Companies going public through a merger with a special purpose acquisition company, or SPAC, are facing skyrocketing premiums for directors and officers’ liability coverage due to the higher risk of litigation and increased regulatory scrutiny. Lower coverage limits and high deductible-like “retention” costs are forcing many companies to consider limited coverage or self-insurance as an alternative.
Companies being formed through SPACs sidestep disclosure requirements and other hurdles of a traditional initial public offering, but many have faced lawsuits associated with the identification and acquisition of a target company. Regulatory scrutiny and enforcement over the SPAC sector have also increased after two years of booming activity, although new SPAC formations have slowed this year.
The scrutiny and lawsuits have piled more risk on the market for directors and officers, or D&O, insurance. Standard D&O coverage protects a corporation and its directors’ and officers’ personal and professional liability. The sector has already been grappling with emerging risks, such as environmental, social and governance issues while battling high loss ratios from past pricing mistakes. In addition, little new underwriting capacity has entered the market despite soaring demand for D&O insurance.
A SPAC is a publicly listed company formed with the intention of seeking and acquiring a privately held company. The two firms merge through a so-called “de-SPAC” transaction, in which shareholders in the private company get shares in the SPAC or cash, and the combined firm thereby becomes publicly traded.
“We’re starting to see insurance carriers regard the path of de-SPACing to be more risky, and therefore it costs a little bit more than what we’re seeing for IPOs,” Priya Huskins, senior vice president, Management Liability at insurance brokerage Woodruff-Sawyer said.
Premiums for newly formed public companies have roughly risen five-fold in the first quarter of 2021 from the comparable period in 2018, Huskins said. Firms that could have obtained $10 million worth of D&O coverage for less than $500,000 in early 2018, will now have to pay about $2.5 million for the same coverage. Companies formed via de-SPAC transactions may have to cough up 10% to 20% more for D&O insurance than a comparable firm going public through a regular IPO. By comparison, the broader D&O insurance market saw premiums jump by 40 percent in 2020 and 20 percent in 2019, after several years of flat to declining revenue in growth, according to Fitch Ratings agency data.
The sheer volume of companies needing to purchase D&O coverage overwhelming a market where only a limited number of insurers are willing to write coverage for the SPAC sector, said Nancy Adams, co-chair of the insurance practice and law firm Mintz.
The sticker shock facing companies going public through de-SPAC transactions is forcing D&O coverage to become a larger part of the discussion when going public. “D&O insurance was usually on a closing checklist. For a de-SPAC, insurance has suddenly become a material part of the process,” Adams said.
Some companies have considered buying less comprehensive coverage or even mulled self-insurance as “retentions” – or costs borne by the policyholder before insurance kicks in – ranging between $15 million to $20 million have become common, regardless of the overall coverage level.
D&O insurers have been dealing with heightened litigation risk and increased severity of claims in the last few years, making them cautious about underwriting SPACs. SPAC-related lawsuits have been seen in larger numbers in the state courts, especially in New York, industry watchers said. Most lawsuits accuse directors or officers in SPAC transactions of breaching fiduciary duties or of disclosure shortcomings.
Many lawsuits came after the U.S. Securities and Exchange Commission issued guidance related to SPAC disclosures in December, 2020. Plaintiffs in lawsuits in New York appear to be using the SEC’s disclosure guidance as a road map for their complaints, focusing allegations on inadequate disclosures on topics mentioned in the SEC’s guidance, Mintz attorney Kristen White said. Lawsuits filed in federal courts have been mostly related to securities claims.
Experts have called many of the disclosure lawsuits “frivolous,” and many allegations of inadequate disclosures are voluntarily discontinued after the company files amended disclosures. A “mootness fee” is often paid by the company to the plaintiff in such cases, in exchange for not pursuing the allegation.
With lawsuits being filed against almost every de-SPAC transaction, D&0 insurers remain cautious about underwriting these new entities.
“There is a significant amount of securities litigation resulting from de-SPAC transactions – even more so than with a typical IPO – and insurers are mindful of the comments coming from the SEC regarding these transactions,” Adams said.