How to Buy an Insurance Company: Regulatory Due Diligence | Newsletters | Legal news: Insurance
During the development of a business, whether through an existing insurance holding company structure or in another context such as private equity, the question may arise: “How does one ‘assurance ?” This article provides a broad overview of considerations for this issue, focusing on regulatory due diligence. Of course, this article does not contain an exhaustive list of such considerations, and prospective purchasers should consult corporate and regulatory counsel on the specific circumstances relating to such matters.
1. Philosophy and approach
The following philosophies serve as useful touchstones in focusing a team tasked with analyzing a target insurance company.
1.A Hot areas
The due diligence team should consider potential areas for increased scrutiny and attention arising from the nature of the insurer’s business as well as its regulatory positioning. Each time a document is identified in one of these “sensitive areas”, the document must be reassembled and examined more carefully, regardless of its immediate appearance of materiality. The following points can be used as a map for the creation of these “hot zones”:
- Where is the insurer domiciled and what is its supervisory authority? Documents to or from the home regulator are in a sensitive area, and research should be undertaken regarding required regulatory approvals and filings regarding the home regulator.
- Which regulators are major, but non-domiciliary regulators? For example, using the insurer’s annual statement, Appendix T, what are the insurer’s top three state markets in terms of direct written premiums? Documents to or from these main regulators are in a sensitive area.
- What are the lines of business of the insurer, and have any of these specific lines or business sub-types been subject to large-scale/multi-state regulatory review? These potential regulatory issues are in a hot zone.
1.B Monitoring and distribution of materials
The due diligence team needs to determine if someone with a regulatory background is best suited to be the data room “guru” (i.e. the person who knows everything in the room data, when it arrives and who is responsible for initiating the distribution of materials and updating due diligence lists). Often, someone with insurance regulatory experience (either insurance compliance or insurance regulatory law) will be able to identify potential legal and operational issues arising from various documents on the subject that a business development professional or corporate lawyer cannot identify.
The Data Room Guru can monitor data room updates in real time and distribute documents to subject matter experts for “soft”/preliminary analysis. This speeds up the identification of hardware issues and can allow business development personnel to determine the feasibility of the deal in a faster (and less expensive) time frame.
Especially in a due diligence scenario with regulatory implications, a thorough memorization of the due diligence process is recommended. On-site analyzes should be incorporated into an omnibus due diligence document, along with other minor reviews and analyzes that were not worth immediately identifying and discussing. That said, throughout the due diligence process, it may be prudent to also maintain a brief bulleted list of sensitive topics and other significant issues identified and communicated at short notice.
2. Preliminary and publicly available due diligence
Even before a data room on the target is available, it is advisable to create a preliminary due diligence report based on publicly available information. This report may contain information from the following sources:
- NAIC Annual Financial Statements (the most recent annual statement as well as the most recent quarterly statement).
- A summary of information available on the NAIC’s Consumer Information Database (including licensing, financial, and complaint information).
- The most recent financial reviews of the target or the target’s insurance holding company structure.
- Any recent review of business practices involving the target.
- Any prior transactional history of the target (traceable from public insurance company databases or similar).
3. Insurance Regulatory Documents
When reviewing insurance regulatory documents provided in the data room, the following best practices should be considered:
- Compare the copies of the regulatory documents provided in the data room to the publicly available documents identified during the preliminary due diligence (taking into account any differences between the copies).
- Represent and analyze all regulatory correspondence (especially those from identified sensitive areas).
- Review actuarial analyzes and memoranda with regard to potential regulatory or operational issues, but, of course, defer to staff and actuarial advisors with respect to these documents.
4. Business Documents with Insurance Workflow Overlaps
If separate regulatory/compliance and corporate/transactional workflows are used in the due diligence process, workflow owners should discuss the due diligence document assignment in detail from the outset. Often these workflows overlap and inefficiencies can result. The review of the items listed below should be discussed in particular, and both work streams should communicate widely on their findings to ensure that any potential issues are identified:
- Board and committee minutes
- Organization charts
- Operating agreements
- Subscription, distribution and product forms
- Intercompany agreements
- Agency and/or MGA agreements
- Reinsurance agreements
5. The hero’s or heroine’s journey
In Joseph Campbell’s 1949 book The hero with a thousand faces, Campbell summarized and proposed various theories related to the so-called “monomyth” (i.e., a construction model for stories involving a hero or heroine who travels on an adventure, undergoes challenges and crises, and returns victorious). Key elements of this construct include: the “call” to adventure, the appearance and mentorship of a “guiding” figure, challenges and temptations culminating in revelation, atonement, and victorious return.
The diligence of an insurance company should also be seen as a hero’s or heroine’s journey incorporating many of these concepts. The “call” introducing the prospect of a new or new acquisition presents the excitement of the unknown, the opinions and advice of colleagues will have to be sought and dispensed, many challenges will be presented, and there may even be a moment indicative of learning or decision making. After extensive work and discussion, producing a document summarizing all the results should create a well-deserved feeling of achievement.
This article is intended to provide some considerations on approaching this trip, but, of course, potential buyers should consult corporate and regulatory advice regarding the details of any major transaction.