On July 21, 2016, a working group of the nation’s main insurance regulatory standard-setting body proposed factors to guide regulators when reviewing insurance company mergers and acquisitions. The proposed guidance offers clues as to how insurance regulators approach acquisitions of insurers for purposes of granting statutory approvals and is “required reading” for anyone considering a purchase of a U.S. insurance company.
In particular, the guidance underscores points of regulatory emphasis and scrutiny that may not be obvious based on a mere reading of the applicable statutes and regulations, including details relating to corporate ownership, transaction structure, source of funds and corporate affiliations.
By way of background, the National Association of Insurance Commissioners (NAIC), which comprises all of the state insurance commissioners and provides support and resources to state insurance departments, provides in its model Insurance Holding Company Act that any acquisition of an insurer is subject to the prior approval of the domiciliary regulator. The model act or an equivalent has been adopted in all states, and as a result each state requires an acquirer of an insurance company domiciled in that state to apply for and obtain its regulator’s approval. Approval is sought by means of a filing known as a “Form A,” which must include certain required disclosures and exhibits. In addition, filing a Form A may trigger a public hearing requirement. A Form A is an extensive document and can be the subject of rigorous (and protracted) review before approval is granted.
In last week's development, the National Treatment and Coordination Working Group of the NAIC’s Financial Condition (“E”) Committee issued a proposed set of “best practices” (exposure draft available here) that regulators would be urged to follow in reviewing Form As. The proposal is subject to a public comment period and further NAIC action. Not all of these are new concepts by any means, but some do suggest new points of focus for the NAIC in acquisitions of insurance companies.
The best practices guidelines are divided into nine general categories, each with a list of specific factors that regulators should consider when evaluating a prospective acquirer’s Form A. The categories are as follows:
- Initial Review — includes factors relating to initial administrative procedures such as identifying relevant parties and contact persons, determining how to treat confidential information and assigning insurance department staff to the review process.
- Background, Identity and Risk Profile of Acquiring Persons — includes factors such as reviewing the acquirer’s ownership structure, determining the ultimate controlling person of the acquirer and reviewing the audited financials of the acquirer and, if applicable, the acquirer’s public filings, particularly 10-Qs and 10-Ks.
- Communication and Record Maintenance — includes factors such as classifying confidential information, contacting other applicable regulators and considering any information provided by third-party external sources.
- Transaction Review — includes factors with respect to reviewing the transaction structure and the transaction documents.
- Purchase Consideration — relates to the purchase consideration, including the fairness of the consideration and particular attention to debt used in financing the acquisition.
- Insurance Operations — relates to the intended post-acquisition operations of the target company, including operational changes post-acquisition, plans for the target’s management and key employees and suitability of any new affiliated and non-affiliated material agreements.
- Market Impact — includes factors relating to the market impact and anticompetitive effect of the acquisition and the imposition of tailored conditions subsequent or undertakings in order to address competitive market concerns.
- Post-Approval Considerations — includes factors relating to the closing of the transaction.
- Post-Acquisition Considerations — includes factors regarding the post-closing period, including receipt of notification of the final purchase price and any adjustments, the receipt of the amended Insurance Holding Company System Registration statement from the acquired company and compliance with any conditions subsequent or undertakings imposed on the acquirer as part of the approval.
An acquirer should be particularly sensitive to the following factors in the best practices guidelines that reflect new emphases by the NAIC or recent regulatory trends:
- The guidelines direct regulators to review the source of funds in determining the insurer’s new ultimate controlling parent. Accordingly, the acquirer should be prepared to clearly articulate the source of funds to be used for the purchase consideration, including the use of any debt financing (and any resulting leverage this would create). If funding sources do not align with the legal entities participating in the acquisition, this may be a point of focus.
- More generally regarding the source of funds, categories 2, 4 and 5 of the guidelines include suggestions that regulators explore in detail the source of all funds to be used in the transaction, including the treatment of “minority interests,” and satisfy themselves on the “equivalency” of consideration. This aligns with our experience involving Form As even where a transaction is capital-neutral or capital-accretive to the target insurer, and even where no debt or other leverage is involved. Insurance regulators can be expected to look closely at the purchase price that the seller is receiving even though this may bear only secondary relevance (if any) to the future operations of the insurer or the fitness of its management.
- The guidelines also call for regulators to scrutinize complex ownership structures for “hidden ownership.” While the guidelines do not clarify what is meant by hidden ownership, it has been our experience that regulators are becoming increasingly concerned, in the case of closely held parties, with interlocking or affiliate relationships between shareholders who otherwise would hold less than 10% ownership of the acquirer or the target company (10% being the presumptive threshold of “control” for Holding Company Act purposes).
- The guidelines direct regulators to review, if applicable, “SEC disclosures by board members of publicly traded UCPs” (that is, companies that would become new ultimate controlling persons of the insurer). Therefore, acquirers that are public companies should take particular care that disclosures presented in the Form A application and supplementary materials are consistent with all Section 16 filings made with the SEC (e.g., statements of director/officer ownership of securities) and other SEC disclosures on directors and officers included in such materials as proxy statements, 10-Ks and 10-Qs.
- In a nod to the 2010 amendments to the Holding Company Act that emphasized enterprise risk, and the Risk Management and Own Risk and Solvency Assessment Model Act adopted shortly thereafter, the guidelines recommend that, when multiple domiciles are involved in the transaction, regulators contact other regulators reviewing the proposed acquisition, including the lead state regulator.
- The guidelines also suggest that regulators review “board resolutions, power points and related board minutes concerning the Form A transaction.” Although in our experience up until now regulators typically do not request such documents, the guidelines suggest that this may change, so acquirers should consider carefully how the deal is presented in internal written materials, including during the period of deal development and negotiation.
- The guidelines direct regulators to examine Form D filings (relating to proposed material affiliate transactions) for post-closing arrangements. This is relevant particularly where an acquirer plans to include the target in the acquirer’s existing inter-affiliate cost allocation agreements, tax-sharing agreements, reinsurance pools and other related party arrangements. Where possible, these proposed inter-affiliate contracts involving the target insurer should be submitted prior to closing, so that they can take effect at closing. The guidelines suggest that a Form D of this sort can be reviewed by the regulator in connection with its review of a Form A.
- The emphasis on market impact in category 7 seems very timely considering the regulatory obstacles (both at the state insurance regulatory and federal antitrust levels) facing the pending Anthem-Cigna and Aetna-Humana mergers.
Interested parties should submit comments on these guidelines to the working group by Aug. 19, 2016.