In recent months, the New York Department of Financial Services (the DFS) has raised concerns over the perceived trend of private equity firms and other investment companies acquiring insurance companies, particularly those that write fixed and indexed annuity contracts.

In an April 18, 2013 speech, Benjamin Lawsky, Superintendent of Financial Services, relayed his concern over what the DFS perceives to be the short-term focus of private equity firms on maximizing their immediate financial returns, rather than ensuring that policyholders receive their promised benefits. To this end, Superintendent Lawsky opined that “private equity firms typically manage their investments with a much shorter time horizon – for example, 3-5 years – than is typically required for prudent insurance company management.”

Shortly following these remarks (which were posted on the DFS website on April 24, 2013), the press reported that the DFS had subpoenaed several companies, including Apollo Global Management, LLC, Guggenheim Partners LLC, Harbinger Group Inc. and Global Atlantic Financial Group, to obtain information on the investments held by these companies to back their fixed annuity business. Separately, in May 2013, the DFS sent written requests, commonly referred to as “Section 308 Letters,” to certain New York authorized insurers requesting information on “inquiries, offers or solicitations you received from private investors, since January 1, 2010, to acquire, reinsure or invest in your annuity or life insurance business, annuity contracts or life insurance policies.”

In light of this history, recently the DFS was asked to approve the proposed acquisition of control of Sun Life Insurance and Annuity Company of New York (Sun Life New York) and Aviva Life and Annuity Company of New York (Aviva New York) by Guggenheim Partners LLC and Athene Holding Ltd., respectively. The DFS eventually approved both acquisitions, but subject to the condition that the acquiring parties agree to an “enhanced set of policyholder safeguards.” In order to complete the acquisitions, Guggenheim and Apollo Global Management, LLC (an affiliate of Athene) agreed to implement these safeguards. In this regard, the DFS stated publicly that Guggenheim’s agreement marks “the first time a private equity firm has agreed to an enhanced set of policyholder safeguards in an acquisition of an annuity company[.]”

Specifically, as a condition to DFS approval of Guggenheim’s acquisition of Sun Life New York, Guggenheim agreed to the following:

1. Heightened RBC Levels – Instead of the typical 250% company action level RBC requirement, Guggenheim agreed to maintain Sun Life New York’s RBC levels at an amount not less than 450%. 
2. Backstop Trust Account – Guggenheim will establish a backstop trust account totaling $200 million to provide policyholders with protection beyond the heightened capital levels.  If Sun Life New York’s RBC levels fall below 450%, the funds in the backstop trust account will be used to top off the Sun Life New York RBC level to at least 450%.  The funds in the trust account will be held separately from Sun Life New York’s other funds for at least seven years and will be dedicated to the sole purpose of protecting policyholders.
3. Prior Written Approval of Material Changes to Plan of Operations – Any material changes to Guggenheim’s plan of operations of Sun Life New York, including investments, dividends or reinsurance transactions, require prior written approval of the DFS.
4. Stronger Disclosure and Transparency Requirements – Sun Life New York will file quarterly RBC level reports to the DFS, rather than annually.  Sun Life New York will also disclose to the DFS information concerning corporate structures and control persons, as well as other information regarding the operations of the company.

Apollo also agreed to implement a nearly identical set of policyholder safeguards as a condition to DFS approval of Athene’s acquisition of Aviva New York. Based on published reports, the only safeguard that is different is the amount of the backstop trust account, which is required to total approximately $35 million, as opposed to the $200 million required in the Guggenheim transaction.

Additionally, the Iowa Insurance Division (the IID) imposed several “enhanced” conditions with respect to its approval of Athene’s acquisition of Aviva Life and Annuity Company (Aviva). Specifically, the IID’s approval order is conditioned upon Aviva not paying dividends or distributions for five years, changing its plan of operations, or making investments, payments or agreements (whether or not below the Form D materiality threshold) with an affiliate without the Insurance Commissioner’s approval.  Further, Aviva is required to reserve for all non-variable deferred annuities containing guaranteed minimum death benefits or withdrawal benefits using AG 33, as opposed to AG 43. The conditions imposed by the IID are in addition to enhanced reserving measures voluntarily offered by Athene as part of its “change of control” filings.  Specifically, Athene has agreed to voluntarily increase policy reserves by an additional $150 million and to enter into a capital management agreement with respect to RBC requirements.

The approval conditions imposed by the DFS and the IID are noteworthy in several respects. The “enhanced policyholder protections” required in these transactions appear, in large part, to be predicated on the regulators’ characterization of the proposed acquirer as a “private equity firm” and either the implicit or explicit belief that the business model, investment practices and plan of operations of such firms result in increased risk to policyholders. From that perspective, it is difficult to predict the full ripple effect of these transactions on future acquisitions of insurance companies. Despite this uncertainty, the potential implications of these precedents may include the following:

1. Future acquirers may attempt to distinguish their operations from companies which have been characterized by regulators as “private equity” firms. In this connection, neither the DFS nor the IID has published objective parameters or criteria for identifying companies that will be deemed private equity firms or that otherwise will be required to provide enhanced policyholder protections.
2. Sellers of insurance companies or blocks of business may attempt to obtain the contractual commitment of prospective buyers to agree, in advance, to accept regulatory approval conditions similar to those imposed in the Sun Life and Aviva acquisitions.
3. Traditional insurance companies may highlight the extent to which they differ from so-called private equity firms in an effort to enhance their bids (as presenting lower “regulatory” or “deal execution” risk) in auctions of insurers or blocks of business.
4. Other state insurance departments may follow New York’s and Iowa’s lead and impose similar approval conditions with respect to acquisitions of insurance companies by acquirers that are deemed by regulators to be private equity firms.
5. State insurance departments may consider, in appropriate situations, requiring “enhanced policyholder safeguards” in acquisitions by more traditional insurance groups that conceptually might not be considered private equity firms.