United States: Recent Developments At The NAIC Private Equity Issues (E) Working Group

The NAIC Private Equity Issues (E) Working Group ("Working Group") held a conference call on Thursday, October 23, 2014 and an open meeting on Saturday, August 16, 2014 at the NAIC Summer Meeting in Louisville, Kentucky ("Summer Meeting").

The Private Equity Issues (E) Working Group's 2014 charge is to "consider development of procedures that regulators can use when considering ways to mitigate or monitor risks associated with private equity/hedge fund ownership or control of insurance company assets, including the development of best practices and consideration of possible changes in NAIC policy positions as deemed appropriate."1 During the Summer Meeting, the Working Group focused on creating procedures and guidelines to help regulators evaluate the risks of private equity and hedge fund ownership of insurance companies. During the conference call on October 23, 2014, the Working Group reviewed specific comments and revisions made by Working Group members, the NAIC staff and Athene Holding Ltd. ("Athene")2 to the draft of Section E of the Financial Analysis Handbook ("Handbook"), as of October 23, 2014 ("Draft"). The Draft focuses on standards that regulators should consider in evaluating proposed transactions subject to a Form A (an application statement regarding the acquisition of control of or merger with a domestic insurer).

Recap of the Summer Meeting

During the Summer Meeting, Jim Armstrong, Deputy Commissioner and Chief Examiner of Iowa and Vice Chair of the Working Group, led a discussion on the treatment currently afforded to private equity and hedge funds' investments in insurers. He stated that the Working Group needed to develop some type of procedure or framework to review merger and acquisition transactions involving private equity firms (or hedge funds). Doug Stolte, Deputy Insurance Commissioner of Virginia and Chair of this Working Group, stated that a future conference call would be needed to discuss this issue further.

The Working Group considered whether to make changes to the Handbook in regards to the review of Form A applications by regulators. Both Cynthia Donovan, Insurance Chief Financial Examiner of Indiana, and Athene, submitted comments on the proposed changes to the Handbook.

Review of Form A Applications

During the October 23rd conference call, several of Athene's written comments in the Draft regarding disclosures by non-insurance members of a Form A applicant's holding company system were reviewed and discussed by the Working Group. The Draft currently recommends that regulators seek information from non-insurance affiliates regarding their investment portfolios if it is needed to fully evaluate the risks within a holding company system: "...the analyst should evaluate the potential enterprise risks posed to the insurer from other non-insurer group members, and may need to request information regarding the investment portfolio of the entire [holding company] group." Athene proposed including a confidentiality provision to protect any additional information regarding the investment portfolio of members of the holding company system that may be provided by non-insurer affiliates: "In all cases where information is sought relating to non-insurer affiliates, controlling persons and other equity holders, care should be taken to ensure that confidentiality of such information can be appropriately protected." During their review of this proposed addition, the Working Group did not voice any objections. Such non-insurer affiliates may include hedge funds and private equity owners who may be harmed if any of their confidential information or investment strategies are released to the public. Currently, states have varied confidentiality statutes, and the inclusion of this confidentiality provision in the Draft may ensure a minimum level of protection to any disclosures by non-insurer affiliates.

The Draft also suggests that regulators employ investment specialists to help evaluate complex investment portfolios of non-insurer affiliates. Athene had suggested that the terms "investment banker" and "actuary" be included in the language describing the types of specialists that should be engaged. The Working Group accepted the insertion of "actuary," with certain members of the Working Group agreeing that an actuary may be able to aid regulators in evaluating an investment portfolio. The Working Group, however, rejected an explicit reference to "investment banker" as a type of specialist involved. Some of the Working Group members believed that there were professionals other than solely bankers who may be involved in or may be knowledgeable of complex investments.

When discussing evaluation of investment portfolios and strategies, the Draft suggests that regulators determine whether each holding company system member's "investment strategy and related affiliated agreements are appropriate for the backing of the insurance contracts from a risk and asset/liability matching perspective." Athene's written comments expressed concern that regulators may "substitute his or her own judgment on the appropriateness of the insurer's investment strategy." Athene was concerned that the word "appropriate" was too subjective and would provide regulators with too much discretion in evaluating whether an investment strategy were acceptable. The Working Group addressed this concern by adding the phrase "or not excessively risky" after "appropriate". Overall, the language introduced by the Working Group limits regulatory discretion and raises the standard for rejecting an application based on an insurer's or its affiliates' investment strategies.

The Draft also contemplates that the regulators review and determine whether private equity firm fees and other fee structures charged or to be charged to the insurance company, as well as any similar arrangements between the insurance company and broker dealers, are reasonable. Athene proposed language to limit the review of the reasonableness of these arrangements to only proposed arrangements. The Working Group, however, decided to expand the scope to include review of existing arrangements as well. Athene had also proposed that arrangements between the insurance company and only "related" broker dealers be reviewed. The Working Group decided to narrow the scope by changing "related" to "affiliated" broker dealers.3 None of the Working Group members and interested parties had any questions or issues regarding these revisions.

Additional Stipulations from Form A Applicants

After evaluating a transaction, regulators are permitted to seek additional stipulations from Form A applicants if the applicants are unable to satisfy general standards in connection with a Form A. Athene had suggested that these stipulations be broken into two categories: "Stipulations for limited period of time (e.g. 3-5 years)" and "Continuing Stipulations". The Working Group members decided to keep in the Draft the two-category structure proposed by Athene.

In regards to the "Stipulations for limited period of time," the Working Group discussed whether the example time frame of "3-5 years" should be included in the description of the category. Mr. Armstrong believed that this suggested time frame should be removed and that the duration of these stipulations should be a negotiated point between individual insurance companies and regulators in their domiciliary states. Other Working Group members agreed and did not want to be "boxed in" to a specific time frame. Mike Maffei, Chief of the Life Bureau of the New York Department of Financial Services, believed that the "3-5 years" time frame was simply a "permissive and suggested guideline" and that he did not see it as restrictive. He specifically mentioned that currently many such stipulations were required to be provided by applicants in New York for 7 years. After further discussion, the Working Group decided that the "3-5 years" example would be removed from the Draft.

The Draft also contains a stipulation that requires that risk-based capital be maintained at a certain percentage of company action level. The Draft contemplates a range of "400-450%", which Mr. Armstrong believed was "quite high". He stated that there were insurance companies in Iowa that manage to the 300-425% range or greater, but he believed that the level should be negotiated between the applicant and state regulators. Dale Bruggeman, Chief of Risk Assessment Policy and Development, Foreign Analysis, and Administration at the Ohio Department of Insurance, suggested that the reference to a specific percentage be removed to prevent regulators from being "boxed in" to a specific level and that the phrase "trends-test action level" be added into the stipulation. The Working Group decided to accept the changes and modified the stipulation as follows: "Requiring RBC to be maintained at a specific among above company action level/trends-test action level."

State regulators from Virginia suggested that a new "continuing stipulation" be added to require prior Commissioner approval for "material arms-length, non-affiliated reinsurance treaties or risk-sharing agreements." Mr. Stolte stated that this stipulation was important due to the speed with which the financial condition of an insurer can change due to reinsurance. The provided language had been mentioned in previous Working Group meetings, and there were no objections from any of the Working Group members and interested parties. The Draft does not specifically list which parties and which types of acquisitions the stipulation applies to, but it would most likely apply to any acquisition or merger and any party who engages in a reinsurance treaty or risk sharing agreement, including hedge funds and private equity owners.

The Working Group also discussed Athene's suggestion to add a phrase to the "continuing stipulation" requiring the "filing of the audit reports/financial statements of each equity holder of all intermediate holding companies." Athene proposed in a written submission at the Summer Meeting to add the following qualification to the end of the stipulation: "but considering the burden on the acquiring party against the benefit to be received by the disclosure." The Working Group accepted this additional clause, reasoning that it would not limit the stipulation and seemed to be a reasonable consideration for regulators to take note of before requesting such audit reports and financial statements.

The Working Group then reviewed and discussed an example Indiana regulators requested be included in the language describing another "continuing stipulation". This stipulation requires the "filing of personal financial statements for each controlling person or entity of the insurance company and the intermediate holding companies up to the ultimate controlled person company." Indiana regulators suggested that they would be more comfortable with the stipulation if an example of a "controlling person" were provided. The following sentence was added: '"Controlling person' could include, for example, a person that has a management agreement with an intermediate holding company." However, it should be noted that the definition of "control" in Section 1.C of the Act already includes persons with managerial control: '"control' means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person whether through the ownership of voting securities, by contract other than a commercial contract for goods or nonmanagement services, or otherwise..."

After an application is approved, state regulators may continue to perform annual or targeted examinations of certain risks of the holding company system's members. These examinations may include the review of the members' "investment management and other affiliated agreements..." The previous draft provided for these reviews to be conducted on an ongoing basis. Athene suggested replacing the word "ongoing" with "periodic". The Working Group rejected Athene's suggestion, and modified the provision to provide for "periodic and possible ongoing review." This change provides regulators with the ability to conduct targeted reviews or examinations, as needed.

Preview of Fall National Meeting

Mr. Stolte informed the Working Group members that Igor Rozenblit, Senior Specialized Examiner in Private Equity and the co-head of the U.S. Securities and Exchange Commission (the "SEC") Office of Inspections and Examinations, would be giving a 30 minute presentation at the Fall National Meeting in November. Mr. Armstrong and Mr. Stolte also plan to discuss the issue of preferred investors with the SEC. The Working Group members will also have a chance to review a revised copy of the Draft at the meeting following the presentation.

Mr. Stolte plans for the Draft, as recommended guidance to the Financial Analysis (E) Working Group, to be adopted at the Fall National Meeting. He would like to hear the views of the SEC before finalizing the Draft, however, given the possibility that the SEC provides a new perspective that should be addressed in a further iteration of the Draft. There were no objections to this approach from any Working Group members or interested parties.


1 http://www.naic.org/committees_e_private_equity_wg.htm.

2 Athene is a life insurance holding company that, through its subsidiaries, focuses on insuring and reinsuring fixed and equity indexed annuities.

3 "An 'affiliate' of, or person 'affiliated' with, a specific person, is a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the person specified" (Section 1.A. of the Insurance Holding Company System Regulatory Act Model 440 (the "Act")).

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