Exaggerating the risks and related insurance needs involved with a Special Purpose Acquisition Company (SPAC) would not be the first for insurance brokers and companies. If anything, SPACs could be considered as an asset class of their own with less risks than many others, especially when considering different risk return profiles of strategies ranging from Merger Arbitrage, to Private Equity, to publicly traded companies that derive a substantial amount of their growth from M&A activity.
You may have already heard that the downside protection provided to investors and that is inherent in a SPAC’s structure can be analogous to protection offered by a financial derivative such as a put option. How does that impact the procurement of commercial insurance for a SPAC and its directors and officers? What are other considerations in relation to the lifecycle of a SPAC? Let’s dive right into it with a focus on 3 important SPAC insurance policies, which must be reworded and managed independently of insurance brokers or companies:
If you already received a quote or a policy from an insurance broker, it is best you audit it by risk experts independent of brokers or insurers. The audit can be done even after the inception of the SPAC Insurance Policy, however it is recommended to be done prior to inception.
SPAC directors and officers insurance (D&O Insurance)
There are 3 important things to note here. First, the structure of a SPAC as well as the movement of its stock, aside from dynamics of De-SPAC, can impact SPAC D&O Insurance. Second, a claim or suit against a SPAC and its directors or officers may be frivolous in nature (you may have already noticed several suits and investigations against SPACs and their directors and officers brought by different law firms that attempt to rally class actions whether or not frivolous in nature). Third, the probability of occurrence and liability measures of a SPAC D&O Insurance claim also depends on SPAC specific operational risk data.
As an example, let’s consider the following catalysts to a SPAC’s stock price movements and think about how they may impact SPAC D&O Risk:
- Catalyst A: stock movements in the early stages of the IPO mainly driven by rumours and social media threads (ex. Reddit). The price is around $10 with low volume.
- Catalyst B: non-binding letters of intent, along with associated social media reactions and investor participation leading to rising volumes.
- Catalyst C: binding agreements, investor presentations, merger timelines, and associated social media reactions and investor participation impacting volumes and volatility.
- Catalyst D: announcements of the merger vote and firmer dates, with a commensurate impact on volumes and volatility.
- Catalyst E: pre-ticker change, with a commensurate impact on volumes and volatility.
The point is that SPAC D&O Insurance should reflect the dynamic measures of D&O risk attributed to different circumstances within the lifecycle of a SPAC. A one size fit all solution that is sold by insurance brokers and used on thousands of SPACs will most probably, and ironically, add to D&O risk and produce faulty benchmarking reports. Moreover, the methodology used to trigger the SPAC D&O Insurance policy at loss will be different depending on the circumstances of loss, which falls outside of an insurance broker’s purview and expertise. Finally, the SPAC D&O Insurance pricing will be less than that of an off-the-shelf SPAC insurance policy sold by an insurance broker.
SPAC rep and warranty insurance (R&W Insurance)
The above mentioned rationale applies to SPAC R&W Insurance, yet here we are dealing with a different type of risk, which is the SPAC merger risk. Just like a typical merger or acquisition (M&A) transaction, a SPAC’s merger with an operating Target will have inherent risks that should be assessed and managed by experts, as well as contemplated within the overall due diligence framework including valuations. M&A risk due diligence, including R&W insurance, therefore applies to SPACs with the difference of entailing SPAC specific risk assessments.
With respect to SPAC R&W Insurance, and just like any form of commercial insurance, it must be reworded and managed by risk experts independent of insurance brokers or companies. This will result in a much higher insurance payout ratio with the option of extending coverage beyond the representations and warranties made by the Target in the transaction agreement, aside from reducing net cost.
Manuscript SPAC Insurance Coverage
The intent of this coverage is to cover risks left out by the SPAC D&O and R&W insurances.
Just like any commercial insurance policy, the SPAC D&O and R&W insurance policies entail various terms and conditions including coverage exclusions. It is important to measure the non-insured portion of risk by the SPAC D&O and R&W insurance policies and identify the need for further protection through manuscript SPAC insurance coverage.
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