Last week, in Orlando, the NAIC’s Private Equity Issues Working Group (the Working Group) held its second meeting. At meetings of most of the other NAIC working groups formed in recent decades to address specific industry segments or participants, representatives of affected insurers/brokers/buyers have been visible and active. Not so with the Working Group in Orlando; no capital providers submitted comments to the Working Group since Apollo/Athene did so at the first meeting in December 2013 and no representatives appeared before the Working Group in Orlando. The Working Group decided to move ahead with its mission to identify tools, procedures and metrics that regulators can use to monitor and reduce risks some regulators believe could be associated with the growing numbers of U.S. insurers now owned or controlled by one or more private equity/hedge/pension funds (Funds). Based on public discussion among members of the Working Group in Orlando and on our private discussions with regulators either participating in the Working Group or closely following its deliberations, the following early trends appear:
- Both Form A proceedings involving proposed acquisitions of control by Funds and financial examinations of insurers already controlled by Funds should focus on the relevant risks presented by the business plan of the proposed acquirers or investment policies of the insurer, rather than on the fact that Funds are seeking to control or already control an insurer..
- Notwithstanding the foregoing, regulators decided to comb through regulatory precedents to determine what risk-mitigation devices have been utilized by regulators when considering applications to acquire control by Funds and for ongoing regulatory compliance, including:
Increasing capital and/or requiring capital/surplus maintenance agreement;
Establishing trust accounts for the benefit of policyholder;
Increased regulation (e.g., prior approval, not just filing) around affiliate reinsurance, investment management, administrative services agreements, etc. (the SEC’s ongoing review of fees and expenses charged to portfolio companies may play into this); and
Enhanced or more frequent financial reporting (e.g., Iowa requires its domestics to submit quarterly updated investment strategies).
(Note: Several regulators have stated to us, in effect, that “we have all the necessary tools; it is a matter of using them appropriately.”)
- There is considerable uncertainty as to just what response regulators may develop to the question whether Funds must be held to some higher standard in Form A proceedings. Some regulators agree, as urged by Apollo/Athene, that acquirers backed by Funds should be held to the same standards that apply to other acquirers. Others suggest that Form A applications submitted by Funds ought to be tested in ways that Form A applications typically are not tested. For example, regulators might wish to engage investment bankers or investment professionals to vet proposals submitted by Funds (something that occurs routinely in “big” deals and specialty proceedings such as demutualizations). Stress testing pro forma financial projections submitted in Form As was another suggestion (something that captive insurance regulators in some states routinely require for new applications).
- Using other existing tools such as supervisory colleges to maximize regulatory coordination, particularly when Funds or insurance groups controlled by Funds are not U.S.-based.
Regulatory Activity During the Balance of 2014
In Orlando, the Working Group decided to have NAIC staff begin compiling a guidebook that will apparently list U.S. insurers controlled by Funds and survey U.S. insurer investments in private equity and hedge funds.
NAIC staff was also tasked to proceed with drafting guidance points. This would seem to be somewhat premature and some regulators seemed to sense this. One regulator asked that staff pay attention to how “private equity” is defined. We suspect that sooner or later staff will begin to look at differing business models of Funds, with some private equity funds handling investments for insurers they own using strategies that comply with insurer investment laws and some hedge fund-owned reinsurers investing all or substantially all of investable funds in an account controlled by and invested per their hedge fund owner(s) prevailing investment strategy/strategies.