Expected spike in insurance deals presents risk

Legal advisors are warning their private fund clients about the heightened reporting and capital adequacy requirements that come with acquiring insurance firms.

Improving economic conditions will result in a rebound in insurance M&A activity over the next 12 months, but the trend presents new risks for private equity, a report from law firm Mayer Brown warns.

Of the 75 insurers surveyed, a majority expect private fund advisors to lead a trend that will see more M&A deals in property & causality and life insurance. Most believe these deals will occur in the lower, middle-market range ($100 million to $250 million) and take place in Europe and the Americas.

However legal advisors warn that insurance M&A now comes with heightened legal and regulatory risk. Last April, the New York Department of Financial Services (NYDFS) Superintendent Benjamin Lawsky, the state’s top banking and insurance regulator, voiced concerns regarding the increasing number of insurers controlled by private equity firms.

“Private equity firms typically manage their investments with a much shorter time-horizon, for example three to five years, then we typically require for prudent insurance company management,” Lawsky said at the 22nd Annual Hyman Minsky conference held in New York City.

NYDFS has subpoenaed firms including Apollo Global Management, Guggenheim Partners, Harbinger Group and Global Atlantic Financial Group for data on their fixed annuity investments.

New York and Iowa are two examples of states whose insurance regulators are requiring “enhanced sets of policyholder safeguards” as a condition to approving a number of recent acquisitions by private equity firms, said Mayer Brown corporate partners Edward Best and Lawrence Hamilton.

The safeguards included an obligation to maintain heightened risk-based capital levels at the insurance firm, establish and fund a trust account that would be triggered if the capital level was to fall below a specified amount, obtain prior regulatory approval of material changes to the acquired company’s plan of operations and comply with more extensive reporting obligations (such as quarterly risk-based capital level reports and reports on corporate structures, control persons and other operating information).

The National Association of Insurance Commissioners has also created a private equity working group that is developing procedures for state insurance regulators to use when considering ways to mitigate the perceived risks associated with private equity ownership of insurance firms.

In Europe, regulatory uncertainty is also presenting new risks in insurance M&A activity. Solvency II, which harmonizes insurance regulations across Europe, requires all insurance companies to hold a greater amount of capital against investments deemed riskier than plain vanilla fixed-income or equities. The new rules also demand a boost in governance processes, reporting and transparency for insurance companies. Solvency II is expected to take effect from January 2016.