The way companies shift from private to public and vice versa has evolved, challenging the process of securing coverage to insure those moves. SPAC (special purpose acquisition company) IPOs have skyrocketed in popularity, but issues with SPAC insurance policies are also on the rise. The number of underwriters willing to write primary Directors & Officers (D&O) coverage for SPACs is decreasing, and those that remain are writing lower limits, with higher SIRs (self-insured retention) and higher pricing.
As the court system was shut down for most of 2020, the securities class action lawsuits that were making their way through the court system had slowed. How the clogged claims pipeline and possibly increased government regulations will impact SPACs and underwriting moving forward remains to be seen.
SPACs Rise to Fame
Increased regulatory scrutiny shrank the number of publicly traded companies by half in the last ten years. Stringent government oversight had a lasting impact in the space, changing the ways companies transitioned from private to public. The Sarbanes Oxley Act was adopted right after the dot-com bubble burst in 2002, making it more costly for companies to go public. In 2008, the financial crisis prompted more regulations, including the Dodd-Frank Wall Street Reform and Consumer Protection Act, creating additional hurdles. When SPACs emerged as an easier and more cost-effective option to go public, the number of companies going public via a SPAC transaction quickly increased.
Issues SPACs Face Today
SPACs continue to lead as the preferred path to IPO, with increasing popularity. In the last few years, a record number of SPAC IPOs have come to market, with 248 in 2020, and 613 in 2021. The pandemic did not curb the number of SPAC IPOs entering the market, nor did it impact their coverage. Litigation in this space does not normally happen until the SPAC announces a business combination, so carriers were still actively writing D&O for SPAC IPOs throughout the first two years of the pandemic.
In 2021, based on the statistics published by NERA and Cornerstone, there was a material jump in SPAC-related securities class action cases as they comprised 14.7% of all the securities class action lawsuits filed that year, a six-fold increase from 2020. The significant increase in litigation activity has drawn further scrutiny from the SEC and Congress as to how SPACs are structured, how they account for the warrants issued as part of the IPO, conflicts of interest between the SPAC and target company’s directors & officers, affiliates, and different classes of shareholders. There is also an increased focus on the adequacy of disclosures, as well as what investors perceive to be undisclosed, and improper benefits for sponsors in contrast to all other shareholders.
Carriers are now being more careful in how they write SPAC IPOs due to the escalating claims frequency, as well as the increased scrutiny placed on SPACs, and the possible de-SPAC transaction by regulators such as the SEC and DOJ. It has become common to see high retentions and high pricing, due to underwriter awareness of rising claim volumes. As a result, there are not a lot of carriers willing to write D&O policies for SPAC IPOs on a primary basis.
Underwriters are also carefully watching the outcomes and severity of the claims that have been filed, as this will dictate the size of limits they will deploy, the SIRs they will attach to a SPAC IPO (which historically have been lower than traditional IPOs), and the premium they will charge.
If the increased frequency of claims also leads to increased severity of claims, both in defense costs and average settlement values, there could be further restrictions in coverage with a corresponding increase in pricing and SIRs closer to what we see with traditional IPOs.
Due to the complex nature of SPAC indemnification language, restrictive coverage, and substantial premium levels, more companies involved in SPAC IPO transactions are purchasing Side A insurance. This is the agreement in a D&O policy that provides first-dollar coverage for asserted claims when costs are not indemnified or advanced by corporate entities as a proportion of its total tower. From a personal asset protection perspective, Side A insurance is a smart option to help board members cover themselves.
What’s Next?
How increased scrutiny from the SEC and Congress will affect SPACs’ structure and popularity long-term is uncertain. There is already a significant slowdown in the number of SPAC IPOs compared to the previous year. As litigation trends develop and the claims pipeline unclogs, all parties are concerned about the potential impact on claims settlements and carrier reactions.
Risk Strategies continues to monitor the situation as it evolves, providing safe navigation and expert counsel as the risks become known.
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