Last year, like 2013 before it, continued to see financial buyers make significant commitments to the U.S. insurance space. Key transactions included the Canada Pension Plan Investment Board’s $1.8 billion acquisition of Wilton Re and the acquisition of Philadelphia Financial Group, Inc. by funds managed by the Tactical Opportunities Group of The Blackstone Group L.P. 2014 also saw the closing of some significant transactions announced in 2013, including the acquisition of Lincoln Benefit Life Company from Allstate by Resolution Life Holdings. Beyond announced transactions, interest in the U.S. insurance space by a number of financial buyers remained high.
This year is likely to be another active year in the U.S. insurance market. While the drivers of this activity are numerous, a few trends, beyond the basic business rationale for insurance company acquisitions, are worth highlighting. One such driver is increasing clarity around regulatory conditions likely to be imposed on financial buyers. The other is a continued broadening of the types of financing and the number of financing counterparties available to fund acquisitions in the life and annuity space in particular.
Increasing Clarity on Regulatory Conditions
Acquisition of “control” of a U.S.-domiciled insurer currently requires the prior approval of at least the domestic state insurance regulator of the target insurer, with control generally presumed if any person directly or indirectly owns or controls 10% or more of the voting securities of the insurer.
Multiple insurance regulatory authorities – the most vocal of which has been the New York Department of Financial Services – have expressed concern about the growing presence of private equity firms in the insurance industry and, in particular, the annuities markets. These concerns have focused on the potential disconnect between the perceived short-term profit interests of some financial buyers and the long-term, conservative investment profile traditionally implemented by insurance companies. These concerns are focused primarily on private equity and hedge fund acquirers, but they can extend to other financial buyers as well.
While it was initially unclear what these expressions of regulatory concern would mean for the future of financial buyers in the domestic insurance space, a regulatory consensus has formed around one or more of the following.
- Heightened Capital Standards. An acquirer may be required to maintain minimum capital levels at the target insurer.
- Backstop Trust Account. A trust may also need to be funded and drawn on to top-up the target insurer’s capital if it falls below a specified threshold.
- Enhanced Regulatory Scrutiny of Operations, Dividends, Investments and Reinsurance. Any changes to the insurers’ plans of operations, including investments, dividends and reinsurance transactions, may require prior approval. This requirement may be combined with a temporary dividend block.
- Stronger Disclosure and Transparency Requirements. Each target insurer may be required to file more frequent reports regarding its capital level than the annual reporting generally required and agree to provide additional information concerning its corporate structure, control persons and operations.
While conditions such as these have not necessarily been welcomed with open arms by financial buyers (strategic acquirers have for the most part not had similar conditions imposed), they have not scuttled any announced deals to date. Importantly, whereas as few as 12-18 months ago many financial buyers were left to make semi-educated guesses as to what conditions may be imposed by a regulator considering a change-of-control application, the significant focus on these transactions by multiple state regulators has provided buyers considering a transaction today significantly greater certainty as to what may be required of them.
An Increasing Variety and Sources of Financing Options
A variety of regulatory impediments, most notably dividend restrictions at the target operating insurers, restrictions on pledges of insurance company assets and restrictions on the ability of target insurers to issue or guarantee acquisition debt, have historically required that acquisitions of insurance companies in the United States be financed with substantially less leverage than acquisitions in other industries. However, financing in various forms is becoming increasingly prevalent in insurance-sector transactions even though such financing can differ significantly from financing used in a typical leveraged acquisition. Equity issuances, bank debt, bonds, insurance reserve financings and reinsurance transactions have all been employed in recent acquisitions, and a single acquisition may involve multiple types of financing.
Particularly when looking at life insurer acquisitions, it is important to understand the types of insurance-specific financing that are available to supplement or replace more traditional acquisition debt.
- Reserve Financings. Acquirers of U.S. life insurers may finance a portion of the statutory reserves of a target insurance company. These structures typically involve reinsurance to a captive reinsurer and can have the effect of increasing the capital and surplus at the target insurer. Such facilities require separate regulatory approval and have come under enhanced regulatory scrutiny from state regulators and the National Association of Insurance Commissioners in recent years. Despite this, insurance reserve financings have been important parts of several recent life insurer acquisitions, including Harbinger’s acquisition of Old Mutual’s U.S. operations, Resolution Group’s acquisition of Lincoln Benefit from Allstate and Global Atlantic’s acquisition of Aviva’s U.S. life insurance business.
- Reinsurance. By reinsuring a portion of a target insurance company’s portfolio, an acquirer can use less of its own capital to finance an insurance company acquisition without incurring debt on the insurance company’s balance sheet that may run afoul of regulatory constraints. Reinsurance can take various forms, including sales of portions of a target company’s business that the acquirer is not interested in and capital relief transactions, which typically take the form of modified coinsurance. These transactions may require separate regulatory approvals as well. Reinsurance, in varied forms, was used by Athene to transfer Aviva’s U.S. life insurance business to Global Atlantic in connection with Athene’s acquisitions of Aviva’s broader U.S. operations and by Resolution Group to provide additional capital support to Lincoln Benefit.
Finally, in addition to using insurance-specific types of financings, insurance company buyers have also been looking to a broader number of potential financing counterparties, including in connection with more traditional acquisition debt. A prime recent example was Blackstone’s acquisition of Philadelphia Financial, where Hannover Re, a global reinsurer, provided acquisition financing that in other contexts would typically be provided by a bank.