Debevoise Private Equity Report – Insurance Investments: Key Considerations for Investors in the U.S., Europe and Asia
Financial sponsors have long been important providers of capital to the insurance industry, but in recent years, private equity acquisitions of insurance businesses have become more common. While this trend has been most noticeable in the United States and Europe, it is beginning to take hold in Asia as well. Private equity sponsors considering insurance investments in Asia and in emerging markets can look to lessons learned from deal experience in United States and Europe—but need to keep in mind the quirks across different jurisdictions regarding capital, structure and reporting.
This article reviews recent trends and compares key considerations for private equity players in insurance investments in the United States, Europe and the APAC region. We consider how recent developments may evolve in Asia present opportunities for PE sponsors looking to extend their asset management expertise to insurance investments in these markets.
Insurance Deal Activity and Drivers
Deal activity by private equity sponsors in the United States insurance market has accelerated significantly over the past five years and financial sponsors and pension funds now appear poised to play a permanent role as active M&A participants and controllers in the sector.
Recent examples of growing private equity involvement in the U.S. insurance sector include Blackstone’s pending acquisition of Allstate Life Insurance Company for $2.8 billion, KKR’s acquisition of Global Atlantic for $4.4 billion, Jackson National’s strategic transaction with Athene Holding Ltd to reinsure $27.6 billion of fixed and fixed index annuity liabilities, ThirdPoint Re’s $788 million merger with Sirius Group in Bermuda, and Carlyle Group’s partnership with T&D Holdings to acquire 76 percent of Fortitude Group Holdings from AIG for $1.8 billion. In addition, we’re seeing signs of consolidation in the mutual insurance space with the recently announced sponsored demutualization of Ohio National Mutual Holdings, Inc. by Constellation, an insurance acquisition platform backed by Caisse de dépôt et placement du Québec and Ontario Teachers’ Pension Plan Board.
These transactions illustrate how private equity-backed investments and acquisitions in the insurance space can bring experienced investment management capabilities to insurance companies confronted with the challenges of an ongoing low interest rate environment. For private equity investors, these transactions,particularly in the life insurance space, bring both the opportunity for a reliable return on invested capital and access to the permanent capital provided by an insurance company with a significant base of assets backing reserves.
UK & Europe
Just as in the United States, the UK and Europe have seen a noticeable increase in the involvement of private equity investors in the insurance space in recent years. Any auction process involving an insurance company now typically includes a number of private equity participants as a matter of course.
Private equity sponsors in the UK and Europe often begin their involvement in the sector with investments in insurance service companies and intermediaries; as industry experience, credentials and the relationships with insurance regulators deepen, buyers then expand their reach across the full breadth of the industry—including P&C and life insurers.
Recent deals include GreyCastle’s sale to Monument Re (which is backed by Cinven, among others), Bain Capital Credit’s deal to invest in Beat Capital and their acquisition of LV=, and Lovell Minnick Partners’ take-private of Charles Taylor. Additionally, last year’s bumper crop of start-ups looking to take advantage of hardening rates, the “Class of 2020”, saw support from private equity players on the equity side and in the form of debt; this year’s cohort is expected to continue the trend. Lloyd’s of London remains fertile ground for private equity sponsors, and ongoing and planned expense cutting in the market can only increase Lloyd’s appeal. Inigo is being backed by JC Flowers, StonePoint, CDPQ and others; Blackstone and Fairfax took part in Ki’s capital raise to support its expansion.
In contrast to the United States, in the UK and Europe, private equity investment in insurers in the Asia Pacific region has been relatively limited to date. Some Asian markets present limited opportunity because the industry is still in its early stages, while other markets are further along but still lack the run-off, consolidation and targets that make for scale possibilities and a vibrant deal environment. Structuring considerations and uncertain regulatory environments can also hamper activity.
However, the area seems ripe for change as new region-wide solvency regimes come into effect, capital-intensive back books become increasingly difficult to service in the low-interest rate environment and insurers continue to seek ways to move risk off their balance sheets. Recent transactions include JC Partners’ acquisition of a controlling stake in KDB Life, the strategic co-insurance partnership between Carlyle and Korean Re, and Resolution Life’s AU $3 billion acquisition of the Australian and New Zealand wealth protection and mature businesses of AMP Limited.
Expected Regulatory Control and Disclosure Considerations for PE Buyers
Insurance M&A transactions involving the acquisition of control (generally 10 percent or more of an insurance company’s voting securities) will be subject to approval from the state insurance regulator of the target’s domiciliary state. Because of increased deal activity, state insurance regulators have become increasingly experienced with private equity buyers and the complex structures that they typically present. Regulators are thus examining private equity structures more thoroughly, digging into how control is exercised (including information concerning ultimate controlling persons), proposed affiliate arrangements and their impact on the underlying insurance businesses. To fully understand the proposed deal and the business going forward, regulators now sometimes seek information that private equity sponsors have traditionally been reluctant to provide, including review of limited partnership agreements and other fund documentation, as well as all aspects of investment management or other affiliate arrangements.
In addition, regulators have placed a priority on ensuring that an acquisition by a private equity sponsor will not negatively affect an insurance company’s access to capital sources to back policyholder liabilities. This concern can lead regulators to impose conditions as part of the approval of a change of control, including requirements to maintain a minimum RBC ratio after closing, restrictions on dividends that can be paid by insurance companies without regulatory approval for a certain period of time after closing, and restrictions on affiliate transactions without regard to materiality thresholds that might otherwise exist under insurance law. Given the significant regulatory approval process and the heighted scrutiny of the more complex structures of private equity acquirers, obtaining approval can take between six months to a year. Reinsurance transactions, however, tend to be approved more quickly given the narrower scope of a reinsurance transaction compared to the acquisition of an insurance carrer.
UK & Europe
In the UK and Europe, proposed acquirers of insurance companies, insurance brokers or other intermediaries, as well as certain regulated insurance services firms,will generally need regulatory approval if the transaction involves the direct or indirect acquisition of 10 percent or more of capital or voting rights (20 percent for intermediaries generally). Therefore, unlike in the United States, it is not possible to disclaim control or to use non-voting shares in the transaction to avoid the approval requirement. Additionally, parties which do not individually reach the relevant thresholds can trigger a filing if they reach the threshold on a combined basis and can be shown to have an explicit or implicit agreement to exercise their rights in the same way. Pre-approvals are also required to increase an existing holding above specified thresholds.
Regulators will want to understand any investor’s ultimate beneficial owner; for private equity buyers, this can result in some back and forth as the regulator seeks to map the decision-making structure through the fund. Given the prevalence of private equity investors in the industry, regulators in the UK and Europe are sophisticated in dealing with this type of buyer; to ensure a smooth approval process, it is critical to explain the holding structure clearly and the legal analysis identifying which entities require approval.
As in the United States, regulators will want to see transaction-specific documentation along with detailed information and supporting documents for the relevant entities. Regulators will focus on the buyer’s plans for the target business, including proposed changes to capital structure and dividend plans, management, systems and governance, as well as the details of the expected integration into the buyer’s group. In particular, regulators often require confirmation of the acquirer’s commitment and plans to support the target insurer going forward. Reassurance on this point can be usefully provided where the investor has a proven track record in the industry. While regulators may impose conditions on their approval (e.g., additional capital commitments or dividend restrictions), in our experience this usually reflects underlying concerns regarding the target business rather than the buyers.
The regulatory review timeline in the UK and Europe is clearly delineated, regardless of the type of buyer: 60 working days from receipt of a complete filing (subject to “clock-stopping” for an additional 20 or 30 working days, depending on whether it is a European or non-European acquirer). Approval can generally be expected within three to four months of the first filing, even where complex fund structures are involved.
In Asia, controller thresholds upon which insurance M&A requires regulatory approval varies in each jurisdiction, but can be triggered upon an acquisition of 5% or 10% of the voting securities of an insurer. While the meaning of control varies somewhat by jurisdiction, regulators generally focus on ownership with the ability to exercise, or control the exercise of, voting power.
Regulators will typically require disclosure for all entities “up the chain of control” and information on the general partner including its controlling person, while seeking limited to no information regarding the limited partners. Group structure charts and operating agreements are typically requested, although the depth and level of scrutiny varies by jurisdiction and may also depend on the identity, track record and market reputation of the private equity sponsor.
As part of the approval review and process, regulators will focus on issues around capital adequacy and ongoing support and may impose heightened capital standards, capital support undertakings or dividend restrictions as conditions of approval. To help ensure stable and long-term management, regulators may also subject private equity sponsors to a minimum lock-in period, enhanced operational scrutiny or heightened disclosure requirements.
The views of regulators toward private equity investors vary across the region. While regulators in jurisdictions such as Hong Kong, Singapore, and Korea have experienced successful completion of private equity investment in insurance companies, regulators in jurisdictions in Southeast Asia are still largely untested. As such, the presence of a private equity acquiror will likely extend the timing required for receipt of approvals.
Structuring Considerations in Insurance M&A
The acquisition of insurance companies in the United States can take the traditional form of the purchase of stock or, if the private equity sponsor has already acquired a licensed insurance company, be effected through bulk reinsurance of blocks of business to acquire reserves and a larger pool of assets and cash flows.
Given the lengthy regulatory approval process and additional scrutiny of private equity buyers in the United States, deal negotiations focus on the crafting of covenants and conditions around the obligations to obtain regulatory approval and whether regulatory restrictions imposed on an acquirer by insurance regulators may trigger a right to terminate an acquisition agreement. Buyers and sellers typically negotiate the “burdensome conditions” a regulator could impose that would impede the economic benefits of a transaction for private equity sponsors. These may be developed by the parties following discussions with insurance regulators to better understand the areas of regulatory focus for a particular transaction. These conditions can range from general material adverse effect conditions on one or both parties’ expected economic benefits to more specific conditions around dividend restrictions or capital maintenance and support requirements.
In addition to increased focus on regulatory covenants and conditions, there has also been growing use of complex deal financing solutions, including equity commitments, debt financing, and combinations of traditional stock and merger transactions with reinsurance and reserve financing structures. As part of the regulatory approval process, the sources of funding for any acquisition of an insurance company are closely scrutinized by regulators and greater complexity of a sponsor’s financing arrangement could increase the time needed for regulatory review.
UK & Europe
Share acquisitions are common in UK and European insurance transactions, with locked box pricing mechanisms more likely to be used than completion accounts. Consistent with the effective transfer of economic risk at signing, pre-closing termination rights, including “burdensome conditions” clauses in purchase agreements, have traditionally been less prevalent than in the United States. However, as both strategic and private equity buyers with familiarity with U.S. insurance transactions have entered the market, termination rights have started to become a point for negotiation, depending on the overall transaction dynamics. A growing trend in private equity deals in the UK and Europe is the use of W&I insurance; as well as the obvious benefits, a W&I policy can allow the parties to short-circuit negotiations regarding the scope of warranties and specific points of risk allocation. Provided they are brought on board at the right time, W&I insurers can therefore speed up the pre-signing process, which is valuable in an auction process with a limited exclusivity period.
In the UK and Europe, the transfer of a particular book of business, including in a carve-out, can be accomplished through portfolio transfers. This typically occurs through a court process which has the effect of automatically novating policies and reinsurance from the transferor to the transferee without requiring the consent of each individual policyholder. Supporting assets and employees can also be transferred at the same time. Given the number of safeguards to protect policyholders and the administrative steps involved to complete the transfer (which vary from jurisdiction to jurisdiction), this can be a lengthy process taking 12 months or longer. To more quickly achieve the economic effect of transferring the business, it is common for parties to enter into an interim reinsurance arrangement pending completion of the portfolio transfer.
As in other regions, insurance M&A in Asia can also be structured through a variety of forms, whether through share acquisitions or transfers of particular books of business through portfolio transfers. Both locked box and completion accounts are used in share acquisitions; buyers should expect to encounter similar considerations around the parties’ obligations to obtain regulatory approval and what constitutes “unduly burdensome conditions.” Depending on the jurisdiction, portfolio transfers can range from a relatively streamlined court process where policies are automatically novated to a more burdensome process requiring regulatory approval and policyholder communications that can be held up due to policyholder objections.
In Asia, as a preliminary matter, buyers also need to consider a variety of other structuring factors, including foreign ownership limitations (FOL), single presence rules and local presence requirements. In certain jurisdictions, foreign private equity funds are prohibited from investing directly in a local insurer and instead must structure the acquisition through a private equity invested financial institution or insurer. FOL rules are often in flux. China removed its 51 percent foreign ownership limitation for insurance companies as of the beginning of 2020, and India recently issued draft guidance raising its FOL from 49 percent to 74 percent. Because of this dynamic regulatory environment, anyone doing insurance deals in countries with FOL rules (other than insurers grandfathered under old regimes) will likely need to partner with a local entity.
With respect to single presence rules, any current holdings must be reviewed to ensure the investor does not run afoul of limitations for being a controller in more than one insurance company or line of business, as applicable. In some jurisdictions, a foreign private equity fund cannot itself be the controller of an insurer, but rather must establish a local presence. In still some other jurisdictions, even where there is no local presence requirement, in practice a local presence may still prove to be quite helpful as part of the regulatory approval process.
Given the global nature of the insurance business, it is not surprising that there are a number of themes that are common across jurisdictions. As a result, many concepts and regulatory questions will be familiar to investors entering a new region, and deal teams should be able to leverage off much of their expertise when facing familiar issues in unfamiliar markets. However, given the highly regulated nature of these businesses and the diversity of regulatory perspective and sophistication across the world, the devil will continue to be in the details.
To learn more about private equity’s involvement in the insurance industry, read our recent piece, Private Equity and the Insurance Industry: A Close Look at a Natural Partnership. To hear a discussion of the topics in this article by some of the leaders of our global insurance and private equity teams, an on-demand webinar recording is available here: Global Private Equity Insurance Wave: Recent Trends and Outlook.