Author: John C. Marchisi
The special purpose acquisition corporation (SPAC) entered the 2020 market with increasing momentum, uninhibited by Directors & Officers liability (D&O) rates and retentions as SPAC teams and sponsors capitalized on aggressive pricing offered by participating insurance carriers, which viewed them as attractive risks given the historical loss data that was available.
- D&O: Primary SPAC D&O liability rates were flat over 2019 as we entered into August 2020. Shortly thereafter, primary rates began a rapid rate of increase in increments of 30%–40%, ultimately reflecting a total average increase of between 200%–300% within 30 days. Self-insured retentions have doubled to a current average of $2.5M for Sides B and C.
- D&O: Excess layer and Side A rates were moving downward as we entered into August 2020, as several new markets began competing in the space. After the shift in the primary market and with recent claim activity coming to light, which will be discussed later in this report, both excess and Side A responded with increases in kind. The key point to note is that higher attachment points did not translate into premium reductions, as increased limit factors (ILF) flattened and compressed significantly, with pricing inversions being witnessed in some larger towers.
- Cyber liability: The cyber liability insurance programs we place for SPACs saw premium reductions over 2019 and remain stable. The reasoning behind the purchase of cyber insurance and why we feel cyber to be a significant yet unrecognized risk is documented in a recent Gallagher whitepaper, The Life Cycle of a SPAC.
Risk profile influence on the availability and pricing of insurance coverage
SPACs are devoid of any traditionally quantifiable rating basis, leaving insurance underwriters with a very limited number of ways in which to determine whether or not they would offer terms on a risk, and how they will ultimately rate premium on a specific SPAC.
Typical underwriting considerations include:
- Prior litigation history
- Offering size
- Target industry
- SPAC period/length
Gallagher's unique perspective and experience provides us with an ability to extract far more information, which we use to provide clarity and insight into the marketplace during the underwriting process. This process is expressly what drives and distinguishes the results we are able to achieve and deliver to our SPAC clients.
Understanding the catalysts behind SPAC D&O rate shift – Causa proxima
The graph below provides SPAC IPO filings by quarter, and serves to evidence the precise timing of the upward shift in D&O rates, as the demand for SPAC D&O created by the explosion in IPO filings overtook the available capacity and supply.
Several other influences combined in supporting roles in this shift, with some regarded as more of a temporary imbalance while others potentially signaling a longer-term or even permanent shift in the SPAC insurance purchasing experience.
In what we regard as a more temporary influence, deal fatigue was a key contributing factor, as it was felt not only in the SPAC D&O insurance marketplace, but throughout the entire SPAC ecosystem. As a result, the excessive SPAC deal flow of 2020 created a demand which completely outstripped an already limited capacity, ultimately sidelining several carriers as approvals from reinsurers for the placement of 18-, 21- or 24-month terms were exhausted.
SPAC IPOs by quarter
SPAC — Claim activity update
There has always been a potential liability risk for teams connected with the launch and operation of a SPAC; however, there is a stark contrast in risk profiles when comparing SPACs with traditional IPOs to SPACs historically performing and considered a low-frequency D&O risk. The structure of a SPAC bifurcates the exposure to federal securities laws, shifting in large part away from the initial IPO to the end of the life cycle, where it then centers on the business combination. The business combination process then uniquely combines the potential exposure to liabilities under various sections of the Securities Exchange Act of 1934 and the Securities Act of 1933 with the well-known transactional risks magnetic to mergers and acquisitions. Historically, the majority of allegations filed against SPAC teams have been in response to poor performance of the combined go-forward entity, with failures of due diligence and alleged breaches of fiduciary duties framed around the SPAC and/or sponsor team being perversely incentivized to complete a deal as opposed to incurring a loss of risk capital and dissolution.
Looking ahead into 2021 and beyond
Given the current environment and the claim activity which has emerged and remains open, we do forecast a material reduction in D&O liability premiums in the coming year. The insurance market is seemingly making an effort to align SPAC D&O premiums with the pricing put forth for traditional IPOs. A key point to mention is the availability of funds held outside trust for the payment of D&O policy retentions. There is much conjecture amongst SPAC D&O underwriters around this topic at the moment, and we are providing advisory to the market and negotiating with this in mind. There are developments which we are now expecting to see implemented in Q1 for this purpose, and both premium and retention relief as a result.
COVID-19 disclosures and earlier stage targets record aggregation de-SPAC-INGS
As noted in Gallagher's Life Cycle of a SPAC whitepaper, the goal of the evolution of SPAC structure and the most recent iteration was an effort to provide mechanisms which provide SPAC targets with comfort and relative certainty that the funds needed to consummate the combination would be available post-redemption period.
Please note that a client's risk profile is the primary variable dictating renewal outcomes. Loss experience, industry, location and individual account nuances will also have a significant impact on these renewals. Reach out to Gallagher for more information.
Increase in early-stage companies as SPAC targets
Illustration credit: www.spacresearch.com