If you have not turned on the news or have been hiding under a rock over the last year plus, you have likely missed out on the steady stream of SPAC’s (Special Purpose Acquisition Corporations) having gone public in 2020. 2021 really turned up the heat with over 300 SPAC’s IPO’ing in the first quarter alone.
Recently, Bill Ackman’s Pershing Square Tontine Holdings Ltd. SPAC is turning heads with a new twist on the traditional SPAC using the proceeds to acquire 10% of Universal Music Group from Vivendi SA. Ackman will still have $1.5B in cash which he will use for another deal. The announcement also included the creation of a SPARC (R=Rights) where investors in the SPAC will also get rights to invest in the SPARC. While this type of financial engineering may be better for investors, the complex structure has unintended consequences on the insurance underwriting side.
Setting the Stage
Prior to September 2020, SPAC IPO’s (Initial Public Offerings) were considered lower risk to underwriters; retentions landed in the $250K/$500K range and premium for a typical $10M ABC/$5M Side A DIC program was in the $250K-350K range for a two-year policy (depending on the size of the offering). All that changed and the SPAC IPO market hardened dramatically in September 2020 when John Coates suggested the SEC would start providing greater scrutiny around the myriad SPAC’s going public, specifically around two items: treatment of warrants and the forward-looking guidance the target companies are able to provide. Both Mr. Coates and incoming SEC Chairman Gary Gensler have been open about their concerns related to SPAC’s and protecting investors. In turn, D&O (Directors & Officers Liability) underwriters began to conduct further diligence around placements and the corresponding impact was retentions and premium dramatically increased.
In conjunction with greater underwriter attention to SPAC IPO’s, SPAC-related claims have risen precipitously over the last year due to an increased and specialized focus from the shareholder plaintiffs’ bar. Traditionally, SPAC-related litigation averaged about 1-2% of litigation for 2019/2020. However, the SPAC-related litigation rate has erupted up to 14% of all securities class action suits filed since January 2021. Post de-SPAC companies such as Multiplan, Nikola, and Virgin Galactic have all been sued for violations of federal securities laws in the past year, contributing to underwriter paranoia about SPAC & de-SPAC risk, which again, had been relatively benign prior to September of 2020.
The last contributing factor is the sheer number of SPAC’s that have gone public since the beginning of 2020, putting the laws of supply and demand squarely in the hands of the insurance marketplace, causing carriers to increase retentions for de-SPAC’s, raise premiums, and focus on companies that have a longer-term operating history and experienced management.
Solution, Strategy, and Execution
Finding the right broker partner is job one, particularly a firm that is well-versed in brokering public company D&O for IPO’s, and even more specifically, SPAC IPO’s and de-SPAC transactions, including advocating on clients’ behalf in the unfortunate event of a claim. Not all brokers are alike and having a partner with this background and expertise can save unwanted heartache should a claim be filed against the business combination.
Next is understanding the coordination of policies including the SPAC policy, the target private company D&O policy, the go-forward public company policy, and how the indemnification wording is written. Many unforeseen risks (costs) can be avoided by understanding the balance of the respective policies. Given the large number of SPAC’s seeking targets, target companies are in great position to negotiate on indemnification language. This is also a great time to be thinking about diligence and what that process looks like.
Diligence falls into two categories:
- Audit process between the SPAC and target company. This should not be underestimated, and strong diligence puts the company in a highly defensible position post transaction.
- The attentive review performed by your broker on the combination, i.e., advantages, disadvantages, and how best to communicate the same to the underwriting community. While this may look and feel like an investor presentation, the audience is very different than a typical shareholder audience. Underwriters are investors of sort; in that they are entrusting you and your management team with their capital, which is typically deployed in $5M tranches. The goal is to enable underwriters to have a full understanding of the combination and to prepare management to help put the company’s best foot forward. Typically, a detailed coaching session about the types of questions likely to arise and how the company has looked to de-risk itself during the transition from private to public is time well-invested. This is both a short-term and long-term strategy to drive best-in-industry terms and conditions at highly competitive premium.
Understanding the market evolution from SPAC to SPARC and the underlying factors contributing to market hardening equips your management team with the right tools to drive the best outcome in a worsening market. Turmoil will continue given supply and demand of SPAC’s looking for targets to de-SPAC and an ever-active plaintiff’s bar. That said, there are “green shoots” in the market as capital is efficient and several syndicates have already come on-line to start writing both primary and excess cover. Other carriers are also looking at retentions and premium level and believe now to be a good time to revisit and potentially expand their appetites. This will not happen overnight but there is a spark that should help rationalize the market over time.