are also somewhat larger on average than we have seen in the past — $335M on average versus a $257M annual average from 2016-2019.
At the same time as the general tone about SPACs in the media changed, the SPAC D&O insurance marketplace underwent a fundamental transformation. Before late September, early October 2020, it was not at all unusual to see $10M SPAC D&O insurance policies with a $500k-$1M retention for $150k-$200k in premium. Trust me, those days are gone, at least for the time being. And if anyone tries to tell you that they might be back now that the calendar has turned over to January 1, 2021, well, there is unfortunately zero basis for their optimism.
A more common “off-the-shelf” primary SPAC D&O insurance quote these days for a $250 million raise SPAC is $5M limit, excess of a $2-$5M retention for $500k in premium. That is the beginning of the conversation. But it should not be the end. Alternatives exist, and should be fully explored.
Three components are required for such an exploration:
- Accessing the entire SPAC D&O insurance marketplace.
- Differentiating your SPAC from other SPACs from a risk perspective.
- Evaluating all potential program structure options.
Full Market Access
More than 30 insurance markets around the world are currently willing to consider SPAC D&O risks – it is essential to be able to access all of these insurers as opposed to relying upon just the same 3-4 traditional SPAC D&O insurance markets.
Marketing your risk to all available markets allows spreading of the risk exposure beyond just the insurers who already have limits exposed on 80-150 SPAC insurance programs (and are thus increasingly conservative in deploying additional capital), but also creates competition for each of the layers of your potential insurance program. Each insurer has a unique risk appetite, and different considerations in terms of which types of SPACs they favor from an underwriting perspective, and this must be fully explored in each individual situation.
Despite having so many SPACs launched in the last year, it seems safe to say that not one would say “we are just like that other SPAC.” To the contrary, each SPAC is unique in its team (background, deal experience, public company board experience, philosophy, etc.), investment strategy, terms, structure, financial backing, risk tolerance, cost tolerance, etc. It is imperative that potential insurers understand these considerations as they consider whether and how to underwrite each SPAC’s D&O risk.
Insurers’ greatest concern is that a SPAC will fail to complete comprehensive due diligence on a target company and complete a “bad” de-SPAC deal – SPACs need to demonstrate their ability to properly diligence a deal, and a willingness to walk away from “bad” deals and liquidate the SPAC, if advisable.
This can only be accomplished through a comprehensive presentation and discussion of each individual SPAC’s S-1, investor presentation, etc. between an experienced broker and the insurer, and, where advisable, directly between the SPAC team and a large group of insurers (or certain selected insurers) through an underwriting call.
This is a marked departure from the “traditional” SPAC D&O insurance marketing approach of simply submitting the S-1 to insurers for consideration, but a vital one to ensure optimal pricing and coverage in the current marketplace.
The structure of a SPAC D&O insurance program has traditionally been:
- An 18-month or two-year policy period (to match up with the SPAC’s investment period).
- Primary A/B/C coverage (C-Side coverage for securities claims against the SPAC entities themselves, B-Side for the SPAC directors and officers, where indemnified, and A-Side for the SPAC directors and officers where not indemnified), with or without an equivalent amount of excess Side-A coverage.
- An upfront premium cost paid by the SPAC sponsor team (X) and a pre-negotiated run-off premium (2X) to be paid out of the trust or by the target company at the time of de-SPAC (covering the SPAC and its directors and officers for 6 years after the de-SPAC for any claim alleging that the insureds committed any wrongful act before or as part of the de-SPAC).
However, as costs and retentions have increased substantially, revisiting this traditional structure, considering alternatives, and comparing all potential insurance approaches to the particular SPAC’s risk and cost tolerance has become increasingly important.
Potential alternatives to the traditional structure include:
12-month policy period (with or without guaranteed renewal provisions), as opposed to the 18- or 24-month policy period.
- Side-A only coverage, or a decrease in the ratio between A/B/C and Side-A only coverage.
- Shifting of the premium cost from the upfront premium to the runoff premium (where the majority of the true risk actually lies – the de-SPAC — perhaps .75X upfront and 2.%X or 3X run-off factor).
Each of these approaches has pros (largely cost reduction) and cons (increased consequences if a de-SPAC deal is not consummated in the first year of the investment period, reduced coverage breadth and increased risk-bearing by the insureds, higher de-SPAC transaction costs, etc.).
However, consideration of these various options also opens up additional potential insurance markets for a SPAC’s D&O insurance, as some insurers are unable to offer 2-year and/or primary A/B/C policies. Solicitation of the full variety of options from the entire market, a nuanced discussion of the pros and cons of all such approaches, and an analysis of each individual SPAC’s cost and risk tolerance is therefore imperative to finding the right D&O insurance for each team.
Looking Forward to the Rest of 2021
We have already seen 28 SPAC IPOs in the first week of 2021, with several times that many already poised to go public over the rest of January and the rest of Q1, and even more preparing and/or poised to launch later in the year. There are also currently 260+ (and that number is growing) SPACs in their investment periods, actively seeking merger partners. So where does that leave us, from an insurance perspective?
- SPAC teams preparing to launch their IPOs need to be accurately forecasting insurance costs, liaising with the insurance markets as early as possible in their process (optimally, by the time of the filing of their confidential S-1), accessing all potential insurance markets, differentiating themselves during the underwriting process, evaluating all potential insurance approaches, and selecting an insurance program that fits their needs.
- Post-IPO SPAC teams should mind their existing insurance requirements and limitations as they seek reverse merger partners, but also the potential value of insurance due diligence services, representations and warranties insurance and other insurance-related tools to help optimize management of the risk inherent in the de-SPAC transaction.
- SPAC teams actively engaged in completing an announced reverse merger must comprehensively evaluate existing insurance arrangements at the SPAC and the target company, and consider (1) whether additional limits and/or different insurance solutions are advisable in advance of the reverse merger; and (2) what an appropriate post-de-SPAC operating company insurance policy program for the surviving company should entail (as to both D&O insurance, but other exposures as well).
There will be claims; it is inevitable. Regulatory and securities plaintiffs’ bar scrutiny of the SPAC/de-SPAC world is not going away. We are seeing, and will continue to see de-SPAC (and, to a lesser extent, investment-period) litigation, though perhaps not at the frequency or severity that the naysayers are currently shouting from the rooftops. We have also seen some isolated instances of regulatory investigation and enforcement in the space, and can expect such to continue. SPAC teams, and their counterparts at potential reverse merger target companies, need to be well-educated as to the nature of potential claims, and be confident that they have assistance at the ready in the form of defense counsel and insurance claims advocacy at their insurance broker.
In the meantime, don’t believe the hype when it comes to SPAC D&O insurance. The sky is not falling, though the clouds have certainly caused a significant increase in cost and retentions, and caused the need for greater diligence and creativity in building the right umbrella to shelter from the potential raindrops that may come. But the sky is not falling.
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