Background

State and federal policymakers, including the National Association of Insurance Commissioners (NAIC) and Senator Sherrod Brown (D-OH, Chair of the Senate Banking, Housing and Urban Affairs Committee) have recently taken a renewed interest in Private Equity (PE) interaction with insurers. The NAIC Macroprudential (E) Working Group (MWG) was charged with developing a strategic risk assessment tool and coordinating NAIC activities concerning PE-insurer arrangements. The charge resulted in drafting an initial list of wide-ranging considerations pertaining to PE firm involvement in insurance and the ability of state insurance regulators to adequately monitor and assess the risks of such involvement (PE Considerations List).

An initial PE Considerations List was exposed 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.

PE Considerations List

The current version of the PE Considerations List identifies 13 observations related to PE investment in and control of insurers that, in general, pertain to regulators’ ability to effectively monitor affiliate transactions, determine whether “control” exists for insurance regulatory purposes, mitigate potential conflicts of interest, preserve insurer autonomy and ensure financial stability. The current version also includes a baseline of activities and potential next steps for the first six observations (discussed in further detail below). The PE Considerations List includes the following notable observations:

• Regulators may not be obtaining a clear picture of risk due to: holding companies structuring contractual agreements in a manner to avoid regulatory disclosure requirements; and, affiliated party agreements impacting an insurer’s risk that may be structured to avoid disclosure.
• Control may exist with less than 10% ownership, e.g., a party may exercise a controlling influence over an insurer through board representation or contractual arrangements, including non-customary minority shareholder rights or covenants, investment managements agreement (IMA) provisions such as onerous or costly IMA termination provisions, or excessive control or discretion given over the investment strategy and its implementation.
• The material terms of IMAs and whether they are arms’ length transactions (including the amount and types of investment management fees paid by the insurer, the termination provisions, and the degree of discretion or control of the investment manager over investment guidelines, allocations and decisions).
• Owners of insurers may be focused on short-term results that 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 could effectively act as a form of an unauthorized dividend in addition to reducing the insurer’s overall investment returns or owners may not be willing to transfer capital to a troubled insurer.
• Possible increased risk and lack of transparency related to material increases in privately structured securities.
• Regulator’s concern about the level of reliance on rating agency ratings and their appropriateness for regulatory purposes.
• The trend of life insurers in pension risk transfer (PRT) business and supporting such business with certain of the more complex investments.
• Insurers’ use of offshore reinsurers (including captives) and complex affiliated sidecar vehicles to maximize capital efficiency could introduce complexities into the insurance group structure.

Current status and next step

On April 5, 2022, the FSTF and the MWG reported that the PE Considerations List had been updated after meetings with the chairs of other NAIC financial, investment, accounting and actuarial committees and a regulator-only discussion on March 25, 2022. Those discussions resulted in the addition of an introductory paragraph on solvency monitoring (for those “spectators” that are not familiar with insurance regulation), established a baseline of activities and included a plan as to how the regulators will move forward on the first six of the 13 observations. The baseline includes a list of current regulatory tools, parallel NAIC workstreams and potential action items.

Discussion results for the remaining seven observations are expected to be drafted in regulator-only meetings before the NAIC Summer National Meeting (scheduled to be held in Portland, Oregon from August 9-13, 2022) and exposed for comment. It is worth noting that consideration of any potential action items identified as a result of the PE Considerations List drafting process (e.g., amendments to NAIC model laws, regulations or handbooks, or additional insurer reporting or disclosure requirements) would be subjected to their own adoption process (including opportunities for public review and comment).

Senator Brown letter to FIO and NAIC

On March 16, 2022 Senator Sherrod Brown (D-OH, Chair of the Senate Banking, Housing and Urban Affairs Committee) sent a letter to the Federal Insurance Office (FIO) and the NAIC that “express[ed] concern that insurance investment products workers depend on for their retirement are being transferred to these risky companies [private equity firms] that have a track record of undermining pension and retirement programs.” As a result, the letter requests that FIO, in consultation with the NAIC, collect additional data and issue a report to Congress addressing each of six concerns:

• Risks that more aggressive investment strategies pursued by private equity controlled insurers present to policyholders;
• Risks that lending and other “shadow-bank” activities pursued by companies that also own or control significant amounts of life insurance-related assets pose to policyholders;
• Whether there are risks to the broader economy related to investment strategies, lending, and other “shadow-bank” activities pursued by these companies;
• For pension risk transfer arrangements, the impact on protections for pension plan beneficiaries if plans are terminated and replaced with lump-sum payouts or annuity contracts;
• Given that many private equity firms and asset managers are not public companies, whether risks to transparency arise from the transfer of insurance obligations to these firms, and whether retirees and the public will have visibility into the investment strategies of the firms they are relying on for their retirements;
• Whether state regulatory regimes are capable of assessing and managing the risks related to the more complex structures and investment strategies of private equity-controlled insurance companies or obligations and, if not, how FIO can work with state regulators to aid in the assessment and management of these risks;

The report to Congress is due on May 31, 2022.

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