SPAC Boom Making D&O Insurance More Expensive

248 SPACs were listed on U.S. Exchanges in 2020, raising more than $80 billion. As a result of this, the niche insurance market for SPAC D&O insurance exploded in popularity, as the flood of new SPACs rushed to buy coverage for their management.

Unlike many kinds of insurance, there isn’t a developed reinsurance market for SPAC D&O insurance. Instead of going to another, generally larger, insurance company and buying insurance to cover the D&O policies that were written, insurers are forced to raise premiums, or cut the amount of coverage that is offered on a gross basis.

In late 2020 the premiums on SPAC D&O insurance rose rapidly. Aon, a major issuer of D&O insurance, told media that in mid 2020 a SPAC could expect to pay around $20,000 per $1,000,000 in D&O coverage. By October of last year, that amount had quintupled to $100,000 per $1,000,000.

The Evolving SPAC D&O Insurance Market

While SPAC D&O insurance is a vital part of any SPAC’s operations, the market for D&O insurance was small prior to the 2020 boom. SPAC D&O insurance is a unique form of coverage, which is part of the reason why there weren’t many companies that were ready to handle the rush to secure relatively huge amounts of SPAC D&O coverage.

A SPAC’s life cycle is spread out over three stages, and each stage requires insurance that is created especially for the company’s executives. In addition to being an area of specialist insurance to begin with, every SPAC may need to create bespoke insurance for its specific fundraising and acquisition strategy.

Small SPAC D&O insurance departments simply weren’t ready to digest the huge influx of new insurance demands, or sort through the executives that were entering the SPAC space. In addition, most SPACs have traditionally sought two years of coverage, which is the maximum amount of time they are allowed to make an acquisition.

In the days before 2020, this time frame was acceptable to insurers, as they had few SPACs to cover. When the rush hit, the additional year of insurance doubled the amount of time that was being asked for when compared to standard D&O insurance plans, which are generally renewed annually.

Yelena Dunaevsky, who is a corporate finance and securities attorney at Woodruff-Sawyer & Co., commented:

“When you have such a large influx of SPACs and a limited insurance market that’s able to cover them, you get into your standard supply-and-demand situation where insurers are dictating terms and hiking up prices.”

Added Costs and Coverage Gaps

From the standpoint of the SPAC, the situation was equally challenging, as the companies had to decide on how to deal with the gaps that were emerging in the amount of insurance they were able to secure.

For many SPACs, the only solution was to accept the new cost structure for SPAC D&O insurance, and also work with the smaller amounts of coverage that were on offer. As the amount of total coverage available fell, the price for retention (a deductible) rose.

SPACs may have been expecting to buy $20 million worth of D&O insurance with $1.5 million in retention, but by the end of 2020, many had to deal with an offer of $5 million in coverage with $5 million in retention, and at much higher prices than just a few months earlier.

In some cases SPACs that failed to secure D&O insurance early in their life cycle were forced to delay IPOs, as the needed insurance was far more expensive than was planned for – if it was available in the quantities needed at all.

New Faces in the Game

One aspect of the SPAC D&O insurance equation that may have been a surprise to many of the new companies’ executives is that previous experience in the SPAC sector helps to secure D&O insurance on favorable terms, as insurers are likely to give preference to executives that know their way around a SPAC’s nuances.

Much in the same way that there aren’t many dedicated SPAC D&O insurance operations, there really aren’t many SPAC executives out there with deep knowledge of the company structure, and the potential issues that can arise during the life cycle of a SPAC.

There are numerous aspects of a SPAC that can create the potential for litigation, and experienced SPAC board members and directors need to fully understand the consequences of their actions. Many SPACs have executives that simply lack experience, which makes writing large amounts of D&O insurance a difficult prospect for insurers.

To complicate things further, many execs who have experience in the SPAC sector won’t accept an appointment without good D&O coverage in place, although this may not enter into the thought process of people who are new to the sector, and simply don’t understand the risks of a SPAC.

A Complex Insurance Structure

Insuring SPAC D&Os is actually a very complex process, as specific insurance has to be written for every stage in the SPAC’s life cycle.

According to Woodruff Sawyer, an insurance specialist, SPACs are exposed to five forms of private litigation:

-Plaintiffs can allege liability for damages for material misrepresentations or omissions of facts in the SPAC’s S-1 registration statement.

-Plaintiffs can bring a suit challenging the completeness of the proxy statement filed in connection with the SPAC’s acquisition of an operating company during its de-SPAC transaction.

-Plaintiffs can sue after the merger transaction because they are unhappy with the resulting company, alleging that SPAC shareholders learned of the true nature of the target company only after the merger was completed.

-Plaintiffs can bring a securities class action suit against the newly public operating company after the SPAC combination.

-Directors of a SPAC that purchases a target company which subsequently becomes bankrupt may be sued by the bankrupt company’s creditors.

Given the rush into using SPACs in 2020, and now in 2021, it is easy to see why the SPAC D&O insurance market has been under strain, and also why it has been difficult to scale up coverage to meet the demands of the SPAC boom.

Will the SPAC D&O Insurance Industry Evolve?

Clearly, there is demand for more SPAC D&O insurance, and some insurers think that insurance companies will expand their coverage to meet market demands. However, this may not address some of the underlying issues in the marketplace.

The simple fact is that while SPACs have become popular, the number of experienced SPAC directors and officers hasn’t grown alongside the boom in SPACs. This may prove to be difficult for many of the new SPACs, which will struggle to safely navigate the complex life cycle of the company.

Whether or not the board and directors of a SPAC are experienced may mean the difference between a successful SPAC, or a company that ends up in litigation without adequate insurance to cover the lawsuits that are brought by jilted investors.

Shanda Consult has been working with SPACs for many years, and our network of SPAC executives has deep experience in the sector. If you need to learn more about how to successfully use the SPAC structure, we are here to help.

Please contact us with any questions you may have.

Nicosia, Cyprus, Feb 20, 2021.

Important note:
SPAC Consultants is not offering and/or providing investment advisory services in the sense of regulated investment advisory services as per respective EU Directives and their implementation into national law of EU Member States. Instead, SPAC Consultants offers SPAC Project Management services and consults regarding the general principles of US SPACs and their business structuring. Any investment, legal and financial advice that may become necessary for possible sponsors and investors at advanced stages will be provided by the network partners of SPAC Consultants.