For a variety of reasons, life insurers buy or are purchased by other companies, merge with other insurers, or enter into strategic alliances with other companies. The basic purpose of these affiliations is to strengthen company operations and activities to increase efficiency and profitability. The rapidly changing world of financial services has spurred insurers to undergo various corporate restructurings and to undertake transactions that enhance their competitive position by expanding into new product or geographical areas and that help them survive the challenges of new competitors entering into traditional insurance areas.

An acquisition occurs when a company, an individual, a group of individuals, or some other group buys a controlling interest in a company. Mutual insurers can acquire but cannot be acquired since there is no stock to be purchased. Stock insurers can both acquire and be acquired.

The reasons for an acquisition vary greatly. Sometimes the stock acquired is solely for investment purposes, and the acquired company�s management continues to direct the company operations. In other situations, the benefits of merging with another company may be the motivation for the acquisition. In these cases, the new controlling stockholder(s) may either retain the existing management or install new management.

The acquisition of a company can be friendly or hostile. In a friendly takeover the acquiring company offers to purchase a company. The company to be purchased agrees to the acquisition and the price for the stock. The board of directors of the company to be acquired approves the offer and publicly recommends to its stockholders that the offer be accepted. The acquisition requires the approval of both the stockholders and the insurance commissioner in each state in which any insurers involved in the acquisition are domiciled. The Securities and Exchange Commission (SEC) and the antitrust authorities may also be involved.

A hostile takeover occurs when the acquirer proceeds with a takeover even though the board of directors of the company to be acquired (the target company) refuses the acquisition offer. To obtain a controlling interest the acquiring company makes a tender offer�a public offer to purchase the target company�s securities directly from the shareholders at a specified price�thereby circumventing the board of directors. As further discussed below, under the federal securities laws, the company making the tender offer files information with the SEC about the reasons for the acquisition, any plans to liquidate the target company or sell a major portion of its assets, and the source of funds for the acquisition. The acquirer then publicly announces the offer to purchase the target�s stock at a specified price, usually significantly in excess of the market value of the stock. Not uncommonly, the purchase is conditioned on the acquirer�s ability to obtain a certain percentage of the target company�s shares within a specified period of time (to assure the acquirer of at least practical controlling interest if and when the tender offer is successful). If the takeover succeeds, the acquiring company obtains control, can elect a new board of directors, and can decide on management policy.

In the 1980s the leveraged buyout (LBO) came into vogue as a means of acquiring a company. In an LBO the acquiring company finances the acquisition primarily through borrowing. After a successful takeover, the acquirer repays the debt from money generated by the acquired company�s operations or through the sale of some of the acquired company�s assets.

A merger occurs when two or more companies are legally joined together to become one. One company may be absorbed by another�the surviving�company, or two or more existing companies may be merged into an entirely new company.

The advantages of a merger depend on the circumstances. An insurer in weakened financial condition, for example, may seek a stronger partner to help the insurer overcome its financial difficulties or gain access to additional surplus to fund expansion and growth. An insurer that has decided to offer new products or services may determine that it would be more feasible to merge with an existing company that already offers those products and/or services than to expend the time and money to develop them itself. An insurer that wants to expand into new geographical areas may find that joining an insurer already licensed and marketing in those areas is a more rapid and economical mode of expansion. Since unit costs decrease as the size of operations increases, a merger is also attractive to a company that wants to reduce the price of its products and increase profits through economies of scale. Moreover, large and growing companies often attract both security-minded customers and high-quality management and other personnel.

Mergers may also have significant drawbacks. A merger often incurs enormous legal and accounting costs. It can cause great anxiety among managers and employees, resulting in either the loss of key people or the cost in time and money to retain them. When merging companies are in different locations, there can be substantial costs to move personnel, as well as the inevitable costs of employee turnover. Many business relationships will need to be reviewed and perhaps reestablished, including contracts with agents. Difficulties will undoubtedly arise in efforts to blend different managements, corporate philosophies, and company systems. Finally, there is the danger that the perceived benefits of the merger may not be realized, at least to the extent the companies had contemplated, and that this will create new difficulties.

A merger between two or more insurance companies involves several steps. First, potential merger partners must be found and evaluated; usually, an independent actuarial or investment banking firm examines each company�s financial condition. Then the boards of directors must approve the plan of merger, typically by a two-thirds majority vote of the stockholders or, if a mutual company, by two-thirds of the policyowners. Stockholders who disapprove must be paid a fair market value for the forced surrender of their stock if the merger actually occurs. The state insurance regulatory authorities in the insurer(s)� domiciliary state(s) must also approve the merger. The final merger document must be filed in the new or surviving company�s state of domicile and a new or amended certificate of incorporation must be obtained. The merging companies� assets and liabilities must be transferred to the new or surviving company. And, finally, the new or surviving company must obtain licenses in all states where it does business.

When a company acquires one or more companies (purchases a sufficient amount of stock to possess controlling interest), the acquired companies become subsidiaries of the acquirer, the parent company. The group of companies has formed a holding company system, and the parent company is the holding company.

A holding company is any person or organization (firm) that directly or indirectly controls an authorized insurer. (Control commonly means the power to vote 10 percent or more of the insurer�s voting securities.) An insurance holding company system consists of two or more affiliated persons or organizations (firms), one of which is an insurer (that is, a holding company system is an insurer, its parent, subsidiaries and/or other affiliated organizations).

Traditionally, insurers operated as independent, free-standing entities or as a part of insurance company groups. Originally, the holding company concept was utilized to acquire a group of companies in related lines. By the late 1960s, however, this changed in the insurance industry as a result of two trends.

First, to improve earnings and long-term growth, many insurers sought to diversify by venturing into new lines of insurance (for example, a life company acquiring a property and liability insurer) or into noninsurance enterprises, commonly in the financial services area (acquiring securities/broker-dealer organizations, mutual fund management companies, consumer finance companies and other related institutions). Several life insurers found that forming a holding company system gave them greater ability to diversify their services and products, imposed fewer restrictions on their investments, and enhanced their capital-raising flexibility.

Second, several life insurers were taken over by other insurers or noninsurance company acquirers and thus became part of a conglomerate (a group of unrelated businesses under the control of a holding company). Sometimes being part of the conglomerate contributed to the insurer�s strength. On occasion, however, the acquirer was less interested in the insurer�s well-being than in gaining access to the insurer�s accumulation of liquid assets and substantial cash flows.

A holding company may be an insurer or a general business corporation. As noted before, a mutual insurer, by its very nature, is not subject to acquisition by another company purchasing shares of the insurer�s stock since there are no shares. However, a mutual insurer (or a stock insurer if it so chooses) can become involved in a downstream holding company system by creating or acquiring subsidiaries, perhaps including a downstream holding company, which, in turn, can acquire other enterprises as subsidiaries. The mutual insurer sits atop the holding company structure. A downstream holding company has fewer insurance regulatory concerns since the parent insurer, which continues to control its own destiny as well as that of any subsidiaries acquired downstream, remains directly subject to insurance regulatory control.

By contrast, there are upstream holding company systems in which the holding company acquires the insurer�s stock. Stock insurers tend to become involved in upstream holding company systems in one of two ways. First, a stock insurer can organize an upstream noninsurance holding company that sits atop the intercorporate structure. The insurer�s board of directors and management, or appropriate portion thereof, becomes the board and management of the holding company; the insurer becomes its subsidiary. As a noninsurance company, generally speaking, the new parent is outside the scope of insurance regulation. It can engage in a host of activities through its different subsidiaries, including insurance business, other financially related businesses, and totally unrelated enterprises. Second, as noted earlier, a stock insurer can become involved, either voluntarily or involuntarily, in an upstream holding company system by being acquired by an outside company that becomes the insurer�s upstream holding company.

Although acquisitions, mergers, and holding companies are common, insurers have also formed strategic alliances�which involve less drastic structural changes�to accomplish some of the same objectives. A strategic alliance is an ongoing relationship in which two or more independent organizations share the risks and rewards. Through this alliance, a life insurer gains access to the resources of other firms but still retains its independence.

Insurers have a long tradition of entering into some form of strategic alliance with other business firms�foreign and domestic insurers, securities firms, third-party administrators, commercial banks, and so forth. Through cooperation with other firms, an insurer can improve its ability to handle the increased competition from traditional competitors, the integration of financial services, and the globalization of the financial service marketplace.

As mentioned earlier, firms can diversify or grow through internal development, by acquisition, or by merger. Often, acquisitions or mergers prove to be the more attractive routes. Although they have corporate advantages, however, since acquisitions and mergers may involve changing management, company structure, and perhaps even the competitive nature of the marketplace, they can give rise to public policy issues that come to the attention of the state insurance regulators, federal antitrust enforcement authorities, and the SEC.

Regulatory Concerns. Although acquisitions and mergers have long been subject to state insurance department regulatory approval, the rash of insurance company takeovers�many of them hostile�in the late 1960s heightened regulatory concerns. These takeovers usually involved tender offers, which enabled the acquiring company to avoid dealing directly with the target company�s resistant management. Unlike affiliations involving willing partners, such as two companies agreeing to merge, tender offers were essentially unregulated.

Regulators became concerned when affiliations of insurers with noninsurance companies pursuing different interests began to occur, which gave control of the insurers to noninsurance parents outside of insurance regulatory control. Their concern increased when noninsurance holding companies that lacked insurance experience, focus, and orientation toward safeguarding policyowner interests started to acquire and control stock insurers. During the ensuing years, regulators� concern proved to be justified. Actual and potential abuses in these affiliations included rapacious acquirers looting insurers� assets, raiding insurer surplus to finance either the holding company itself or the operations of other holding company subsidiaries, subtle threats to insurer solvency, and circumvention of various state requirements enacted to protect the insurance-buying public.

At the same time, however, regulators acknowledged that the interests of the public, policyowners, and shareholders might not be compromised by�perhaps even be benefited by�permitting insurers (1) to engage in activities that would enable them to better use their management skills and facilities, (2) to diversify into new lines of business, (3) to have free access to capital markets to fund diversification programs, (4) to implement sound tax planning, and (5) to serve the public�s changing needs by being able to compete with a comprehensive range of financial services. Nevertheless, regulators recognized that public, policyowner, and shareholder interests could be adversely affected if (1) persons seeking control of an insurer utilized that control contrary to policyowner and public interests, (2) the acquisition of an insurer substantially lessened competition, (3) an insurer in a holding company system entered into transactions or relationships with affiliated companies on unreasonable or unfair terms to the insurer, or (4) an insurer paid dividends to the noninsurance parent or other shareholders that jeopardized the insurer�s financial condition.

Holding Company Act. As regulatory concerns mounted, both the regulators and the insurance industry moved to develop a legislative response. In 1969, following legislative enactments in New York and Connecticut, the NAIC adopted a model Insurance Holding Company Systems Regulatory Act (hereafter referred to as the Holding Company Act) and a model regulation setting forth rules and procedural requirements to assist in carrying out the provisions of the act. All states regulate the acquisition of insurance companies in some way, whether as a part of the act or separately from it. Furthermore, all states have enacted some type of holding company law, most of which are patterned after the NAIC model act (although not necessarily adopting all of the amendments made to it throughout the 1980s).

To exercise control over holding company situations, the model act (1) facilitates insurer diversification, (2) requires disclosure of relevant information relating to changes in the insurer�s control and commissioner approval of such changes, (3) requires insurer disclosure of material transactions and relationships between the insurer and its affiliates, including certain dividends distributed by the insurer, and (4) establishes standards governing material transactions between the insurer and its affiliates. To avoid unnecessary multiple and conflicting regulation of insurers, the model act applies only to domestic insurers, except where otherwise specifically stated.

Insurer Diversification. From the insurance industry�s perspective, the traditional investment law limitations precluded or severely constrained insurer�s ability to diversify and grow. This contributed to the pressure for insurers to organize holding company systems with the insurer as a subsidiary of a noninsurer parent that had the flexibility to acquire or establish subsidiaries in diversified fields. In response, the Holding Company Act relaxed some of the investment restraints but did so within a somewhat controlled environment.

Approval of Acquisitions and Mergers. Under the Holding Company Act, any person or organization (firm) acquiring securities that would result in obtaining direct or indirect control of a domestic insurer or entering into an agreement to merge with a domestic insurer must file specific information with the commissioner and obtain his or her approval before the acquisition or merger can be effected. The information, as required by supplementary regulation, must include the method of acquisition; the identity and background of the applicant and individuals associated with the applicant; the nature, source, and amount of funding used for the acquisition or merger; future plans for the insurer; and financial statements. The information that must be provided to the commissioner not only alerts the target insurer to the potential takeover but also gives the insurer�s management a better opportunity to make its case to the shareholders about whether or not to accept the offer.

Registration of Insurers. Every insurer that is a member of an insurance holding company system and licensed to do business in the state (except a foreign insurer already subject to substantially the same disclosure requirements and standards in its domiciliary state) must register with the commissioner. Each registered insurer must keep the required information current.

Standards Governing Transactions between the Insurer and Its Affiliates. Transactions within a holding company system are subject to several standards, including the fairness and reasonableness of terms, charges and fees for service. Expenses must be allocated to the insurer according to customary insurance accounting practice, and accurate and clear records must be maintained as to the nature, details, and reasonableness of transactions between affiliates. The insurer�s surplus for policyowners, following dividends or distributions to affiliates, must be reasonable in relation to the insurer�s liabilities and financial needs.

Insurer Management. As early as 1972, some commissioners urged the adoption of management standards giving the insurer�s officers control over all facets of the insurance operation, rather than permitting a general corporation�s board of directors to usurp this function. The 1985 amendments to the act include provisions to this effect, stating that the insurer�s officers and directors continue to be responsible for the insurer�s management and must manage the insurer in a manner that ensures the insurer�s separate operating identity.

Enforcement. In addition to various ways to monitor compliance with provisions of the holding company law�reviewing the various information filings, examining insurers and sometimes insurers� affiliates, and compelling the submission of books, records and other information�the commissioner has a host of sanctions with which to enforce the act, including monetary penalties and recoveries, cease-and-desist orders, and license revocation. Furthermore, if it appears that any insurer or any director, officer, employee, or agent willfully violated the act, the commissioner may cause criminal proceedings to be instituted. The insurer is subject to dollar penalties; individuals are subject to fines, and if fraud is involved, imprisonment.

If violations of the act threaten a domestic insurer�s solvency or make further transaction of business hazardous to policyowners, the commissioner may proceed under the state�s rehabilitation and liquidation law. (See chapters 26 and 27.) If the commissioner believes a violation makes the continued operation of an out-of-state insurer contrary to policyowner interest, after a hearing, he or she may suspend or revoke the insurer�s license to do business.

In the 1980s, numerous insurers became insolvent or nearly so. Although a majority of insolvencies involved property and liability insurers, the life insurance industry was not immune. The record of insolvent insurance companies is replete with self-dealing abuses in relationships between insurers, their parent holding companies, and their affiliates, involving intercompany loans, dividends, management contracts, and investments. Regulators and liquidators were concerned that they did not have adequate access to the interrelated corporate networks� books and records affecting insurer operations and were thereby deterred from effective regulatory action. A series of amendments to the Holding Company Act in the 1980s reflect regulatory responses to such abuses.

In the United States the first wave of corporate mergers occurred around the turn of the century. The only federal antitrust statute at the time was the Sherman Act. However, the need to prove either a conspiracy in restraint of trade or some type of monopolization activity rendered the act a somewhat less-than-effective deterrent to anticompetitive mergers. Consequently, Congress enacted Section 7 of the Clayton Act, which was ultimately amended to prohibit a corporation from directly or indirectly acquiring the stock or assets of another corporation if, in any line of commerce in any section of the country, it substantially lessened competition or tended to create a monopoly. Unlike the Sherman Act, which requires finding actual anticompetitive effects, the test under Section 7 is probable effect in order to combat incipient monopolistic tendencies.

Prior to the 1960s, the Department of Justice and the Federal Trade Commission (FTC) showed little interest in challenging insurance company acquisitions and mergers, perhaps because there were few of them or that it was difficult to overcome a McCarran Act defense (see chapters 26 and 27). In the early 1960s, however, a few lower court decisions sanctioned the application of federal antitrust law to insurance acquisitions. Although the Supreme Court has not definitively determined whether the McCarran Act bars federal antitrust jurisdiction in many situations and even though good legal arguments support such a bar, as a practical matter, the potential for applying the federal antitrust law to insurance company acquisitions and mergers has become a fact of life.

To the extent that federal antitrust jurisdiction is not barred by the McCarran Act, the issue becomes whether a state insurance regulator applying holding company law is preempted by federal antitrust law. Since the Sherman and Clayton Acts were enacted long before the antitrust laws were deemed applicable to insurance, it appears unlikely that the Supreme Court would find Congressional intent to preempt. As to the conflict test under the preemption doctrine, antitrust law seeks to prohibit anticompetitive acquisitions and mergers. If the insurance commissioner disapproves the transaction, there will be no conflict with antitrust law. However, if the commissioner approves what antitrust law prohibits and if the McCarran Act defense to antitrust actions is inapplicable, preemption of the holding company law is probable. In short, unless Congress acts in some way to change the existing balance, dual assertion of federal antitrust law and state insurance acquisition and merger regulatory authority promises to continue in the years ahead.

The emergence of the tender offer technique and the frequency of its use revealed a deficiency in the disclosure of information to investors. Therefore in 1968 Congress enacted the Williams Act as an amendment to the Securities Exchange Act of 1934. (In 1970, this act was made applicable to insurance securities.) The central philosophy of the Williams Act is disclosure. Among other things, the act requires that upon the commencement of a tender offer, the offeror must file pertinent information with the SEC and provide such information to the target company�s shareholders and management. All shares tendered must be purchased at the same price. The offer commences at the time of the first public announcement, and it must remain open for at least 20 days.

Congress believes that the Williams Act strikes a fair balance between the party making the takeover bid and the management of the target company by enabling both to present their cases to the shareholders. More important, compelling timely, full, and fair disclosure puts the shareholders in a position to make informed decisions.

In the absence of McCarran Act protection, insurance commissioner authority to approve or disapprove an acquisition pursuant to a tender offer is questionable under the preemption doctrine. Even though the commissioner reviews a tender offer from the perspective of protecting the policyowners, a disapproval of a tender offer precludes the offer itself. This directly affects those shareholders who want to accept the offer. Thus insurance commissioner disapproval would appear to constitutionally prohibit what Congress authorizes and fosters�the shareholders� freedom to make informed decisions about accepting or rejecting a tender offer for their shares.

Consequently, the states� ability to protect policyowners from adverse acquisitions by tender offers most likely depends on the scope of the McCarran Act in such situations. In SEC v. National Securities, Inc., the Supreme Court found that an insurance commissioner�s approval of an acquisition under an insurance holding company law�s standard of the transaction�s fairness to the shareholders was the regulation of securities, not the regulation of the "business of insurance." Hence the application of the Securities Exchange Act proxy rules were not barred by the McCarran Act. This decision has been cited in the proposition that acquisitions and mergers are not part of the business of insurance as that term is used in the McCarran Act.

However, in most acquisition and merger situations, the application of the holding company law focuses on standards to ensure the protection of policyowners and the competitiveness of the insurance marketplace. Although the National Securities decision suggests that this application constitutes regulating the business of insurance, the more recent judicial narrowing of this language leaves the issue in some doubt. In the meantime, states continue to regulate acquisitions and mergers under their holding company laws.