The last few years have seen increasing private fund activity in the insurance sector, including acquisitions of existing carriers as well as start-ups. Organizations as diverse as Apollo, Harbinger Group, Third Point and Blackstone, and a number of others, have made significant investments in portfolio insurance companies and related businesses. As commentators have observed, insurance companies can be attractive as a source of “permanent capital” in an industry where equity must generally be deployed or returned to investors. Insurance investments also offer risks and rewards that may not be correlated with macroeconomic conditions such as interest rates or price levels. In addition, insurance businesses can take advantage of a variety of nimble hedging mechanisms such as reinsurance and insurance-linked securities to manage exposures. However, in this highly regulated sector, an understanding of some of the basic pillars of insurance law — particularly the oversight by regulators of those who control insurers — is essential for playing in this space. This article focuses on such oversight and what it can mean for acquirers and management. In future editions of FundsTalk we will cover related areas such as ancillary transactions (including reinsurance) and statutory determinations of control in the context of fund structures.
Regulating Control over U.S. Insurers
An entity seeking to acquire control of an existing insurer must file a detailed application (known generally as a “Form A”) with, and obtain the prior approval of, the domiciliary state regulator. Once acquired, a controlled insurer must report periodically to the regulator on its relationships with its holding company (affiliate transactions, changes in management and similar events), including a requirement under certain circumstances to pre-file affiliate transactions with the regulator.
“Enterprise Risk” and “Own Risk Solvency Assessments”
In late 2010, the National Association of Insurance Commissioners (“NAIC”) adopted new requirements concerning so-called “enterprise risk,” defined broadly as any “activity, circumstance, [or] event…that, if not remedied promptly, is likely to have a material adverse effect upon the financial condition or liquidity of the insurer” or its affiliate group. Form A applicants seeking approval to control an insurer will be required to commit to the regulator in writing that it will comply with these enterprise risk requirements, including annual reporting obligations to the “lead” state of an insurance group. A number of states have already adopted these requirements (including key insurance jurisdictions such as Connecticut, California and Texas); accordingly, some companies will be required to begin filing enterprise risk reports with their principal state regulator as soon as early 2014.
Similarly, the NAIC has formulated rules concerning so-called “Own Risk Solvency Assessments,” or “ORSAs.” These rules will require insurers or their affiliate groups to conduct self-examinations intended to determine risks to the insurer’s current business plan and the sufficiency of capital to support those risks. Summaries must be filed annually with the lead state. An exemption is available for an insurer whose annual premiums are less than $500 million and whose total annual premiums together with those of its affiliates are less than $1 billion. As with the enterprise risk requirements, the new ORSA provisions are in the process of being adopted on a state-by-state basis, with January 1, 2015 being the expected date by which all ORSA requirements should take effect.
- Document submissions. In most (but not all) states, a Form A is a public document; the Holding Company Act does not shield it from disclosure and, therefore, it falls under typical state-law provisions on open records. Although most states do not post submitted Form As on their insurance department websites, some do, and this can include the underlying legal documentation (such as the purchase and sale agreement) required to be annexed to the Form A.
Notwithstanding these general statutory require- ments, regulators will frequently entertain requests to keep materials within a Form A (such as detailed business plans, trade secrets and certain financial disclosures) confidential. However, this willingness varies from state to state, and even a particular state’s grant of confidentiality to components of a Form A in a previous deal cannot be regarded as precedential. Information rarely shielded from public disclosure includes basic deal terms and the underlying deal documentation.
By contrast, annual registration statements, notifications of affiliate transactions, enterprise risk reports and ORSA summaries are all accorded confidential treatment.
- Public hearings. In some states, a regulator is permitted or even required to hold a public hearing on the merits of the Form A. Such a hearing can give aggrieved parties (such as employees, competitors, policyholders and other suitors of the target company) an opportunity to attack the transaction and urge the regulator to disapprove it. Where the regulator concludes that such a party would be particularly affected by the transaction, she can permit such party to formally intervene in the proceedings or even grant party status. As a legal matter, this is difficult to achieve, because the regulator is limited to examining the specific criteria set forth in the statute for purposes of reaching a decision on a Form A. Similarly, as a practical matter, regulators generally wish to avoid contentious hearings and will usually try to coax parties toward a consensual outcome prior to any such hearing. As with the other requirements discussed herein, care should be taken in navigating these filing and approval procedures, making appropriate disclosures and communicating with the regulator generally — a fund’s ability to enter or compete in the space increasingly depends on it.