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D&O underwriters aren’t singing the unicorn’s praises

July 24, 2019

Unicorns, privately-held companies valued at more than $1 billion, present risks and challenges for D&O insurers — especially those that pursue initial public offerings (IPOs). But insurance coverage isn’t quite as elusive as the fabled creature.
Financial, Executive and Professional Risks (FINEX)

The light-hearted 60s folk song proclaims that "…the loveliest of all was the unicorn," but today you would be hard pressed to find anyone in the directors and officers (D&O) liability underwriting community characterizing "unicorns" as lovely. In fact, the opposite is likely to be true.

The much talked about unicorn is a privately-held company valued at over $1 billion that, according to CB Insights, is as rare as its name implies: As of January 2019, there were roughly only 300 unicorns globally, with a combined value of about $1 trillion.

62 IPOs raised
$25 billion
in Q2 2019 alone

So, what is troubling D&O underwriters about unicorns?

Generally speaking, when private companies hit these high levels of valuation and the stock market is up, a logical and popular next phase in raising capital is an IPO. There have been over 400 IPOs since 2017 with over $100 billion in proceeds raised according to global IPO investment advisor Renaissance Capital.

The second quarter of 2019 alone has seen 62 IPOs raise $25 billion. Clearly, rapid growth/large market-opportunity companies are in demand by investors. But IPOs come with heightened risks, and those risks often play themselves out at the expense of D&O insurers.

IPO risks for D&O underwriters

Five significant risks plague the D&O community:

  1. 01

    Frequency of claims

    Companies making initial offerings are more likely to get sued by shareholders than other, more tenured publicly-traded companies. Leading insurers peg the number at a 20% to 30% likelihood of being sued in a calendar year compared with a likelihood of less than 10% for all publicly-traded companies.

  2. 02

    Severity of loss

    Large valuations, and perhaps outsized expectations for unicorns' stock performance, often coupled with poor historical financial performance, create the potential for complex cases, high legal costs and large settlements.

  3. 03


    About 60% of recent IPOs are health care or technology companies, highly volatile industries that are statistically and historically the most likely to get sued.

  4. 04


    The U.S. Supreme Court's 2018 decision in Cyan, Inc. v. Beaver County Employees Retirement Fund has spurred significant discussion around the future of IPO litigation. Faced with the prospect of having to defend state court filings nationwide, along with the continued prospect of concurrent federal litigation, companies contemplating an IPO (and their D&O insurers) face more risk and uncertainty.

  5. 05


    In addition to the parallel litigation tracks (state and federal courts) referenced above, D&O underwriters also point out that state courts are not as familiar with securities litigation, creating the concern of added legal expenses due to protracted litigation. To date, about 33% of state cases are dismissed versus about 45% of federal cases.

The result? IPOs are one of the most challenging D&O placements for brokers to execute in 2019. From insurers, we see:

  • High premium charges, sometimes five to 10 times typical publicly-traded D&O pricing
  • Limited capacity (offering no more than $1 million to $5 million in limits of liability, per company)
  • Eight-figure retentions in some cases, considerably higher than typical D&O retentions
  • The first $50 million treated as "all primary" exposure, meaning that discounts in premium are not available, or very inconsequential, for excess layers (i.e., $2.5 million excess of $2.5 million, $5 million excess of $5 million)
  • In some cases, only offering Side A coverage (covers individual insureds only, not the company), but still charging historically high premiums
  • Reintroduction of hard market options such as coinsurance to help alleviate premium pressure

Weathering the storm

of recent IPOs are health care or technology companies, the most likely industries to get sued

Soon-to-be-public companies can improve their chances of obtaining favorable D&O coverage by taking specific actions such as using an experienced D&O broker that has proven IPO capabilities, a commitment to differentiating risks in the D&O marketplace, strong insurer relationships, and experienced claims and legal teams. Those teams should be able to address potential gaps in coverage or opportunities to tailor coverage to meet the unique risk issues of the company and its leaders.

Further, predictive analytical tools (not just peer benchmarking) are necessary to test assumptions about loss frequency and severity. Through analytics, a company can evaluate the optimal limits and retention for its D&O program and make more educated decisions. Alternative program structures can also be vetted, with predicted costs compared across varied structures.

Demystifying the process – advice for companies

20% to 30%
the likelihood a company offering an IPO will be sued in a calendar year

Engage early with current and prospective insurers to tell your company's story. That will give you the best chance of achieving more favorable terms, as underwriters generally feel more comfortable insuring companies and people that they have met and questioned. Similarly, your current D&O insurer already knows your story, and if you've had a good track record as a private company, look to leverage that relationship to obtain the best terms possible at the IPO.

Ultimately, weigh any terms offered by your incumbent insurer against those of any new insurers interested in offering D&O coverage, and make sure your broker has the ability to canvas all marketplaces for capacity (i.e., the U.S., Bermuda and London) directly. Don't let the company's message get lost in translation because an additional intermediary is inserted in the process.

A final tip

Get defense counsel preapproved by your D&O insurer(s). National firms may be better suited to coordinate a multistate defense and resolve complex settlements with locally-respected talent. Negotiating this agreement upfront with your insurers can prevent anxiety during an actual claim.

Getting the coverage you need

For D&O underwriters, the risks and challenges unicorns present when they complete an IPO are all too real, but so are the specific, strategic actions available to newly public companies to find coverage with relatively favorable terms. A good company story, a good broker, strong relationships with insurers and the right predictive analytical tools can go a long way toward putting critical D&O protection in place.

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