The Legal Intelligencer

As private equity and venture capital investors add insurance company and health care investments to their portfolios, the investment process may be more than they bargained for. Such investments can trigger a change in control under state insurance laws modeled after the NAIC Insurance Holding Company System Regulatory Act (NAIC Model #440) (the “Holding Company Act”), which requires that any person acquiring 10% or greater of the voting securities of a domestic insurer (if consummation of the proposed transaction would place that person, directly or indirectly, or by conversion or by exercise of any right to acquire) in control of the insurer or any person controlling the domestic insurer, to first file a so-called Form A Statement of Change in Control of Domestic Insurer with that insurer’s domestic state insurance regulator and secure approval for such proposed transaction prior to consummation. See also the NAIC Insurance Holding Company System Regulatory Model Act (Model #440) and the NAIC Insurance Holding Company Systems Model Regulation (Model #450).

NAIC Model 440 defines the term, “control” which triggers regulatory review:

“Control.” The term “control” (including the terms “controlling,” “controlled by” and “under common control with”) 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 non-management services, or otherwise, unless the power is the result of an official position with or corporate office held by the person. Control shall be presumed to exist if any person, directly or indirectly, owns, controls, holds with the power to vote, or holds proxies representing ten percent (10%) or more of the voting securities of any other person. This presumption may be rebutted by a showing made in the manner provided by Section 4K that control does not exist in fact. The commissioner may determine, after furnishing all persons in interest notice and opportunity to be heard and making specific findings of fact to support the determination, that control exists in fact, notwithstanding the absence of a presumption to that effect. While states differ as to the precise definition of “control”, the Model Act embodies the most common triggers.

Thus, if an investor takes a board seat and that seat is viewed by the state regulator as indicia of control, the person becomes an Applicant in the Change in Control Application, requiring regulatory approval in the targeted insurer’s state of domicile.  An investor (whether private equity or otherwise) with the ability to control day-to-day management or to influence even a shareholder vote by contract or equity interest can also trigger a change in control. This regulatory review process is referred to as the Form A process which contemplates broad financial disclosure, demonstration of credibility, and submission of detailed biographical information, which in most instances has to be third party verified and often requires criminal background checks and/or finger printing of Applicants as well as proposed officers and directors of the regulated entity.

Indeed, the National Association of Insurance Commissioners (the NAIC) Financial Stability (E) Task Force recently addressed the impact of private equity investments on domestic insurer’s holding company obligations during a virtual meeting of the Task Force held on September 30, 2021. It was reported that private equity (PE) firms have increasingly been intertwined with insurance companies because of low interest rates and the changing PE business model.  Further, the NAIC’s Capital Markets Bureau maintains a manually researched and constantly updated list of 177 companies owned or controlled by PE.  The report concluded that continued concern about PE ownership of insurance companies has been broadly expressed but to be actionable, these concerns need to be translated into a specific characteristic or behavior that differentiates the PE ownership structure from other insurance companies.  

Presumably these concerns have led to stricter scrutiny by state regulators when they evaluate the initial investment through the Form A process.  This degree of scrutiny has both contributed to the time it takes to complete the regulatory review process as well as expanded the scope of intercompany transactions subject to approval prior to consummation. In states like New Jersey where the definition of “insurer” to which the Holding Company Act obligations apply, including health maintenance organizations and licensed organized delivery systems, increased regulation certainly can elongate and complicate the investment process.  

PE investments also have led to the proposed revision to the NAIC Models to include a definition of “Financial Entity Owned Insurer” as:

a regulated insurer, which is controlled by or has a long-term investment management agreement with an entity, which:

  • Derives the majority of its revenue through the management of or investment in financial assets.
  • Is not itself a regulated insurer.
  • Has some minimum amount of assets under management.

Enhanced disclosures that bolster the definition of “affiliate” to include entities managed by an affiliate of the Financial Entity Owned Insurer have also been discussed at the Task Force level and would include:

  • Fees paid or accrued to 1st and 2nd degree affiliates.
  • Assets under management of all affiliates.
  • Investments where there are other relationships with 1st and 2nd degree affiliates.

On April 19, 2022, New York’s Superintendent of Financial Services, issued guidance to advise industry participants, including prospective acquirers and counterparties of insurers and their advisors, of the broad definition of “control” under Article 15 of the New York Insurance Law. And reminded the regulated industry of its obligations under the Insurance Holding Company Act with regard to those that control domestic insurers. The Circular letter acknowledges the enhanced insurance merger and acquisition activity in recent years, The Circular Letter confirms that a determination of control depends on all the facts and circumstances of a transaction, and cannot be avoided by formulaic structures such as limiting the number of voting shares or board seats of a transaction party. Control is presumed under § 1501(a)(2) if a person, directly or indirectly, owns, controls, or holds with the power to vote, 10% or more of an insurer’s voting securities.  However, this presumption does not create a safe harbor for acquisitions below the 10% threshold, which may still result in a control determination.  Additionally, while § 1501(a)(2) makes clear that any director of an insurer, or any person with the right to appoint such a director, is not presumed to control the insurer, these facts may, in combination with other factors, lead to a control determination

Significantly, an acquirer of less than 10% of an insurer’s voting securities, or with the right to appoint a single board member, may still be deemed to control the insurer based on all the facts and circumstances, including the terms and conditions of the proposed transaction.  Moreover, a control relationship can arise from a contract or other factors, in the absence of any ownership of voting securities of an insurer.  Section 1501(a)(2) defines “control” in relevant part as “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 (except a commercial contract for goods or non-management services) or otherwise…” Furthermore, § 1501(b) provides that the Superintendent may find a controlling relationship if a person “exercises directly or indirectly either alone or pursuant to an agreement with one or more other persons such a controlling influence over the management or policies of an authorized insurer as to make it necessary or appropriate in the public interest or for the protection of the insurer’s policyholders or shareholders that the person be deemed to control the insurer.”  Finally, the Circular Letter acknowledges that the Superintendent may nonetheless consider and grant an application for a disclaimer under or for a determination of non-control pursuant to § 1501(c) of the New York Insurance laws.

While not detailed in the Circular Letter, the changing nature of insurance company investments to include PE and venture capital investments, among other investment vehicles, and the sophistication of ownership structures as well as these transactions implicating multiple parties, investment funds with individual investors or groups of investors, has made more complex the control analysis necessary to guide the regulatory process as well as to determine which persons (either individual or entities) should be applicants in the Form A process.  Continued regulatory scrutiny and increased regulation are likely to result as private equity and venture capital investments in the insurance industry continue.

Reprinted with permission from the May 6, 2022 issue of The Legal Intelligencer. ©2022 ALM Media Properties, LLC. Further duplication without permission is prohibited.  All rights reserved.

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