Earlier this week, Tesla decided to cancel its D&O insurance because it was too expensive. I will argue it wasn’t expensive enough. A 100% rate on line sounds appropriate to me.
Elon Self Insures
First, let’s review what exactly Elon did. Below is the language from the revised 10-K (all emphasis mine).
Tesla determined not to renew its directors and officers liability insurance policy for the 2019-2020 year due to disproportionately high premiums quoted by insurance companies. Instead, Elon Musk agreed with Tesla to personally provide coverage substantially equivalent to such a policy for a one-year period, and the other members of the Board are third-party beneficiaries thereof. The Board concluded that because such arrangement is governed by a binding agreement with Tesla as to which Mr. Musk does not have unilateral discretion to perform, and is intended to replace an ordinary course insurance policy, it would not impair the independent judgment of the other members of the Board.
Tesla 10-K/A
So to summarize…
1) Elon thinks his D&O costs too much.
2) He took his D&O coverage away from his directors and replaced it with a personal indemnification.
3) This personal indemnification is undoubtedly a worse cover for the directors and officers.
Why The Insured Are Worse Off
There is a giant conflict of interest Elon has created here. Elon is looking to save $ at the expense of his directors. This isn’t really self insurance. He’s not insuring himself. It’s more like a captive that he is funding for the benefit of others.
This approach undoubtedly leaves his Ds and Os with worse coverage and more personal risk than third party cover. Why? For starters, Elon’s balance sheet is less sound than an insurer. Most of his wealth is in Tesla stock. If Tesla stock crashes, there will be a major D&O suit at the same time Elon’s financial stability is challenged.
In fact, Kevin Lacroix at the D&O Diary pointed out a similar situation during the financial crisis. A private bank Chairman went down the same path as Elon. He pulled the D&O cover and substituted his own personal indemnification. As the bank’s solvency worsened, the Chairman’s wealth was depleted and he was unable to maintain the indemnity. The directors ended up with no cover and were exposed personally.
Additionally, Elon’s willingness to pay is likely less than an insurer. Elon is, to say the least, unconventional. He likes to pick fights and challenge norms. One could certainly see him refusing to pay his director’s defense costs if he thought they were unjustified.
While the Ds and Os could obviously sue him (and likely would as a last resort), they will likely to be reluctant to do so given the inherent conflict and desire to retain their position. Let’s be honest. If they were willing to stand up to Elon, they likely wouldn’t be working for him or serving on his board.
Frankly, if they were willing to stand up to him, they would have insisted he maintain private D&O coverage. They are clearly disadvantaged in trying to negotiate truly equivalent coverage.
Is Tesla’s Cover Really Too Expensive?
As I said in the open, Tesla’s ROL should probably be 100%, or at least close to it! Elon has a history of reckless behavior (including drug use), has tangled with the SEC, and creates plenty of volatility in his stock (which increases the odds of a material sell off that would trigger a claim).
In fact, only days after cancelling the D&O (possibly with an April 30 cutoff???), Elon took to Twitter without informing the company (as required by the SEC settlement).
The stock immediately sold off 10%. If it keeps declining, the directors may be able to test Elon’s willingness to pay sooner than later! How can a clear minded insurance company offer cover to Tesla at any price? I didn’t even get into the precariousness of the balance sheet or the related party issues. It’s uninsurable.
It All Could Make Sense If…
There is one way to make sense of all this seemingly bizarre behavior. Elon has long expressed an interest in colonizing Mars. Perhaps the plan is further along than we realize?
If Elon is close to taking off for Mars, it makes sense to sell all his possessions, not care about Tesla’s stock or any other financial arrangements. You can’t spend American dollars on Mars! And he won’t have to worry about social distancing practices there either! Godspeed, Elon! Take your protein pills and put your helmet on!