With M&A activity for life insurers or blocks of in-force business poised for a possible spike, acquirers of life businesses should consider factors that are peculiar to, or disproportionately affect, the life and annuity sector relative to other types of insurers such as property-casualty (p&c).
Such features specific to life companies include the following, which require a dedicated focus on due diligence and may also require appropriate tailoring of representations and warranties or other provisions in the purchase contract:
- A life insurer’s competitive space differs from that of a p&c counterpart. While a p&c carrier is largely competing against other insurers, a life insurer is potentially competing against not only peer insurers but also providers of investment products such as banks, broker-dealers, investment managers, financial advisers, mutual funds and private funds.
- Life insurance products are by their nature more tax-sensitive than p&c products, requiring special focus on tax compliance of the carrier’s products.
- Variable life insurance and variable annuities are regulated both as securities at the federal level and as insurance at the state level, making compliance issues more acute than for many other types of insurers.
In addition, regulatory developments in recent years affecting life insurers warrant thoughtful attention in all phases of the acquisition. Subjects of these developments include the following:
- Captive reinsurers have been used by life carriers for nearly two decades, especially to finance the redundant reserves associated with certain types of life products (notably, variable annuities, term life and universal life with secondary guarantees (ULSG)). In recent years, the National Association of Insurance Commissioners (NAIC) and state insurance departments have enacted reforms intended to simplify the capital and reserving regimes associated with these products, and thus obviate (or at least reduce) the need for such captives. These reforms include:
- Principle-based reserving. The three-year phase-in period ends on Jan. 1, 2020.
- Actuarial Guideline 48, which was adopted by the NAIC as a model regulation in December 2016 and is pending adoption in the various states. The Guideline specifies the types and amounts of collateral that must be posted in order to secure reinsurance obligations associated with term and ULSG products.
- The NAIC’s Variable Annuity Framework, finalized in 2018 and in the process of being implemented by the states. The Framework is designed to motivate carriers that historically wrote variable annuities and ceded those to captives to recapture that business and bring it back onto the carriers' balance sheets.
- States have begun to consider and adopt “best interest” laws and regulations that impose heightened standards on sellers of life insurance products. These measures have been enacted largely in response to a perception that federal efforts to impose a fiduciary standard on sales of retirement products have slowed under the Trump administration and, similarly, in response to the Securities and Exchange Commission’s recent Regulation BI for broker-dealers. The state measures being adopted apply more squarely to life insurance products in general. Historically, carriers and producers were required to observe “suitability” requirements (that is, to take measures to ensure that a product offered to a consumer was suitable for that buyer). Under these new requirements, generally, an insurance agent would have to act in the consumer’s “best interest” — a more rigorous threshold. For example:
- New York’s amended Regulation 187, which survived a judicial challenge in July and became effective Aug. 1, is a prime example of this new generation of producer regulations. New York’s version specifically requires a New York-licensed insurer to establish a system of supervision over its producers to achieve the insurer’s and the producer’s compliance with the fiduciary-type requirements.
- Nevada and Maryland have also taken steps on similar measures.
It can be expected that compliance with these rules for new business will be a key focus of New York and other state insurance regulators going forward. Acquirers will want to make sure they understand the reach of any such new requirements and the resulting compliance implications for their target.
- In another key New York development of recent years, the New York Department of Financial Services (DFS) now may require an acquirer of a New York-domiciled life insurer to post a collateral trust if the superintendent determines such a trust necessary for protection of policyholders or shareholders. The trust would have to conform to Regulation 114, New York’s detailed requirements for reinsurance collateral trusts. The provision is mainly aimed at acquirers that are private funds, and the Superintendent may take into account such status in determining whether a trust is required. Acquirers will want to consider this risk in crafting the “burdensome condition” provision of the purchase contract, among others.
- An emerging issue for life carriers concerns the use of artificial intelligence (AI) in underwriting. Carriers writing business in New York are subject to the DFS’s January 2019 guidance on the use of external sources in underwriting life insurance products, the first significant effort by a state insurance department to impose restrictions on and guidelines for the use of AI by life insurers. (For a fuller discussion of the DFS guidance, see our article in the August 2019 Funds Talk, here.) In addition, the NAIC is actively studying a range of issues resulting from the use of AI in insurance generally, suggesting that future regulation across the states on the use of “big data” is possible.
An acquirer should consider all these developments carefully in the context of a particular insurance target, not only from a valuation standpoint but also for purposes of representations and warranties in the purchase agreement such as those relating to actuarial reserving, reinsurance, investments, capital adequacy and regulatory and other compliance.