By GREGORY DL MORRIS, who has covered the chemical and financial industry issues for the past 20 years
By definition, an initial public offering (IPO) is the first time through the process for any company. Even if directors and officers have been through it with other firms, the people with the most personal and institutional experience are likely to be the company's insurance brokers. With the IPO market expected to accelerate this year, risk managers and brokers will rely even more on each other to streamline the process.
"Even if the CFO has done it before at another company, they go through so much with the auditors and the road show that I promise you they do not remember the insurance part," said Bryan Perrault, client advocate at Willis in Austin, Texas.
Such was the case with global consultancy Booz Allen Hamilton, which went public in November 2010.
"We looked for our brokers to have a clear strategy from the start and explain it up front, and still be able to adapt on the fly," said Al Hartmann, risk manager for Booz Allen Hamilton. "The brokers had to know what we were willing to compromise on, in terms of price points and retention levels, and what we simply had to have in the coverage."
The Booz Allen IPO took about a year and a half, reported Christian Hoffman, the managing director with Aon in Philadelphia who handled the D&O placement. "That was longer than many companies take, but careful preparation is in their culture."
According to Hoffman, directors' and officers' liability (D&O) insurance coverage is by far the biggest insurance change when a firm goes private to public.
"The board often expands, and exposure is heightened," he said.
One commonly cited guideline is that limits, retentions and premiums can rise as much as an order of magnitude from the time of a company's IPO to several years after. It is also common that most insureds and their carriers prefer to retain the relationships that they have, although there are some insurers that prefer not to write public-company risks. Underwriters may choose to stay with an owner, but opt for a different position in the tower for the IPO and after.
"We went through several rounds of meetings with the market," said Hoffman. "Placing coverage for an IPO is not like a typical renewal, most notably because there is no fixed date. It is a moving target. The whole process is not just longer, but there are a lot more people to sign off on everything."
Most large companies like Booz Allen have significant in-house resources for the IPO process, but smaller firms rely even more heavily on their brokers.
"We were able to assess the increase in costs, scoping and sizing the premiums and layers of coverage," said Ron DiNella, chief financial officer for Morton's Restaurant Group in Chicago, about using the broker metrics. "Our broker helped us understand where the risks lie, where claims against a public company were likely to arise and what were hot-button issues for the market."
Morton's went public a few years ago.
The broker's role in the IPO continues well after the bell rings to open the first day of trading, DiNella said, explaining how risks can "spike" at the offering but costs can reduce after about three years.
"They did for us," he said.
THE D&O IPO
Kristi Nowicki, vice president for Aon in New York, handled the D&O insurance for Morton's and also for the Bravo Brio Restaurant Group, which went public in October. For most private companies, she explained, there is a shared limit for D&O, employment practices and fiduciary liability. In a public firm, each coverage is discrete and has its own limit. Road-show coverage for the representations made is also important, she added. Most carriers have it in the private-company form, but coverage must be seamless into the public-company form.
Many smaller private companies do not even carry D&O coverage, said David Garrett, managing director with insurance brokerage Wortham in Houston. In that case, he said, it is important to talk about buying private coverage well in advance of the IPO process. The elements inherent in the IPO process are where the risks lie, he said.
"Company officials are making representations and warranties about the firm and its prospects. That is exposure. People put down their money for shares based on the S-1," he said.
If there is a problem in the process, it is likely to come to light in the first few years, which is why D&O coverage is expensive for the IPO and immediately after.
"The numbers can be shocking to a private company," Garrett said. "There is a legitimate concern by underwriters about the exposures."
The broadest concern within the D&O coverage when planning an IPO is the amount, said Nowicki.
"You certainly want to have enough, but there can be too much. Market-capitalization analysis is very important," she said.
If a risk manager can alert the broker to the possibility of an IPO even years before one might take place, the stage can be set during renewals in private-company coverage, she advised.
"Make life easy," she said. "Get the broker involved early. Bring the broker in to meet senior management to walk through the process."
Perrault suggested that some tips to mitigate the necessarily higher costs in the first few years.
"If you get started early, and show the executives a range of options, then you can go through and scrub the terms and conditions--especially in a soft overall market," the Willis broker said.
He also stressed early involvement to get facts and numbers in front of people, preparing executives on "actual exposures, rather than on perceptions." For example, board members often get ideas from their friends and associates that their company will need large levels of coverage.
Two of Willis's recent IPO clients were Convio, a maker of software for nonprofit firms, and NetSpend, an issuer of prepaid debit cards.
Other brokers confirm that this issue is prevalent, particularly within metropolitan areas where there tend to be interlocking boards.
"No one ever gets as much information as they would like," said Eric Kessler, risk manager for Bravo Brio in Columbus, OH. "Getting the broker involved early in the mix gets the executives focused on the decisions that need to be made about the program so there do not have to be last-minute decisions."
In many instances, according to David Hong, managing director at Marsh in San Francisco, clients want all the details. Not just appropriate amounts and benchmarking levels, but types of claims, sources of claims and even shareholder derivative claims for comparable firms.
"We track regulatory enforcement policies and statutes, as well as litigation. Anything that will give a client heartburn. The key question is: What does a public company need for comfort," he said.
Putting an even finer point on the breakout of D&O from the rest of the coverage for a public company, Hong noted that once the D&O limit is agree, there needs to be a discussion about how that is divided among Side A coverage for pure D&O coverage, Side C coverage for just the company and Side B coverage for in between.
Bravo Brio generally kept the same carriers from private to public, adding some new carriers in the IPO and having an incumbent that was primary go into excess, or vice versa.
"But it is not my philosophy to bid out every year. That is not the way to build relationships with your carriers," Kessler said.
THE WHAT-IFS (OR NOTS)
Garrett at Wortham added that the IPO process includes preparation for what might happen if the offering does not take place. That is not necessarily a disaster. Indeed, for one of Nowicki's client firms, the offering was never made because a private investor came in at the last minute with a substantial offer. In other cases, market conditions might shift suddenly to an environment where the IPO might not gain traction.
"The trigger for binding is the actual issuance," Garrett said. "You do not have a public exposure until you have a public shareholder."
If that does not happen, the company and carriers cannot simply leave in place the existing private-company coverage and return to the status quo ante. Even if the reasons are sound, private owners could get upset after all.
"People say they are friends and partners in a private company, but that may only be true until someone loses money," Garrett said.
There are other exogenous threats. Perrault has seen companies get sued on the eve of an IPO.
"Maybe it was coincidental, maybe it was predatory," he said.
He also warned that underwriters can jump off for any reason until a policy is bound.
"That requires you to be alert and ready and available for the last two weeks of the process. Know where your people are. This process owns the broker and the client at the end, especially the last 48 hours," he said.
February 17, 2011
Copyright 2011© LRP Publications