Sorry, but I’m afraid I’ve got another SPAC-related topic for you this morning. I recently blogged about the concept of using a captive insurance company to help take the bite out of D&O premiums for SPACs. A Woodruff Sawyer blog says that’s not a good idea. Here’s an excerpt:
As a general matter, captives make the most sense for high-frequency, low-severity, predictable claims that pay out over many years. Workers’ compensation claims are a good example; director and officer claims, on the other hand, are not. That is because D&O insurance claims are, by nature, low-frequency, high-severity events.
Remember, too, that the captive has to be funded. If a SPAC is challenged in having enough risk capital to purchase D&O insurance at the current rates, that SPAC will certainly not be able to fund a captive properly.
The upfront investment in captive formation and capitalization will likely be more than the cost of two years of D&O insurance. There is also the additional cost of regulatory compliance and possibly being required to add more capital to the captive over time.
In addition, the tax benefits that captives offer—a major reason to form an insurance captive—likely don’t apply here. Captives are particularly ill-suited for SPACs given the fact that SPACs don’t have operating profits against which they could deduct expenses (such as captive premiums) for a tax benefit.
Additionally, consider timing. Most SPACs are formed and go public in a very short period of time, at which point D&O insurance must be in place. There is unlikely to be enough time to form a captive.
In addition to these concerns, the blog argues that captives are unlikely to be able to cover the waterfront of D&O risk. Specifically, if the captive is a wholly-owned sub of the parent, then it might be unable to indemnify a director or officer in the case of a derivative claim or corporate bankruptcy. In order to cover this risk, Side A coverage would almost certainly need to be purchased.
-John Jenkins, DealLawyers.com April 20, 2021