Regulators Scrutinize Private Equity’s Impact On Insurance

While the massive growth in private equity investment in insurtechs continues unabated, private equity is generating new levels of scrutiny from regulators and insurance commissioners concerned about the impact the trend will have on the insurance industry as a whole.

The worry is not so much financial calamity but that the budding insurtech startups attract a new class of investors unfamiliar and unprepared for the regulatory requirements and licensing restrictions of the traditional insurance industry.

“The way that many of these new investors expect short-term and long-term returns is butting up against what regulatory capital requires,” said attorney Greg Hoffnagle, a partner in Goodwin’s financial industry group and insurance practice. “They're not used to putting an investment in and finding out that their investment can only be used for certain things.”

Many of the new insurtech investors gauge their experiences with notable high-tech startups like Uber, Google, Tesla and others that brought relatively quick and sky-high returns. Or they are non-U.S. speculators and venture funds with little knowledge of the regulatory world of insurance.

“If you're a foreign investor, and you've never invested in a U.S-regulated insurance entity, some of the concepts or the requirements can be foreign, literally and figuratively,” Hoffnagle said.

Hoffnagle said states and commissioners are trying to determine if regulations need to be amended or “tweaked” to accommodate these “alternative investments” that are pouring into the insurtech business.

In a recent paper for JDSupra, Hoffnagle highlighted a National Association of Insurance Commissioners’ list of “Regulatory Considerations Applicable (But Not Exclusive) to Private Equity Owned Insurers.” It said, “Regulators may not be obtaining clear pictures of risk due to holding companies structuring contractual agreements in a manner to avoid regulatory disclosures and requirements” and that “control considerations may exist with less than 10% ownership.”

After a 30-day comment period, the NAIC’s Macroprudential Working Group adopted an amended list in February. Among other things, it said that the NAIC will continue to evaluate conflict of interest considerations even where private equity firms may maintain less than the traditional 10% ownership interest. It also said that the NAIC is focused on assessing the operational, governance and market conduct practices of private equity investors and analyzing whether any conceivable focus on short-term results may not be aligned with the long-term nature of many insurance products.

The amended list also said “asset-management services may need to be distinguished from ownership when assessing and considering controls and conflicts” and that certain transactions “may be excluded by [existing] affiliate reporting due to nuanced technicalities.”

All this essentially means that investors may not realize the restrictions of investing in a heavily regulated industry, and regulators might not have full cognizance of where the money is coming from and whether more disclosure is appropriate.

“Traditional insurance companies have boards and public filings, and you pretty much know what you’re getting into and who it is. There’s no need to what we call ‘go up the chain’ to see who’s behind things,” Hoffnagle said. “Now, regulators are starting to look a bit harder or want to go up the chain with these insurtechs.”

The 13-point regulatory considerations from the NAIC task force also hinted that regulators may need to look more closely at “insurers’ use of offshore reinsurers (including captives) and complex affiliated sidecar vehicles to maximize capital efficiency, reduce reserves, increase investment risk and introduce complexities into the group structure.”

“The insurance space is horribly antiquated and definitely ripe for innovation,” Hoffnagle said. “But some insurtechs may set up mechanisms or types of funds or different arrangements that may reduce their regulatory scrutiny. And then all of a sudden, the regulators are coming forward and saying, ’Hey, investor, we need all this information from you.’ And a lot of them are unpleasantly surprised that they didn't know that this was common.”

Hoffnagle said the bottom-line concern for regulators is simply an insurers’ liquidity, solvency and ability to pay claims.

While increased scrutiny or regulation, if it comes, might discourage some investors and even cause some to pull their investments, Hoffnagle isn’t worried that it will upset the market or budding industry.

“I think any disaster may be averted because there just seems to be a never-ending flow of alternative capital in this space,” he said. “If three people bow out because they don’t want to deal with the regulations, three new people will come in.”

Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].

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Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].