State and federal policymakers, including the National Association of Insurance Commissioners (NAIC) and Sen. Sherrod Brown (D-OH, Chairman of the Senate Banking, Housing, and Urban Affairs Committee) recently renewed their interest in private equity (PE) interaction with insurers. The NAIC’s Macroprudential (E) Working Group (MWG) was tasked with developing a strategic risk assessment tool and coordinating the activities of the NAIC regarding agreements between venture capital insurers. The charge resulted in an initial list of far-reaching considerations regarding the involvement of private equity firms in insurance and the ability of state insurance regulators to adequately monitor and assess risk. of such involvement (List of PE Considerations).
An initial list of PE considerations has been outlined by the NAIC’s Financial Stability (E) Task Force (FSTF) for a 30-day comment period ending January 18, 2022. The list was adopted by the MWG on February 1, 2022, and subsequently adopted by the FSTF on February 22, 2022.
List of PE Considerations
The current version of the list of private equity considerations identifies 13 observations related to private equity investment and insurer oversight which, in general, relate to the ability of regulators to effectively monitor affiliate transactions, determining whether “control” exists for insurance regulatory purposes, mitigating potential conflicts of interest, preserving the autonomy of insurers and ensuring financial stability. The current version also includes a baseline of activities and potential next steps for the first six sightings (discussed in more detail below). The list of PE considerations includes the following notable observations:
- Regulators may not get a clear picture of risk due to: holding companies structuring contractual arrangements to avoid regulatory disclosure requirements; and agreements between affiliated parties affecting an insurer’s risk that may be structured to avoid disclosure.
- Control may exist with less than 10% ownership, for example, one party may exercise dominant influence over an insurer through board representation or contractual arrangements, including non-standard rights or liabilities minority shareholders, the investment management agreement (IMA) provisions such as onerous or costly IMA termination clauses, or excessive control or discretion given to the investment strategy and its implementation.
- The material terms of IMAs and whether they are arm’s length transactions (including the amount and types of investment management fees paid by the insurer, termination provisions and the degree of discretion or investment manager’s control over investment guidelines, allocations and decisions).
- Insurer owners can focus on short-term results that may not match the long-term nature of life insurance product liabilities. For example, excessive investment management fees paid to an affiliate could effectively act as a form of unauthorized dividend in addition to reducing the insurer’s overall investment return or owners may be unwilling to transfer capital to an insurer in difficulty.
- Possible increased risk and lack of transparency related to significant increases in privately structured securities.
- Concern of the regulator regarding the level of confidence in the ratings of the rating agencies and their relevance for regulatory purposes.
- The tendency of life insurers to transfer pension risk (PRT) and supporting these activities with some of the most complex investments.
- Insurers’ use of offshore reinsurers (including captives) and complex parallel affiliate structures to maximize capital efficiency could introduce complexities into the structure of the insurance group.
Current status and next step
On April 5, 2022, the FSTF and MWG reported that the list of PE considerations had been updated after meetings with the chairs of other NAIC finance, investment, accounting, and actuarial committees and a discussion reserved for regulators on March 25, 2022. These discussions resulted in the addition of an introductory paragraph on solvency control (for “spectators” who are not familiar with insurance regulation), established a baseline of activities and included a plan for how regulators will move forward on the first six of 13 observations. The baseline includes a list of current regulatory tools, parallel NAIC workflows, and potential actions.
The results of the discussion for the remaining seven observations are expected to be drafted at regulator-only meetings prior to the NAIC’s summer national meeting (to be held in Portland, Oregon, August 9-13, 2022) and presented for comment. It should be noted that consideration of any potential action items identified as a result of the process of drafting the list of PE considerations (e.g., changes to model laws, regulations, or NAIC manuals, or additional reporting or disclosure requirements by insurers) would be subject to their own adoption. process (including opportunities for public review and comment).
Letter from Senator Brown to FIO and NAIC
On March 16, 2022, Senator Sherrod Brown (D-OH, Chairman of the Senate Banking, Housing, and Urban Affairs Committee) sent a letter to the Federal Office of Insurance (OIF) and the NAIC which “express[ed] fear that the insurance investment products that workers depend on for their retirement will be transferred to these risky companies [private equity firms] who are used to undermining pension and retirement programs. Accordingly, the letter directs the FIO, in consultation with the NAIC, to collect additional data and issue a report to Congress addressing each of the six concerns:
- The risks that more aggressive investment strategies pursued by private equity-controlled insurers pose to policyholders;
- The risks that lending and other “shadow banking” activities carried out by companies that also own or control significant amounts of life insurance-related assets pose to policyholders;
- Are there risks to the wider economy associated with the investment strategies, lending and other “shadow banking” activities pursued by these companies;
- For pension risk transfer agreements, the impact on the protections of pension plan beneficiaries if the plans are terminated and replaced by lump sum payments or annuity contracts;
- Given that many private equity firms and asset managers are not public companies, whether any transparency risks arise from the transfer of insurance obligations to these companies, and whether retirees and the public will have visibility on the investment strategies of the companies on which they rely for their retirement;
- Whether state regulatory regimes are able to assess and manage the risks associated with the more complex structures and investment strategies of private equity-controlled insurance companies or bonds and, if not , how FIO can work with state regulators to help assess and manage these risks;
The report to Congress is due May 31, 2022.