For much of the past 10 years, the National Association of Insurance Commissioners (NAIC) and individual state insurance regulators have highlighted their awareness of the increasing number of insurers controlled by private equity (PE) funds. The NAIC’s Capital Markets Bureau publishes an annual report about those insurers it considers to be controlled by PE funds, and the year-end 2020 report can be found here.

IN-DEPTH

Earlier this week, during a meeting of the Financial Stability (E) Task Force (the Task Force), it became apparent that the NAIC and state regulators are about to take a deeper look, assigning the task of coordinating said project to the Task Force’s subsidiary committee, the Macroprudential (E) Working Group. The Task Force is not the only NAIC committee that is looking at PE funds’ ownership or the control of insurers as the list of “regulatory considerations” below indicates. While PE funds control both property-casualty and life-annuity insurers, based on discussions during recent Task Force meetings, as well as several of the regulatory considerations below, it appears that regulators are most concerned with life and annuity insurers. Regardless, any and all types of re/insurers owned or controlled by PE funds should be paying attention.

At the same meeting, Superintendent of the Maine Bureau of Insurance Eric Cioppa (the Financial Stability Oversight Council’s (FSOC) insurance regulator representative) indicated in his report to the NAIC committee that the FSOC is aware that both state and federal regulators are monitoring PE fund investments in, and control of, life insurers. The Federal Insurance Office’s (FIO) Annual Report on the Insurance Industry (September 2021) confirms that the FIO has been monitoring—and will continue to monitor—the impact that PE fund control has on investment policies and practices of certain life and annuity insurers, as well as considering various management agreements with advisors of all kinds (including advisors that are fellow portfolio companies) and fee structures involved in these relationships.

As to the “deeper look” that the NAIC’s Macroprudential (E) Working Group will be taking, a list of topics to be considered was released during the Task Force’s session on December 7, 2021. The list makes clear that the considerations are not exclusive to PE-controlled insurers, but rather are generally applicable to any insurer whose holding company structure and affiliate relationships exhibit similar characteristics. Comments are due to NAIC staff by January 18, 2022.

Below is the list verbatim:

Regulatory Considerations Applicable (But Not Exclusive) to Private Equity (PE) Owned Insurers

A summary of currently identified regulatory considerations follows with no consideration of priority or importance …. Most of these considerations are not limited to PE owned insurers and are applicable to any insurers demonstrating the respective activities.

1. Regulators may not be obtaining clear pictures of risk due to holding companies structuring contractual agreements in a manner to avoid regulatory disclosures and requirements. Additionally, affiliated/related party agreements impacting the insurer’s risks may be structured to avoid disclosure (for example, by not including the insurer as a party to the agreement).

2. Control is presumed to exist where ownership is >=10%, but control considerations may exist with less than 10% ownership. For example, a party may exercise a controlling influence over an insurer through Board and management representation or contractual arrangements, including non-customary minority shareholder rights or covenants, investment management agreement (IMA) provisions such as onerous or costly IMA termination provisions, or excessive control or discretion given over the investment strategy and its implementation.

3. The material terms of the IMA and whether they are arm’s length —including the amount and types of investment management fees paid by the insurer, the termination provisions (how difficult or costly it would be for the insurer to terminate the IMA) and the degree of discretion or control of the investment manager over investment guidelines, allocation, and decisions.

4. Owners of insurers may be focused on short-term results which may not be in alignment with the long-term nature of liabilities in life products. For example, excessive investment management fees paid to an affiliate of the owner of an insurer may effectively act as a form of unauthorized dividend in addition to reducing the insurer’s overall investment returns. Similarly, owners of insurers may not be willing to transfer capital to a troubled insurer.

5. Operational, governance and market conduct practices being impacted by the different priorities and level of insurance experience possessed by entrants into the insurance market without prior insurance experience, including, but not limited to, PE owners. For example, a reliance on [third party administrators] TPAs due to the acquiring firm’s lack of expertise may not be sufficient to administer the business. Such practices could lead to lapse, early surrender, and/or exchanges of contracts with in-the-money guarantees and other important policyholder coverage and benefits.

6. No uniform or widely accepted definition of PE and challenges in maintaining a complete list of insurers’ material relationships with PE firms. (UCAA (National Treatment WG) dealt with some items related to PE.) This definition may not be required as the considerations included in this document are applicable across insurance ownership types.

7. The lack of identification of related party-originated investments (including structured securities). For example, this may create potential conflicts of interests and excessive and/or hidden fees in the portfolio structure. Assets created and managed by affiliates may include fees at different levels of the value chain. Regulatory disclosures may be required to identify underlying related party/affiliated investments and/or collateral within structured security investments. (An agenda item and blanks proposal are being developed by [Statutory Accounting Principles (E) Working Group] SAPWG.)

8. Though the blanks include affiliated investment disclosures, it is not easy to identify underlying affiliated investments and/or collateral within structured security investments.

9. Broader considerations exist around asset manager affiliates (not just PE owners) and disclaimers of affiliation avoiding current affiliate investment disclosures. (A new Schedule Y, Part 3, has been adopted and will be in effect for year-end 2021. This schedule will identify all entities with greater than 10% ownership—regardless of any disclaimer of affiliation—and whether there is a disclaimer of control/disclaimer of affiliation. It will also identify the ultimate controlling party. Additionally, SAPWG is developing a proposal to revamp Schedule D reporting, with primary concepts to determine what reflects a qualifying bond and to identify different types of investments more clearly, including asset-backed securities.)

10. The material increases in privately structured securities (both by affiliated and non-affiliated asset managers), which introduce other sources of risk or increase traditional credit risk, such as complexity risk and illiquidity risk, and involve a lack of transparency. (The NAIC Capital Markets Bureau continues to monitor this and issue regular reports, but much of the work is complex and time-intensive with a lot of manual research required. The NAIC Securities Valuation Office will begin receiving private rating rationale reports in 2022; these will offer some transparency into these private securities.)

11. The level of reliance on rating agency ratings and their appropriateness for regulatory purposes (e.g., accuracy, consistency, comparability, applicability, interchangeability, and transparency). ([Valuation of Securities (E) Task Force] VOSTF has previously addressed and will continue to address this issue.)

12. The trend of life insurers in pension risk transfer (PRT) business and supporting such business with the more complex investments outlined above ([Life Actuarial (A) Task Force] LATF has exposed questions aimed at determining if an Actuarial Guideline is needed to achieve a primary goal of ensuring claims-paying ability even if the complex assets (often private equity-related) did not perform as the company expects, and a secondary goal to require stress testing and best practices related to valuation of non-publicly traded assets. Additionally, enhanced reporting in 2021 Separate Accounts blank will specifically identify assets backing PRT liabilities.) Considerations have also been raised regarding the [risk-based capital] RBC treatment of PRT business:

    1. Review applicability of Department of Labor protections resulting for pension beneficiaries in a PRT transaction.

    2. Review state guaranty associations’ coverage for group annuity certificate holders (pension beneficiaries) in receivership compared to Pension Benefit Guaranty Corporation (PBGC) protection.

13. Insurers’ use of offshore reinsurers (including captives) and complex affiliated sidecar vehicles to maximize capital efficiency and introduce complexities into the group structure.”

As indicated above, this is not the first time that the NAIC will be scrutinizing these issues, including in connection with PE funds’ control of insurers. It’s also not the first time that regulators in individual states have done so. For example, in 2013, in connection with Form A change of control proceedings, the New York Department of Financial Services (DFS) acted to enhance policyholder protection in connection with the acquisition of three New York-domiciled life-annuity insurers. In two cases, the DFS imposed higher capital standards and required funding of backstop trust accounts, along with mandating stronger financial disclosures, more frequent financial reporting and increased scrutiny of reinsurance transactions, investments and dividends. In another case, the DFS acted to ban a prominent PE fund principal from exercising control or serving as an officer or director of insurers for seven years.