Firms can diversify and/or grow through internal development, by acquiring other existing companies or by merger. Often the latter routes prove to be more attractive. However, since they may involve changing control of the insurer, the insurer’s management, the structure of the company and perhaps even the competitiveness of the marketplace, acquisitions and mergers give rise to public policy concerns engendering the attention of the state insurance regulators, federal antitrust enforcement authorities and the SEC.

Traditionally, mergers between insurers involved willing partners, each having decided that joining together would be in its own best interest. The merger process between two or more insurance companies involves several steps. Potential merger partners need to be found and evaluated. Terms of the merger need to be negotiated. Usually independent actuarial or investment banking firm(s) will appraise the financial condition of each company. The merger process is usually prescribed by the applicable merger statute(s) of the domiciliary state(s) of the merging parties. The board of directors of each merging company must approve the plan of merger. Approval also requires a typically two-thirds majority vote of the stockholders or, if a mutual company, a two-thirds majority vote of the policyholders. Stockholders disapproving the merger 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 insurers’ state(s) of domicile must approve the merger. Perhaps some other states might have to approve as well.

Policyholder protection is the most fundamental issue which needs to be considered both by the insurers entering into a merger and by the insurance regulator(s) approving or disapproving the merger. In a merger involving stock insurers, the proprietary interest of the stockholders is protected through the pricing of the exchange of stock which occurs at the time of closing. As to policyholders of merging stock insurers, policyholder protections are instituted under the state insurance holding company laws as discussed below. In the context of a merger between mutual insurers, the proprietary interest of the policyholders arises from the insurance contract. No change in the contract is effected by the merger. The policy is an obligation assumed by the surviving company as a matter of law. The question of fairness to the policyholders of the two mutual companies is especially important in the combining of the mortality experience of the two insurers as well as the historic and emerging expense experience of the separate companies so as to formulate an aggregate dividend policy for the surviving company which is fair to all policyholders.

The final merger document must be filed in the state of domicile of the new or surviving company and a new or amended certificate of incorporation must be obtained. The assets and liabilities of the merging companies are transferred to the new or surviving company. And the new or surviving company must assure the acquisition or continuance of certificates of authority to do business and must obtain anew, confirm or reaffirm product filings and agent licenses and appointments in all states where it contemplates doing business.

Although acquisitions and mergers have long been subject to state insurance department regulatory approval before they could be effectuated, commencing in the late 1960s, regulatory concerns heightened with the rash of takeovers of insurance companies, many of them hostile. These were typically achieved through the technique of tender offers, that is, a public offer by an acquirer to purchase securities of a target company directly from that company’s shareholders at a specified price. Through this technique the acquirer could avoid dealing directly with a resistant management of a target company. Unlike other methods of combination involving willing partners, such as two companies agreeing to merge, tender offers were essentially unregulated.

Regulators became concerned over the affiliation of insurers with noninsurance companies pursuing different interests, especially when the control of the insurer rested in the hands of a noninsurance parent which is beyond insurance regulatory control. Such concern became exacerbated with the acquisition and control of stock insurers by noninsurance holding companies lacking insurance experience, focus and orientation toward safeguarding policyholder interests. During the ensuing years, these concerns proved to have some foundation. Actual and potential abuses stemming from insurance holding companies included looting of assets by rapacious acquirers, raiding of insurer surplus to finance either the holding company itself or the operations of other holding company subsidiaries, more subtle threats to insurer solvency resulting from unregulated holding company situations, and circumvention of a host of state requirements enacted to protect the insurance buying public.

At the same time, however, regulators recognized that the interest of the public, policyholders and shareholders might not be compromised by, and perhaps may even be benefited by, permitting insurers (i) to engage in activities which would enable them to better use their management skills and facilities, (ii) to diversify into new lines of business, (iii) to have free access to capital markets to fund diversification programs, (iv) to implement sound tax planning and (v) to serve changing needs of the public by being able to compete through providing a comprehensive range of financial services. Nevertheless, the regulators also declared that public, policyholder and shareholder interests may be adversely affected when (i) control of an insurer is sought by persons who would utilize such control contrary to policyholder and public interests, (ii) the acquisition of an insurer would substantially lessen competition, (iii) an insurer in a holding company system is caused to enter into transactions or relationships with affiliated companies on unreasonable or unfair terms to the insurer, or (iv) an insurer pays dividends to the noninsurance parent or other shareholders which jeopardize the financial condition of the insurer.

As regulatory concerns mounted, both the regulators and the insurance industry moved to develop a legislative response. In 1969, following recent legislative enactments in New York and Connecticut, the NAIC adopted its 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.

Triggered by the failure of Equity Funding Corporation of America in 1977, the NAIC undertook a major review of the model Holding Company Act. The commissioners concluded that the Act was essentially sound. However, by the mid 1980s with the collapse of Baldwin-United and several other insolvencies, it became clear that insurer solvency is often tied in many ways to the fate of its affiliates. This time, the NAIC performed major surgery. The Act became less one of permission and more one of solvency regulation.

All states now, in some fashion, regulate the acquisition or merger of insurance companies whether as a part of or separately from a holding company act. Furthermore, all states have enacted some type of holding company laws, most of which are patterned after the NAIC Model Act (although not necessarily adopting all of the amendments made thereto and adopted throughout the 1980s).

An insurance holding company is defined as any person who directly or indirectly controls an authorized insurer. An insurance holding company system consists of two or more affiliated persons one of which is an insurer (i. e., a holding company system is an insurer along with its parent, subsidiaries and/or other affiliated organizations). To avoid unnecessary multiple and conflicting regulation of insurers, the Act applies only to domestic insurers except where otherwise specifically stated. To exercise control over holding company situations, the Model Act (1) facilitates insurer diversification, (2) requires commissioner approval of changes in control of the insurer, (3) requires registration of insurers in a holding company system and insurer disclosure of material transactions and relationships between the insurer and its affiliates including certain dividends distributed by the insurer, (4) establishes standards governing material transactions between the insurer and its affiliates, and (5) imposes certain requirements as to corporate governance.

Facilitate Diversification. From the insurance industry’s perspective, the traditional investment law limitations precluded or severely constrained insurer ability to diversify and grow. This contributed to the pressure for insurers to organize holding company systems with the insurer becoming a subsidiary of a noninsurer parent and the parent possessing 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.

Under the Act, a domestic insurer can organize or acquire one or more subsidiaries engaged in specified kinds of business. However, the Act did not take a stand as to either authorizing noninsurance subsidiaries or restricting subsidiaries to insurance related business. Instead, it contains alternative provisions for the individual states to select from. One alternative specifies that subsidiaries of insurers may conduct only certain enumerated insurance-related operations (for example, any kind of insurance business; acting as insurance agent or broker, management of mutual funds; acting as a broker-dealer under the Securities Exchange Act of 1934; providing actuarial, loss prevention, claim and other similar types of services; financing insurance premiums; or any business activity determined by the commissioner to be reasonably ancillary to an insurance business). The other optional provision authorizes a domestic insurer to organize or acquire subsidiaries which may conduct any type of lawful business. Furthermore, because of limitations imposed elsewhere in the insurance law, the Act provides additional investment authority, subject to specified limits, to invest in the stock and debt obligations of the insurer’s subsidiaries provided that after such investments the insurer’s surplus as regards the policyholders will be reasonable in relation to the insurer’s liabilities and adequate to its financial needs.

By liberalizing the types of businesses into which an insurer could enter through subsidiaries and the investments in subsidiaries which could be made, the Holding Company Act better enables an insurer to diversify downstream and grow without the necessity of becoming involved with upstream noninsurance parent holding company systems. (This was particularly important to mutual insurers which have little alternative.) Nevertheless, upstream holding company systems became increasingly common due to outside acquisitions of insurers or insurers forming their own upstream holding companies for organizational reasons. Thus, as discussed below, the Holding Company Act seeks to exercise control over the acquisitions of or mergers with domestic insurers and over certain intercorporate activities of holding companies.

Approval of Acquisitions and Mergers. Under the Holding Company Act, any person acquiring securities which 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 specified information with the commissioner and obtain his or her approval before such acquisition or merger can be effectuated. The specified information, as required by the supplementing regulation, must include the method of acquisition, the identity and background of the applicant, the identity and background of individuals associated with the applicant, the nature, source and amount of funding used to effectuate the acquisition or merger, future plans for the insurer, and financial statements. The information provided to the insurer not only alerts the insurer to the potential takeover but also affords management a better opportunity to make its case to the shareholders as to whether they should accept the offer.

The approval authority enables the commissioner to prevent an acquisition or merger contrary to public policy as defined by the statute. The commissioner shall approve the acquisition or merger unless he or she finds that such transaction gives rise to specified adverse circumstances including (i) inability of the insurer, after the change in control, to meet the requirements for the issuance of a license to write its current lines of insurance, (ii) a substantial lessening of competition in the state, (iii) the financial condition of the acquirer possibly jeopardizing the financial condition of the insurer or prejudicing the interests of the policyholders, (iv) acquirer’s plans to liquidate insurer, sell its assets or other material changes in the insurer’s business, corporate structure or management which are unfair and unreasonable to the policyholders and not in the public interest, (v) competence, experience and integrity of the persons to control the insurer operations not being in the policyholder or public interest and/or (vi) the acquisition likely to be hazardous or prejudicial to the insurance buying public. In preventing inappropriate acquisitions and mergers, the insurance holding company laws serve a variety of insurance regulatory purposes including safeguarding an insurer’s financial condition, avoiding conduct contrary to policyholder interest and fostering competition in the marketplace.

Registration of Insurers. Every insurer which is a member of an insurance holding company system and which is licensed to do business in the state (except a foreign insurer subject to disclosure requirements and standards in its domiciliary state which are substantially the same as in this state) shall register with the commissioner. The Act specifies the content of the registration statement which must be filed on a form prescribed by the NAIC. The form shall include information as to the capital structure and financial condition of the insurer; ownership and management of the insurer; identity and relationships of every member of the holding company system; and specified agreements in force and transactions currently outstanding between the insurer and its affiliates (such as loans; purchases, sales or exchanges of securities of affiliates by the insurer or of the insurer by its affiliates; purchases, sales or exchanges of assets; guarantees or undertakings for benefit of an affiliate; management agreements, service contracts and cost sharing arrangements; reinsurance agreements; and dividends and other distributions to shareholders). Such information need be disclosed only if material for the purposes of the law. Each insurer shall report to the commissioner all dividends and other distributions to shareholders within 15 business days following the declaration. Each registered insurer shall keep current the information required to be disclosed in the registration statement by reporting material changes within 15 days. This ongoing disclosure enables the regulator to monitor developments within a holding company system more closely than if monitoring relied solely upon examination. The thrust of these provisions is detailed disclosure to the insurance commissioner of the insurer’s state of domicile.

Standards Governing Transactions between the Insurer and Its Affiliates. The conversion of the Model Holding Company Act from primarily a permissive form of regulation to solvency regulation can best be seen in the amendments pertaining to interaffiliate transactions. Transactions within a holding company system are now subject to several standards including the fairness and reasonableness of terms, charges and fees for service. Expenses allocated to the insurer shall be done according to customary insurance accounting practice. Accurate and clear records shall be maintained as to the nature, details and reasonableness of transactions between affiliates. The insurer’s surplus as regards policyholders, following dividends or distributions to affiliates, shall be reasonable in relation to the insurer’s liabilities and financial needs.

Furthermore, several transactions (not just extraordinary dividends) involving a domestic insurer and any person in its holding company system require advance notice to the commissioner and the absence of his or her disapproval within 30 days. With the experience of Baldwin-United and other recent insolvencies fresh in their minds, the commissioners concluded that after the fact reporting of interaffiliate transactions was too late for regulatory prevention or cure. Thus certain transactions were brought under a form of prior approval regulation. These transactions include, for example, (i) sales, purchases, exchanges, loans, credit extensions, guarantees or investments if the dollar amount exceeds specified percentages of the insurer’s assets or surplus, (ii) certain loans or extensions of credit to nonaffiliated persons, (iii) reinsurance agreements in which the reinsurance premium or a change in the insurer’s liabilities exceeds 5 percent of the policyholders’ surplus, (iv) management, service and/or cost sharing agreements, and (v) any material transactions deemed by the commissioner to adversely affect policyholder interests.

Corporate Governance. As early as 1972, some commissioners urged the adoption of standards as to management so that the officers of the insurer would be responsible for retaining control over all facets of the insurance operation rather than permitting the board of directors of a general corporation to usurp this function. The 1985 amendments, as optional provisions because of considerable controversy surrounding them, include provisions as to corporate governance. They provide that the officers and directors of the insurer shall continue to be responsible for the management of the insurer and shall manage in such manner to ensure that the insurer’s separate operating identity is consistent with the Act. Furthermore, to assure some independent oversight of the insurer’s operations, at least one-third of the board of directors and of each board committee shall be persons who are not officers or employees of the insurer or of any entity controlling, controlled by or under common control with the insurer and who are not beneficial owners of a controlling interest in the voting stock of the insurer or entity. In short, one-third should be outside directors. And the board shall establish one or more committees comprised solely of such independent directors. This committee(s) shall be responsible for recommending the selection of independent CPAs, reviewing the insurer’s financial condition, reviewing the results of the independent audit and any internal audit, nominating candidates for being directors, evaluating the performance of the principal officers of the insurer and recommending to the board the selection and compensation of the principal officers of the insurer.

Enforcement. The commissioner has various means to monitor insurance compliance with the Holding Company Act. In addition to reviewing the various information filings, he or she possesses the general authority to examine insurers. Furthermore, the Act authorizes the commissioner to order any registered insurer to produce such books, records or other information in possession of the insurer or its affiliates as are reasonably necessary to ascertain the financial condition of the insurer or the legality of the insurer’s conduct. If the insurer fails to provide the information, the commissioner can examine the affiliates even though they are not otherwise subject to his or her regulatory authority. And, in 1988, the NAIC Annual Statement was amended to require detailed information as to the inflow and outflow of funds between affiliated companies in an insurance holding company system. The disclosure of this information is designed to enhance the regulators’ ability to monitor self-dealing types of transactions.

The commissioner possesses a host of sanctions with which to enforce the Act. These include 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/or, if fraud is involved, imprisonment.

If violations of the Act threaten insolvency of a domestic insurer or make further transaction of business hazardous to policyholders, the commissioner may proceed under the state’s rehabilitation and liquidation law. If an order for rehabilitation or liquidation has been entered, the receiver has the right to recover from a parent, affiliated company or person who otherwise controlled the insurer (i) the amount of distribution paid by the insurer or (ii) any payment of bonuses, extraordinary salary adjustments, etc., made by the insurer to a director, officer or employee where the distribution or payment was made within a year of the petition for rehabilitation or liquidation. However, such is not recoverable if the recipient can show that, when paid, such was lawful and reasonable and that the recipient did not know that such might adversely impact the insurer’s ability to meet its obligations.

And, if the commissioner believes a violation makes the continued operation of an out of state insurer contrary to policyholder 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 the majority of such 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 the relationships between insurers, their parent holding companies and/or their affiliates. These included intercompany dealings involving loans, dividends, management contracts and investments. Furthermore, significant concern arose as to whether the interrelated corporate networks precluded regulators and liquidators adequate access to the books and records affecting insurer operations thereby deterring effective regulatory action. A series of amendments to the Holding Company Act in the 1980s reflect regulatory responses to such abuses. These amendments are embraced in the discussion above.

Inappropriate use of the holding company system can result and has resulted in both adverse and unfair treatment of policyholders and in insolvent insurance companies. Consequently, insurance holding company systems have received and continue to receive considerable regulatory attention so as to preserve their benefits while deterring their abuses.

Unlike the Sherman Act, which requires the finding of actual anticompetitive effects, the test under Sec. 7 of the Clayton Act is probable effect so as to cope with monopolistic tendencies in their incipiency.

To the extent federal antitrust is not barred by the McCarran Act, the issue becomes whether a state insurance regulator holding company law is preempted by the federal antitrust laws. 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 seeks to prohibit anti-competitive acquisitions and mergers. If the insurance commissioner disapproves the transaction, there would be no conflict with antitrust. However, if the commissioner approves what antitrust prohibits, and if the McCarran defense to antitrust actions was inapplicable, preemption appears probable. In short, unless Congress acts in some way to change the existing balance, dual assertion of federal antitrust and state insurance acquisition and merger regulatory authority promises to be the continuing scenario in the years ahead.

In addition to state insurance and federal antitrust law, the applicability of federal securities laws also must be considered with respect not only to stock company mergers but also to mergers between mutual insurers if such companies are involved in variable life, variable annuity and/or mutual fund products and/or associated lines of business.

Initially, this federal takeover legislation was triggered by the concern that existing management and investors needed protection against corporate raiders engaging in hostile takeovers. However, as a better understanding of the tender offer process grew, legislators came to recognize that tender offers afforded dissatisfied shareholders a means to either oust inefficient management or at least sell their shares at a good price and get out.

The purpose of the Williams Act is to protect shareholders and to present a neutral balance between the tender offeror and the target management. The central philosophy of the Act is disclosure. The Act seeks to ensure that shareholders, confronted with a cash tender offer, are provided adequate and timely information upon which to intelligently evaluate the offer.

It is unlawful for a person to make a tender offer if after consummation thereof such person would be beneficial owner of more than 5 percent of the equity security unless at the time the offer is first published or provided to securityholders the required information has been filed with the SEC. All requests for tenders or advertisements making a tender offer shall be filed as part of such statement.

In accord with the policy of neutrality as between the offeror and the target company management, pursuant to the Act, the SEC affords management with the opportunity to provide its opinion of the tender offer to the shareholders. Under SEC rules, the target management shall recommend to its shareholders how they should respond to the tender offer.

Congress believed that the Williams Act strikes a fair balance between the party making the takeover bid and management of the target by enabling both to present their cases to the shareholders. And, more importantly, by compelling timely, full and fair disclosure, the shareholders are positioned to make informed decisions.

With the enactment of the Williams Act, numerous states enacted so-called general business takeover acts regulating takeovers of general business corporations. This activity occurred about the same time many states were also enacting insurance holding company legislation patterned in various ways upon the NAIC Model Holding Company Law.

Affiliations between insurance companies including alliances, acquisitions, mergers, and holding companies give rise to multiple and often overlapping regulation. The regimes of three major bodies of law—that is, insurance regulation, antitrust law and securities law—arising at the state and federal levels, each with its own focus and sense of priorities, bear upon acquisition and merger activity involving insurance companies. The Department of Justice, the FTC and the state insurance commissioners seek to prevent changes in control which would adversely impact the competitiveness of the marketplace. State insurance commissioners approve or disapprove acquisitions and mergers in terms of actual or potential impact on policyholder and public interest with respect to the insurer’s continued ability to do business, its financial condition, fairness to policyholders and the competence and integrity of the new owners and management. The same acquisitions and mergers pose different concerns for the SEC, whose focus centers on investor protection through full disclosure in the framework of balanced treatment between the acquirer and the management of the target company. With multiple exercise of regulatory authority involving both state and federal government, the prospect for constitutional challenge is quite real. Most likely, however, the Supreme Court will seek to accommodate various regulatory and public policy interests in a manner leaving multiple regulation of acquisitions and mergers substantially intact.