The National Treatment and Coordination (E) Working Group of the National Association of Insurance Commissioners (NAIC) exposed, on July 21, 2016, a draft of best practices for insurance regulators to use in carrying out the Form A review process (the “Best Practices”). Although these proposed Best Practices are targeted to regulators – intended to guide their review of Form A filings – they also provide valuable guidance to the industry on areas regulators will likely focus during their review.
The Best Practices also raise fundamental questions regarding state insurance regulators’ roles in reviewing insurance company acquisitions and the prospect of regulatory creep; whether the potentially vast expansion of regulatory oversight suggested by the Best Practices has support in existing law and regulation is debatable.
In June 2008, in the immediate aftermath of the financial crisis and responding to the EU's Solvency II project, the NAIC launched the Solvency Modernization Initiative (SMI) to critically review the insurance solvency regulation framework in the U.S. and create a roadmap for improvement based on the results of its review.
Among other things, the NAIC concluded that there was a need to enhance systems for group supervision, resulting in the 2010 amendments to the Insurance Holding Company System Regulatory Act and accompanying Regulation. At the time, there was a consensus to adopt, at a future date, a guide outlining best practices insurance regulators should use in their review of holding company act filings, such as Form A acquisition of control filings.
The NAIC has finally exposed the draft Best Practices. This is indeed the second time the NAIC has issued guidance to state insurance regulators regarding Form A filings. In 2015, the Private Equity Working Group (now disbanded) adopted guidance that was added to the NAIC’s Financial Analysis Handbook, which was thought necessary at the time because of increasing acquisitions of insurance companies (principally annuity issuers) by private equity and other funds.
The Proposed Best Practices
The proposed Best Practices set forth instructions and considerations for insurance regulators covering nine main topics:
- Initial Review;
- Background, Identity and Risk Profile of Acquiring Persons;
- Communication and Record Maintenance;
- Transaction Review;
- Purchase Consideration;
- Insurer Operations;
- Market Impact;
- Post-Approval Considerations; and
- Post-Acquisition Considerations.
The Best Practices note that they are merely a guide for regulatory review and that every review of a Form A filing should be customized with consideration for the risks of the target company and the acquiring entity and the nature of the transaction. It remains to be seen the extent to which use of this “guide” will become widespread, thus potentially increasing regulatory oversight of insurers, holding company systems and acquiring parties.
Generally, the Best Practices will promote highly detailed review of the Form A filing, and include numerous considerations for regulators regarding the feasibility and suitability of various elements of a Form A transaction. These considerations include the feasibility of the new holding company group and control structure, the suitability of the ultimate controlling parent, and the suitability of any new affiliated and non-affiliated material agreements. In our experience, experienced regulators in more sophisticated states already incorporate many of these elements in their Form A review.
Insurance regulators are also encouraged to contact other reviewing insurance regulators, including the lead state regulator, and, if applicable, other noninsurance regulators of the target or the acquiring party. Such regulatory communication and information sharing could potentially raise confidentiality issues, and it calls into question the need for involvement of regulators unrelated to the statutory scheme.
Comparison with Model Form A Statute and Regulation
Some of the considerations contained in the Best Practices parallel the required items under the Model Form A statute and regulation. Nevertheless, the Best Practices reflect a more detailed and hands-on approach to Form A review. For example, the Best Practices call on regulators to scrutinize elements of a transaction that are often not traditionally within their purview, such as the propriety of disposition of minority interests and compliance with conditions precedent and conditions subsequent in the transaction documents. Regulators are also called on to scrutinize complex structures for “hidden ownership” interests, and consider plans for technological interfacing with new affiliates and any potential adverse impact on operations. Such considerations reflect recognition that acquisitions increasingly are driven by financial rather than strategic buyers, and the importance technology has for the operations of insurers.
The Best Practices also direct regulators to carefully monitor the target following closing. While such monitoring often takes place in practice, the Best Practices suggest more process, such as monitoring market performance compared to projections for two years after the closing, and requesting a semiannual report under oath of the target’s operations, including the integration process, changes to employment, changes to offices and notice of compliance or actions taken by other state regulatory authorities. Thus, under the Best Practices, regulators are expected to be actively involved in overseeing the completion of the Form A transaction and monitoring its consequences. This focus on long-term operations of the target insurer could possibly encourage regulators to substitute their own business judgment for business judgment of management.
In a time of increasing investments in insurers by financial, private equity and hedge funds buyers, as well as by non-U.S. investors with often opaque ownership structures, the proposed Best Practices reflect an effort by regulators to closely monitor potential risks such transactions present.
To this end, the Best Practices call for increased scrutiny of ownership structure and post-closing changes in the target insurer’s operations. However, how effective regulators will be in utilizing this information, whether it is appropriate for them to do so, and whether the current regulatory scheme will benefit as a result, remains to be seen.
Comments on the proposed Best Practices are due to the NAIC by close of business on Friday, August 19, 2016. We anticipate that industry organizations and other interested parties will provide the NAIC with comments. We will review those comments with great interest and will report further as developments warrant.