State insurance laws impose restrictions and regulatory oversight on the oversight of insurance companies by parent companies and related entities. Such regulation of âinsurance holding companiesâ, which has been in place since at least the early 1970s, is a major focus of the insurance regulatory framework in the United States.
Historically, the main features of the regulation of holding companies, as set out in the Law on the Regulation of the System of Insurance Holding Companies (Holding Companies Law), a point-based model law contact between an insurance company and its subsidiaries.
The Holding Companies Act, issued by the National Association of Insurance Commissioners, regulates insurance groups (i.e. insurers and their related entities) largely taking into account the activities between them. insurer and other group companies. This orientation was designed to expose and deter conflicts of interest that could enrich a holding company to the detriment of policyholders. New York’s insurance holding company laws are codified in Section 15 of the Insurance Act, which, while not based directly on the NAIC model, is functionally similar.
For a little over a decade, the NAIC (which is the umbrella organization of state insurance regulators) introduced new provisions into the Holding Company Act that focus more broadly on risks within an insurance group as a whole, as opposed to these single points of contact. between separate legal entities. These changes were driven by the perception that insurers are at risk not only because of their activities with affiliates, but also because of the nature of the insurance group itself. Reputational and other risks at the parent company, it has been thought, can harm the insurance company even in the absence of a specific transaction or activity between them.
The main reform, adopted at the end of 2010, aimed to regulate the âbusiness riskâ of an insurance group, generally defined as any activity or circumstance involving subsidiaries of an insurer which, if not corrected quickly , is likely to have a material adverse effect on the financial position or liquidity of the insurer or its group as a whole. In 2012, a related model law, the Model Law on Risk Management and Assessment of Risks and Solvency (RMORSA), was added to require insurers to monitor and report on adequacy capital at group level, and not just at the level of the regulated insurance entity itself. -a significant departure from the previous law. New York implemented its versions of the 2010 and 2012 reforms primarily through administrative action, Financial Services Department (DFS) Regulation 203 adopted in 2014.
Many other states have adopted the changes to the Holding Company Act and the RMORSA into their own laws and regulations. The NAIC passed additional amendments to the Holding Companies Act, dealing with international insurance groups, group capital levels, and certain consequences of insolvency, in 2014, 2020 and 2021 respectively.
The decade in which these reforms were in effect saw the continued involvement of financial investors, such as private equity funds and hedge funds, in insurance, particularly in the life sector. A July 2021 special report from AM Best, one of the leading insurance industry analysis companies, indicates that the total capital and surplus of privately held life insurers has grown significantly in proportion of total capital and surplus in the US life industry.
A September 2021 article in The Wall Street Journalhighlighted some of the policyholder issues associated with private equity ownership of insurers. (It should be noted that in 2014, the New York DFS passed even stricter rules to govern acquisitions of private funds by life insurers, including the regulator to require those funds to create trusts for protect policyholders.)
When it comes to regulatory oversight of fund-owned insurers, however, the tools provided by the 2011-2021 changes may not be as useful as the old components of the Holding Companies Act, such as the regulation of holding companies. transactions between affiliated companies, the qualifications of portfolio management and leverage holding companies. These old âbread and butterâ tools should be the main recourse for regulators when considering fund-owned insurers.
Possible limitations of the group approach
As mentioned above, the concept of âbusiness riskâ was designed to examine the characteristics and activities of holding companies that could affect the insurer. This motivation was born from the financial crisis of 2008; observers had noted that large insurance companies had subsidiaries engaged in non-insurer aspects of the financial world such as credit derivatives and securitization. Such companies, they feared, could have a “contagion” effect on the group’s insurers.
Of course, funds that own insurers can be involved in many other activities through their other holding companies. This may suggest that the logic of enterprise risk is equally (if not more) applicable for these parent companies. However, funds keep portfolio companies fairly circumscribed; the companies acquired generally do not expect any âkeepwellâ or similar solvency guarantee from a parent company of the fund. The portfolio companies keep their individual brands distinct in the eyes of consumers.
Additionally, while funds may try to achieve synergies between portfolio companies in related industries, a fund does not attempt to become a functioning business itself. To be successful, a fund remains focused on returning profits to investors by being an aggressive buyer and seller of companies, rather than immersing themselves in a single product line.
As a result, business risk, in the context of fund-owned insurers, becomes less of a factor faced by individual holding companies. Trying to identify a “contagion” that the fund can spread to the insurer is elusive, and an insurance regulator that takes into account the integrity and strength of the insurer’s holding company system would be wiser. to focus on the contact points which may reveal a real risk.
The old âpoint of contactâ model
In acquisitions by funds of insurance companies, regulators indeed focus intensely on touchpoints, suggesting the useful limits of the enterprise risk model. As an example, consider transactions between affiliates. The holding company law has historically required that contracts between insurers and their affiliates be fair and reasonable. Certain categories of these contracts must be submitted and not challenged by state regulators before they come into effect. These include intercompany service agreements, where insurers pay a fee to affiliates for the services.
It is not uncommon for funds that own insurers to provide insurers with services, such as investment management, for a fee, and regulators are likely to focus on the fees associated with the services to determine if they are fair. and at arm’s length from the insurer.
Another example is management skills. The Holding Company Act treats the directors and officers of a parent insurance company primarily as principals of the insurer itself. This means that these people must undergo a thorough screening (often including background checks) before they can be seated in a takeover. The acquirer will need to provide biographical affidavits (in a form promulgated by the NAIC) as part of its application to the regulator to be authorized to acquire control of the insurer. In many states, including New York, fingerprints are also required.
In a fund scenario, regulators have become mindful of the importance of reviewing the track records and credentials of director and executive counterparts, for example, fund general partners, managing members, and investment managers. Once again, this rigor does not come from the corporate risk reforms of the 2010s, but from the pre-existing provisions of the law on holding companies.
Holding company leverage refers to the reliance a parent entity may have on insurance company dividends to service parent company debt or other obligations. of the parent company. If such dependence is too great, the regulator may seek to take measures to isolate the financial resources of the insurer. Although the leverage of holding companies is not expressly mentioned in the holding company law, regulators have historically applied the concept to making decisions about potential acquisitions of insurers.
An acquirer is typically required by the state regulator to submit, as part of its submission to the Holding Company Act to Acquire Control (known as Form A), a business plan for the target. (In New York, a five-year plan of operations is specifically required by section 5 (b) (1) of the DFS implementing instructions coded at 11 NYCRR 80-1.6.) For funds, this regulatory variable may be particularly appropriate given the frequent use of leverage by funds when making acquisitions.
Explosions from the past?
It is conceivable that the assessment of enterprise risk, own risk and solvency and similar group concepts could detect significant risks for policyholders when a fund is the controlling shareholder of the insurer. Funds certainly have their own distinct practices, objectives and characteristics that overlap with several portfolio companies.
However, when it comes to identifying the types of contingencies and exposures that are most likely to make a difference to policyholder outcomes, the older aspects of touchpoint-based holding company regulation seem more likely to be deployed by regulators and better suited to the regulator’s task. Since many of these tools have been around since the 1970s, we can only hope that they won’t bring back loose ties or casual suits with them.
Originally published by the New York Law Journal on November 12, 2021.
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