How to Buy an Insurance Company: Regulatory Due Diligence

14 March 2022 Legal News: Insurance Publication
Author(s): J.J. Silverstein

In the course of corporate development, either by an extant insurance holding company structure or in another context such as private equity, the question may arise: “How do we diligence an insurance company?”  This Article provides a broad overview of considerations in relation to that question focusing on regulatory diligence.  Of course, this Article does not contain an exhaustive list of such considerations, and potential buyers should consult with corporate and regulatory counsel on the specific circumstances related to these issues.

1. Philosophy & Approach

The following philosophies serve as useful touchstones to focus a team responsible for analyzing a target insurance company.

1.A Hot Zones

The diligence team should consider potential areas of increased focus and attention arising out of the nature of the insurer’s business as well as its regulatory positioning.  Whenever a document is identified in one of these “hot zones” the document should be escalated and considered with greater scrutiny regardless of its immediate appearance of materiality.  The following points can serve as a map for the creation of these “hot zones”:

  • Where is the insurer domiciled, and what is its domiciliary regulator? Documents to or from the domiciliary regulator are in a hot zone, and research should be undertaken regarding required regulatory approvals and filings in respect of the domiciliary regulator.
  • Which regulators are major, but non-domiciliary, regulators? For example, using the insurer’s Annual Statement, Schedule T, what are the insurer’s top three state markets by direct written premium? Documents to or from those major regulators are in a hot zone.
  • What are the insurer’s lines of business, and have any of those lines or specific sub-types of business been the subject of broad-based/multistate regulatory scrutiny? Those potential regulatory issues are in a hot zone.

1.B Monitoring and Distributing Materials

The diligence team should consider whether an individual with a regulatory background is best suited to be the data room “guru” (i.e., the person who knows everything that is in the data room, when it got there, and who is responsible for initiating distribution of materials and updating diligence request lists).  Often an individual with insurance regulatory experience (either in insurance compliance or insurance regulatory law) will be able to identify potential legal and operational issues arising out of various subject-matter documents that a corporate development professional or corporate counsel may not.

The data room guru can monitor updates to the data room in realtime, and distribute the materials to specialized subject matter experts for “soft”/preliminary analyses.  This accelerates the identification of material issues and can allow corporate development personnel to determine the feasibility of the transaction on a faster (and less costly) timeline.

1.C Memorialization

Especially in a diligence scenario with regulatory implications, fulsome memorialization of the diligence process is advisable.  On-the-spot analyses should be folded into an omnibus due-diligence document, along with other minor reviews and analyses that were not worthy of immediate identification and discussion.  That stated, throughout the diligence process, it may be prudent to also maintain a brief bullet listing of hot-zone topics and other material issues identified and communicated in the short term.

2. Preliminary & Publicly Available Diligence

Even before a data room on the target is available, it is advisable to create a preliminary 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 along with 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 examinations of the target or the target’s insurance holding company structure.
  • Any recent market conduct examinations implicating the target.
  • Any prior transactional history of the target (discernable from state insurance company databases or similar).

3. Insurance Regulatory Materials

In reviewing insurance regulatory materials provided in the data room, one should consider the following best practices:

  • Compare copies of regulatory materials provided in the data room to the publicly available materials identified in preliminary diligence (considering any differences between the copies).
  • Chart and analyze all regulatory correspondence (especially those in identified hot zones).
  • Review actuarial analyses and memoranda with an eye towards potential regulatory or operational issues, but, of course, defer to actuarial personnel and advisors in respect of such materials.

4. Corporate Materials with Insurance Workstream Overlaps

If separate workstreams for regulatory/compliance and corporate/transactional will be used in the diligence process, workstream leaders should discuss the allocation of diligence materials in detail at the outset.  Often, these workstreams overlap, and inefficiencies can result.  Review of the below-listed items should be discussed in particular, and the two workstreams should communicate extensively on their findings to make sure all potential issues are identified:

  • Articles
  • Bylaws
  • Board and Committee Minutes
  • Organizational Charts
  • Operating Agreements
  • Underwriting, Distribution, and Product Forms
  • Intercompany Agreements
  • Agency and/or MGA Agreements
  • Reinsurance Agreements

5. The Hero or Heroine’s Journey

In Joseph Campbell’s 1949 book The Hero with a Thousand Faces, Campbell summarized and posited various theories related to the so-called “monomyth” (i.e., a template construct for stories that involve a hero or heroine that journeys on an adventure, undergoes challenges and crises, and returns victorious).  Key elements of this construct include: the “call” to adventure, appearance and mentorship of a “guide” figure, challenges and temptations culminating in a nadir revelation, atonement, and victorious return.

Diligencing an insurance company should also be viewed as a hero or heroine’s journey incorporating many of these concepts.  The “call” introducing the prospect of a new or novel acquisition presents the excitement of the unknown, advice and counsel from colleagues will have to be sought and dispensed, many challenges will be presented, and there may even be a revelatory moment of learning or decision-making.  After extensive work and discussion, producing a document summarizing all of the findings should create a well-deserved sense of success.

This Article is intended to provide just a few considerations in approaching that journey, but, of course, potential buyers should consult with corporate and regulatory counsel regarding the details of any major transaction.

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