Six weeks ago, in our last Client Alert on this general topic, New Capital, New Regulations?, we reported that at the NAIC’s Orlando Meeting regulators concerned with various perceived risks associated with the growing number of insurers, particularly annuity writers, owned or controlled by one or more private equity/hedge funds (Funds), had instructed NAIC staff to begin drafting appropriate guidance for regulators to use in connection with change of control or Form A proceedings.
Last week, not waiting for further NAIC deliberation, the New York Department of Financial Services (the Department or NYDFS) put down an early marker in the form of proposed amendments to Regulation 52 – the state’s insurance holding company system regulation – by adding some new requirements but mostly codifying existing departmental practice. Assuming the proposed amendments are ultimately adopted as proposed following a 45 day comment period, acquirers of New York domestic insurers – life, annuity, P&C and others – would be required to provide:
- Five year plan of operations, including five years of financial projections. While some other states (e.g., Pennsylvania) also require five year projections, the general rule in the rest of the country is three years. The Department’s proposal would also require the applicant to update plans of operation/financial projections and expand them to cover an additional five years if certain related party transactions are proposed within the first five year period.
- Copies of any materials used by the applicant to solicit investors funding the proposed acquisition.
- Financial statements and related information, including NAIC standard form biographical affidavits, for managers, managing members, or similar persons for any LLC or general partner of an LP/ LLP and all partners of any partnership AND each person controlling any such manager, managing member, general partner, partner, et al, i.e., underscoring the Department’s existing practice of going “up the chain” to individual controllers AND requiring the filing of any “operating agreement, management agreement, partnership or limited partnership agreement, or any other contract or agreement, pursuant to which any person…controls or purports to control the applicant or any other person identified [as a controller].”
- Statements with respect to any plans or proposals that the applicant(s) or anyone mentioned above may have to declare any dividends or to change the insurer’s investment portfolio – bearing in mind that any change in such plans or proposals must receive the Superintendent’s prior written approval.
- A Regulation 114-style trust account, with amount and duration to be determined by the Superintendent, if the acquisition would otherwise “likely…be hazardous or prejudicial to the insurer’s policyholders or shareholders.” We note that the Department has already required establishment of trust accounts in connection with recent acquisitions of annuity writers.
A Level Playing Field?
During the deliberations of the NAIC’s Private Equity Issues Working Group and in the only comments submitted to regulators by Funds’ representatives, concern was expressed that holding company rules and standards applicable to change of control applications should be the same for all parties. The proposed Regulation 52 amendments would, in theory, hold Funds to the same standards that apply to other acquirers. However, it remains to be seen whether, as a practical matter, the Department will find that only Fund acquirers trigger the requirement to place additional surplus into a trust.
But the impetus for the proposed filing and disclosure – and perhaps financial support – requirements is unmistakably linked to the Department’s observation that “[p]rivate equity-controlled insurers now account for nearly 30 percent of the indexed annuity market (up from seven percent one year ago) and 15 percent of the total fixed annuity market (up from four percent one year ago).”
If further explanation is needed, the Department’s Regulatory Impact Statement notes the regulators’ concern that Funds “focus on maximizing their short term financial returns rather than ensuring that long-term policyholders receive the insurance benefits for which they have paid….They may not be long-term players in the insurance industry, and their short-term focus may result in an incentive to increase investment risk and leverage in order to boost short-term returns.” Perhaps, however, regulatory concerns with respect to insurer investment management by Fund acquirers could be best addressed by amending the investment laws and/or monitoring insurer investment strategies more closely.
Life vs. Non-Life Transactions
The proposed changes could affect acquisitions of any New York domestic insurer, not just acquisitions of domestic life insurers. For example, the trust account provision, a tool that the Department has recently used in connection with conditioning approvals of changes of control of annuity issuers, “merely …highlight[s] the Department’s findings and concerns relating to acquisitions of life insurers. The Superintendent always had, and retains, the discretion to condition an acquisition, in appropriate circumstances as needed, on the fulfillment of additional requirements, including the use of a trust or other financial backstop where a non-life insurer is being acquired.” NYDFS Regulatory Impact Statement, at 2 (emphasis added)
A New and Improved Poison Pill?
Nearly 25 years ago, in Sir James Goldsmith’s titanic struggle to acquire control of UK-based B.A.T. Industries, the latter’s ownership of Farmers Insurance was referred to by some observers as a form of poison pill. The disclosure and filing requirements, the required public hearings and the sheer delay that fully-litigated Form A proceedings in multiple states could produce functioned as an effective deterrent – indeed Sir James and his allies ended their bid after the California Department of Insurance failed to approve the proposed acquisition of Farmers. Recall that in the B.A.T. deal, AXA-Midi had planned to acquire Farmers for $4.5 billion, all of it borrowed. New York’s proposed enhanced Form A disclosure and filing requirements together with the robust statement of the Department’s discretion to take whatever action is required to protect both policyholders AND shareholders should confirm to prospective acquirers of New York domiciled insurers that, at a minimum, NYDFS Form A proceedings will be longer and more thorough than they have been in the past.
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Should you have any questions or want more detailed information about the NYDFS’ proposal please feel free to call or email the authors or any of the Drinker Biddle Insurance Regulatory and Transactional team.