The recent spate of troubled initial public offerings by firms including Uber Technologies Inc., Lyft Inc. and high-end fitness equipment firm Peloton Interactive Inc., whose stock prices dropped after their IPOs, has led to higher directors and officers liability rates and tighter capacity for companies that are going public.
Further exacerbating the situation are higher litigation costs following 2018’s U.S. Supreme Court ruling in Cyan Inc. et al. v. Beaver County Retirement Fund et. al., which held securities offerings litigation can be heard in state court in addition to federal court.
Particularly vulnerable to the tightening market are “unicorns,” startup companies with valuations of more than a billion dollars, observers say.
Unicorns have not performed well over the past few months, “suggesting their valuations were overstated, not only before but in the IPO itself,” said Kevin LaCroix, executive vice president of RT ProExec, a division of R-T Specialty LLC, in Beachwood, Ohio.
The unicorn IPOs’ performance “has driven a lack of capacity,” said Jennifer Sharkey, Boston-based president of the management liability practice for the Northeast with Arthur J. Gallagher & Co. “When capacity is provided, there are less limits provided; it has driven the premiums ups significantly, and the self-insured retentions to levels we have never seen.”
Whereas previously limits of $5 million or $10 million limits were available, “we’re now seeing $2.5 million in limits, but the pricing has definitely increased significantly,” said Sarah Downey, New York-based FINPRO and D&O product leader for Marsh USA Inc.
“There are very few markets willing to write IPOs on a primary basis right now,” said Paul King, Dallas-based senior vice president and national technical director of executive and professional solutions for USI Insurance Services LLC. “The IPO market is more difficult than the general market” because of the perceived IPO failures.
Policyholders may not be able to get full ABC coverage, and instead have a Side A only program, said Christine Williams, New York-based CEO of Aon PLC’s financial services group. Side A protects directors and officers when they are not indemnified by the organization.
Side A is “a way to control costs somewhat and get back to some of the original intention of D&O, to protect the individual, but you’re narrowing your coverage when you do that,” said Mr. King.
Life science and technology companies, whose stocks tend to be volatile, have been particularly affected by the tightening IPO market, according to Priya Cherian Huskins, San Francisco-based senior vice president, D&O, for Woodruff Sawyer & Co.
According to Woodruff Sawyer data, the average cost of the first $10 million of D&O insurance more than tripled from 2017 through 2019’s second quarter for life sciences companies, while the average self-insured retention quadrupled to $8 million in the same period.
Another complicating factor is the Cyan decision, which enables plaintiffs to file D&O litigation in both state and federal courts and has increased litigation costs.
“You’re seeing litigation not only in the federal courts but in state courts, and sometimes in both, so your frequency is significantly higher for a company going public because it’s strict liability with that Section 11 exposure,” said Brian Zink, New York-based head of management liability for Zurich Insurance Group Ltd.
Section 11 of the Securities and Exchange Act of 1933 enables plaintiffs to hold directors and officers liable for damages caused by untrue statements or material omissions of fact within registration statements when they become effective.
State courts “have very little experience with securities class actions, and the rate of dismissal historically” has been much lower, said Ms. Sharkey.
“I think the dollar amounts are often higher when settling with plaintiffs in multiple jurisdictions, so those are real concerns,” she added.
According to a midyear report issued in July by Cornerstone Research Inc., of 61 lawsuits after Cyan, 23 have been filed in both state and federal courts, 12 in federal court only and 26 in state courts only.
“If you’re looking at what the probabilities of a company going public are to being sued, it’s around double” within a year of an initial public offering compared with the rate for an already public company, said Scott Meyer, New York-based division president of financial lines for North America with Chubb Ltd. Given this, “there’s less interest in insuring those companies,” he said.
Mr. Meyer said, “There’s a handful of insurers that have pulled out of the market altogether,” although Chubb has “stepped up to fill that void.”
The IPO situation is unlikely to ameliorate soon, say observers.
“Everyone’s going to continue to watch the impact of the Cyan decision and those Section 11 claims, but I don’t see the IPO market changing, at least in the first half of 2020, until we really see more loss data around the impact of these state court cases,” Ms. Sharkey said.
