Global Insurance Industry Year in Review

Our Global Insurance Industry Year in Review is now in its seventh year. The comprehensive report discusses developments and trends in insurance industry transactions in the past year in North America, Bermuda, Europe, and Asia, with particular focus on mergers and acquisitions, corporate finance, the insurance-linked securities and convergence markets, including pension risk transfers, and tax and regulatory developments.

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1 Mergers & Acquisitions 4 Insurance Regulatory 8. Property-Casualty Sector 60. US/NAIC

8 North America and Bermuda 60 Artificial Intelligence and Its Increasing Impact on the 11 UK and Europe Insurance Industry Asia 13 62 New York DFS Provides the Nation’s First Directive on the Proper Use of Life Sector 15. Unconventional and Alternative Data 15 North America and Bermuda 65 Major New Developments Related 18 UK and Europe to Credit for Reinsurance 19 Asia 69 Corporate Governance Gaining Ground: An Update on the NAIC 21. Additional Topics of Note Corporate Governance Annual Disclosure Act 21 Delaware Court Finds a MAE for the First Time 71 New York DFS Finalizes “Best Interest” Regulation After Demise 25 Bancassurance of the DOL Fiduciary Rule – and SEC Also Weighs In 27. Transactional Liability Insurance 73 NAIC Insurance Data Security Model 27 Corporate Law Progresses Slowly Through State 30 Claims Legislatures 74 Update on Insurance Business Transfer and Division Legislation 2 Corporate Finance in the United States 79 Recent Developments in 36. Equity Capital Markets International Group Supervision and Group Capital Requirements 37. Debt Capital Markets 82 New York Adopts Principle-Based Reserving 84 Looking Ahead – NAIC Priorities for 2019

4 Global Insurance Industry Year in Review 4 Insurance Regulatory (cont.)

86 State Ahead – the NAIC’s Continuing Modernization Program: 2018 Initiatives Focus on Data Collection and Data Management 89 Insurance-Related Legislation in the 115th Congress

91. UK and Europe 95. Asia

5 Technology 100. Insurtech 103. Technology Transactions 106. Cybersecurity & Data Privacy

106 The EU’s GDPR Has Global Effects 108 California Adopts GDPR-like Regulation 109 NY DFS Cybersecurity Compliance Requirements Expand 110 Ohio Adopts Cybersecurity Safe Harbor 112 The United States Releases A National Cyber Strategy

6 Tax

118 The BEAT 119 GILTI 121 Section 1297 PFIC Exception for Insurance Companies

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Mergers & Acquisitions

Property-Casualty Sector | Life Sector Additional Topics of Note | Transactional Liability Insurance 1 Mergers & Acquisitions

PROPERTY-CASUALTY SECTOR Bermuda Targets NORTH AMERICA AND BERMUDA The three biggest P&C M&A deals of 2018 were Overview all acquisitions of Bermuda-based companies.

The number of announced M&A transactions AXA’s $15.3 billion deal to purchase XL Group, in 2018 involving North America and Bermuda which was announced in March 2018 and property and casualty (“P&C”) insurance targets closed in September 2018, was the largest rose to 72 compared to 61 in 2017, according property and casualty insurance deal in North to data compiled by S&P Global Market America and Bermuda since the $29.5 billion Intelligence. The $32 billion in aggregate merger between ACE Limited and Chubb in transaction value ranks as the most active 2015. AXA indicated that a key rationale for the year for P&C M&A since 2015. This headline acquisition was its intention to transform itself number, however, is somewhat skewed, given from a predominantly life- and savings-focused that approximately two-thirds of that amount is company to a predominately P&C company. attributable to two “megadeals”, namely AXA The deal has created the world’s largest P&C S.A.’s purchase of XL Group plc for $15.3 billion commercial lines writer across all lines (based and American International Group, Inc. (“AIG”)’s on gross written premium) and has given purchase of Validus Holdings Ltd. for $5.56 AXA access to enhanced diversification and billion. Most of the P&C insurance M&A activity alternative capital (via XL’s ILS fund manager, in 2018 was instead largely characterized by New Ocean). In May 2018, AXA successfully small- and medium-sized transactions, with more spun off its US life business, AXA Equitable than 70% of deals valued below $500 million. Holdings, Inc., in the largest US IPO of the year. In the offering, AXA sold a 20% equity Despite around $80 billion of catastrophe losses stake in AXA Equitable, raising $2.6 billion. In in 2018, following record catastrophe losses November, they sold another approximately in 2017, the P&C industry continues to be 15% stake. regarded as overcapitalized, driven in part by the influx of capital into alternative vehicles. In In January 2018, AIG announced its largest addition, depressed investment income from standalone acquisition in 17 years: a $5.56 low interest rates and dwindling reserve releases billion, all-cash deal to purchase Validus are driving the need for cost-cutting, which Holdings. The transaction confirmed that insurers are seeking through efficiencies of AIG is emerging from its divestitures to repay scale. Other key factors underlying the increase government assistance since the financial crisis in P&C M&A include federal tax reform and as an expanding actor in the market. The continued inbound interest from international Validus takeover provides AIG not only with a acquirers seeking a meaningful presence in the Bermuda-based reinsurer (Validus Re), but also US market. a crop-insurance business (Crop Risk Service), a specialist in US small commercial excess and surplus underwriting (Western World), a Lloyd’s operation (Talbot) and a respected insurance- linked securities asset manager (AlphaCat).

8 Global Insurance Industry Year in Review Funds under the management of Apollo Global of a wider effort to build the vehicle into a Management LLC, the private equity and standalone legacy acquirer. alternative investment firm, agreed to acquire Aspen Insurance Holdings Ltd. for $2.6 billion, In December 2018, Catalina announced that in August 2018 (the deal is expected to close it had reached a deal to acquire Zurich’s in early to mid-2019), further illustrating asset employment liability business for $2 billion. managers’ attraction to insurance-linked returns The deal is Catalina’s third UK (EL) acquisition and the resulting long-term capital. In addition in just over two years. That deal followed to its major entry into the P&C space, Apollo Catalina’s agreement earlier in the year to already has a majority stake in Athene Holding acquire Arch’s discontinued MGA program. Ltd., the life and annuity company. With the acquisition of Aspen, Apollo also gains access Specialty Insurance to Aspen Capital Markets, Aspen’s ILS and collateralized reinsurance platform. M&A activity continued to be strong in the specialty markets, with established players Runoff looking to consolidate and other insurers looking to add diversification to their books Proactive legacy book management remained of more traditional P&C insurance lines. a key objective for P&C insurers in 2018 with the runoff sector continuing to be active. The In August 2018, Hartford Financial Services continued downward pressure on premiums Group Inc. announced its agreement to acquire and the further rise of alternative capital The Navigators Group Inc. for $2.1 billion in an continued to stoke activity in the North all-cash merger. Publicly traded Navigators is American non-life run-off market, which primarily a US specialty P&C and marine insurer PriceWaterhouseCoopers and AIRROC have and has a sizable international business valued at approximately $350 billion. 2018 has (accounting for approximately a third of its also seen the US regulatory landscape continue revenue) and a global reinsurance platform. to evolve favorably for runoff transactions, with The deal represents a further expansion of The more states introducing or enacting legislation Hartford’s product offerings and geographic to facilitate pro-active exits from legacy reach as it redeploys capital from its sale of portfolios (See “Update on Insurance Business Talcott Resolution, its runoff life and annuity Transfer and Division Legislation in the United business, which closed in late 2017. The States,” in the Insurance Regulatory-US/NAIC Navigators acquisition will also provide The chapter on page 74). Hartford with access to Lloyd’s through Navigators’ syndicate 1221. Available capital continues to grow in the runoff market. RenRe took a minority stake in Catalina In November 2018, The Doctors Company, the in January 2018, with Catalina’s majority owner, second largest medical professional liability Apollo, committing a further $700 million of insurer in the United States, entered into an equity to the business later in the year. The agreement to acquire the professional liability Carlyle Group acquired a minority stake in insurer, Hospitals Insurance Company, and AIG’s legacy carrier, DSA Re in August as part

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its third-party administrator, FOJP Service Corporation, the fourth largest title insurer, Corporation, for $650 million. The deal is for $1.2 billion. The transaction is subject to anticipated to close in mid- to late-2019. pending regulatory approval.

AmTrust Goes Private and Maiden Producer and Intermediary M&A Grapples with Fallout 2018 also saw a continuation of major In our 2017 Year in Review, we discussed activity in P&C producer and intermediary the travails of AmTrust Financial Services, M&A in the US and Bermuda. This activity Inc. over the course of that year related to is not surprising given that the industry its announcement of the need to restate its remains highly fragmented and suitable financials for the previous three financial years. for market consolidation. This was followed by the proposal, in January 2018, from its founding family and private Among several notable P&C producer deals, equity firm, Stone Point Capital, to take the KeyBank, the banking arm of Cleveland-based company private at $12.25 per share, a 21% KeyCorp, sold its insurance and benefits premium to the then stock trading price. brokerage unit to USI Insurance Services in Subsequent to our publication, the deal May 2018. KeyBank had acquired that unit in its obtained board approval in June 2018 and mid-2016 acquisition of First Niagara Financial closed (following regulatory approval) in Group Inc. November 2018, at an increased price of $13.50 per share, a premium of 33% against the pre- announcement trading price, and valuing the In August 2018, Marsh & McLennan acquired company at $2.95 billion. Several related the Texas-based independent broker, Wortham companies of AmTrust will remain publicly-held Insurance, to further expand its footprint in – most notably Maiden Holdings, a publicly Texas; in May 2018, Alliant Insurance Services traded Bermuda reinsurer whose reliance on acquired Crystal & Company, the New York- AmTrust business has become a special risk based insurance broker and employee benefits factor as a result of significant net losses consultant. reported related to its AmTrust reinsurance segment. In August 2018, it was announced Private equity/privately funded acquirers that Enstar was to acquire the North American continue to aggressively pursue opportunities in business of Maiden for $307.5 million and that the sector, with the principal acquirers of agency deal closed later in the year. businesses (by transaction volume, rather than deal value) being Acrisure, Hub International, AssuredPartners and Broadstreet Partners (all Title Insurance of which are private equity/hybrid fund backed) and AJ Gallagher (being public). The trend In March 2018, Fidelity National Financial Inc., of acquisitions of smaller brokerages by such the largest title insurer in the US, announced its acquirers looks set to continue into coming plan to acquire Stewart Information Services years. Notably, KPMG recently estimated that

10 Global Insurance Industry Year in Review there were 30,000 brokerage and insurance transformative to the acquirer is substantial. services businesses operating in the US and that At the same time, however, the volatility of 25% of individual producers are likely to retire the US stock market at the end of 2018/early in or soon after 2018. Those producers looking 2019 may signal the beginnings of a more to retire often sell the businesses they built to conservative outlook for acquirers and have a major players able to maximize returns and damping effect on the M&A market for 2019. looking to ever expand their footprint. UK AND EUROPE There were also several high-profile instances of US entities acquiring UK brokers and Overview intermediaries. Most notable among those was Marsh & McLennan agreeing to buy Jardine In direct contrast to the prior period, 2018 Lloyd Thompson Group plc (“JLT”) for an began strongly in terms of both deal volume enterprise value of £4.9 billion ($6.4 billion). and value across the UK and Europe. Possibly, Other examples include the acquisition of this was momentum from a strong finish to 2017 Broker Beach & Associates by Michigan-based carrying into 2018. However, as the year went Acrisure and Integro’s purchase of Lloyd’s on, the volume of deals fell quite notably to end broker, Tysers, with Integro’s UK Wholesale with an extremely weak fourth quarter. It could Unit transferring onto Tysers’ brand. For further be that wider macro-economic indications of discussion, see M&A-P&C-UK & Europe chapter a general slowdown were having an effect on on page 11. insurance M&A in common with other sectors. There is also the uncertainty surrounding Brexit and the form that will take, which may Outlook for 2019 be affecting confidence levels – and it is often that confidence ingredient that drives a healthy A number of the factors underlying the strong M&A environment. Notwithstanding the Brexit P&C M&A activity over the past couple of years factor, London and Lloyd’s market participants look set to continue into 2019. Economies of have all prepared to the best of their ability scale are likely to remain critical as companies for a variety of possible outcomes with most compete for business with narrow profitability either establishing or growing existing EEA margins. Insurers will continue to look to platforms so as to continue to be able to service restructure their platforms as they look to EEA located business via passporting rights. improve the efficiency of their core operating Elsewhere, we note the temporary permissions capabilities. The Bermuda market will also regime adopted by the PRA and FCA in the UK. continue to be a focus for consolidation. The number of publicly-traded Bermuda reinsurers has been cut in half since 2008 (from 18 to 9). Megadeals

We also expect that we are likely to see As we have noted in previous years, many of established players pursuing strategic the largest cross-border, multi-jurisdictional investments in insurtech businesses. While transactions include European market the deal value of these acquisitions is likely to operations, particularly London and Lloyd’s be small, the potential for the targets to be market entities – and sometimes all three. A

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good example, as also described in “Specialty non-core operations in some of Europe’s more Insurance” in the M&A-P&C-North America and developed and mature markets and buying Bermuda-chapter on page 9, was the Hartford’s insurance assets in more attractive higher- purchase of fellow NYSE-listed The Navigators growth markets in Southern and Eastern Europe Inc. The target group has EU-based operations – such as its purchase of Adriatic Slovenica from in Belgium, a London-based carrier and also a the KD Group. Lloyd’s managing agent – together contributing a meaningful proportion of Navigator’s overall Runoff revenue and global footprint. It is an important step in the transformation and turnaround of the Zurich announced the transfer of a $2 billion Hartford and marks its entry into the Lloyd’s UK employers’ liability portfolio to runoff and specialty markets in particular. Similarly, consolidator Catalina after an auction process AIG’s purchase of Validus gave it Lloyd’s that saw all the usual players participate. The operation Talbot. runoff sector in Europe remains attractive on both the life and non-life fronts as legacy players Lloyd’s increase their fire power to be able to execute larger deals, which in turn allows multi-line Lloyd’s was a busy place for M&A activity during heavyweight carriers to streamline their balance the year, once again showing its attractiveness sheets by disposing such books of business to to overseas buyers – some first-time entrants the specialists. and others increasing their presence significantly. An example of the former was Broker and Intermediary M&A Munich Re’s sale of the Beaufort managing agency to Cincinatti Financial and the latter On the broker and intermediary side, 2018 saw was China Re’s acquisition of Chaucer from The a significant consolidation at the larger end of Hanover Insurance Group. the market with Marsh’s take out of JLT for £4.9 billion. This deal took many market participants As described in “Bermuda Targets” in the by surprise when announced in September, M&A-P&C-North America and Bermuda with closing expected in the springtime. As chapter on page 8, private equity house Apollo has been the case with previous large broker re-entered the Lloyd’s market with its purchase tie-ups, the market expects a certain amount of of NYSE-listed Aspen. Fellow private equity synergy planning to lead to break away startups house Bain Capital took UK-listed Esure plc and defections of teams to rival houses. At the private valuing the personal lines carrier at more niche or specialist end of the market in £1.17 billion. Notwithstanding challenging the UK, Ed Broking was sold by US PE house market conditions at Lloyd’s, the market remains Lightyear Capital to BGC Partners. Multiples for attractive to new entrants and there remain brokerage firms remain high as private equity opportunities for buyers into 2019. players maintain their interest in this sector. The question into 2019 will be whether it can Elsewhere, across continental Europe, Generali continue attracting such lofty multiples. One continued with its reform strategy, selling UK-based broker consolidator shows no signs

12 Global Insurance Industry Year in Review of slowing down its trail of acquisitions with insurance and reinsurance layers (Hurricane Ardonagh Group buying Swinton from French Harvey, Hurricane Florence, Hurricane mutual Covea for £165 million. Michael, Hawaii Volcano, California Wildfires); Outlook for 2019 c) some syndicates have already issued “cash These transactions show that there is seemingly calls” on their members in the light of the no diminution in the enthusiasm of foreign loss events and need for syndicate liquidity investors to acquire Lloyd’s platforms, albeit that to meet claims; pricing has generally moved downwards from that of recent years. On the positive side, it d) a review of Lloyd’s in late 2018 led to a should be remembered that the larger so-called number of syndicates ceasing lines of “Lloyd’s entities” actually have distribution business which were deemed unprofitable networks (sometimes through Lloyd’s, (or loss-making) and a small number of sometimes of their own) in Asia, US and Europe syndicates have ceased business altogether; and so are more akin to multi-jurisdictional P&C and underwriters than their origins as merely one of many syndicates at Lloyd’s. e) faced with losses, cash calls and certain syndicate cessations, members may dispute The China Re/Chaucer transaction drew media their liability to pay and we may yet see a comment as to whether a PRC buyer might face return to the Names litigation of the past. challenges in acquiring one of the more sizeable Lloyd’s syndicates let alone the prized Nuclear Whether any of these factors dampens Syndicate (which might have raised strategic enthusiasm for further M&A in the sector is yet issues), but (perhaps because China Re already to be seen, but, given current trends, the picture participated at Lloyd’s) no such issues impeded is already very different from that in 2017 when regulatory approval. 2018 deals were under consideration.

In considering the significant 2017/2018 ASIA transactions in the London/Lloyd’s market and looking forward to potential further M&A activity Japan in 2019, there are a number of underlying issues affecting the market which, while not appearing Japan e-commerce giant Rakuten made its most to dampen enthusiasm for M&A activity in 2018, significant foray into the insurance market when might yet dampen enthusiasm in 2019: it acquired a 100% stake in Asahi Fire & Marine Insurance from Nomura Holdings for JPY 44.998 a) premium rates in many classes continue billion (approximately US$414 million). to resist any material increase, while many syndicates have already dug deep into Japan’s largest property and casualty insurance reserves; group, Tokio Marine Holdings Group, also had a busy year, including the acquisition of 98.6% b) significant loss events in 2017 and 2018 of Thailand-based Safety Insurance and 80% continue to work their way through of Indonesia-based PT Asuransi Parolamas for

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approximately US$395 million from Insurance Japanese market has been slow to digitalize Group Australia and the acquisition of 22.5% but last year Sompo formed a partnership with stake in South Africa-based life and private Japanese chat operator Line and with Chinese property insurance companies Hollard Holdings online insurer ZhongAn Online P&C Insurance and Hollard International for US$327 million. (which is one of several SoftBank Vision Fund Meanwhile, Tokio Marine Kiln, a London-based investments in the space). Tokio Marine also specialist insurance subsidiary, increased partnered with Japanese mobile carrier NTT its shareholding in California-based WNC Docomo for an artificial intelligence-based Holdings to 100%. WNC, a Managing General insurance service. Underwriter, provides a range of specialty risk management solutions, including private flood, PRC builders’ risk and lender-placed products. The year also saw Tokio Marine Holdings announce In September, China Re purchased Lloyd’s the sale of its 100% stakes in Switzerland-based insurer Chaucer from US-headquartered reinsurance business Tokio Millennium Re and Hanover Insurance for approximately UK-based Tokio Millennium Re (UK) to Bermuda- $950 million. The end of 2018 also saw an based RenaissanceRe Holdings for US$1.5 announcement by Hong Kong-listed property billion. The transaction will allow the Tokio developer Shui On Land of a sizeable joint Marine Group to focus on its primary insurance venture with China Life Insurance and Manulife businesses globally, whilst strengthening its Financial. relationship with RenRe. 2018 saw a handful of transactions that suggest Sompo Holdings acquired a 100% stake in an opening up of the PRC market to foreign a number of subsidiaries of the US-based insurers. For example, during the fourth quarter, Lexon Surety Group, including the Lexon AXA announced a transaction to acquire the Insurance Company, for an undisclosed remaining 50% of AXA Tianping Property & amount. The Lexon Surety Group specializes Casualty Insurance not already owned by it, in providing insurance for major construction thereby giving it full ownership of the P&C and infrastructure projects. This investment insurer. This follows an approval for Allianz represents a diversification of activities and to set up a wholly-owned insurance company risks for Sompo’s US business portfolio. Sompo in Shanghai. Holdings also acquired a 100% stake in Italy- based specialist agriculture insurer A&A. A&A’s Finally, Ping An Insurance was busy during main focus is insuring farmers against loss of 2018 with a handful of capital raises, including agricultural revenue, and Sompo hopes to use for businesses in the healthcare and financial this investment as a springboard for further technology sectors. participation in the European insurance market.

Another trend in 2018 has been business partnerships between Japanese P&C insurers in the insurtech/online insurance platforms. The

14 Global Insurance Industry Year in Review Indonesia, Thailand, Vietnam & The Inc. signed an agreement with Philippines-based insurer, Paramount Life & General Insurance Philippines Corporation (Paramount) over the sale of 100% interest in QBE Seaboard Insurance Philippines, While Indonesia currently has among the Inc. for an undisclosed consideration. The lowest penetration rates for non-life insurance acquisition, which is set to complete in the within the region, investors appear keen to first half of 2019, is expected to strengthen take advantage of the tremendous potential in Paramount’s position in the non-life insurance the market. The most notable deal of the year sector within the country. was Zurich Insurance Group’s US$414 million purchase of an 80% interest in PT Asuransi Adira Dinamika. Upon successful completion of India & Sri Lanka the transaction, Zurich will become the largest property and casualty insurer in Indonesia. In In November 2018, Belgian insurer Ageas December 2018, Singapore-headquartered reached an agreement with Sundaram Finance Great Eastern Holdings acquired PT QBE Limited over the purchase of 40% stake in non- General Insurance Indonesia in a US$28 life insurer Royal Sundaram General Insurance million deal. Co. Ltd for US$210 million. The transaction is in line with Ageas’s three-year strategic plan to Japanese insurer Tokio Marine Holdings, Inc. has expand its existing operation in fast growing expanded its operations in the rapidly growing markets (with a particular focus on non-life Southeast Asia insurance market following its insurance) and is scheduled to complete in the acquisition of (a) a 98.6% stake in Thailand- first-half of 2019. based insurance provider Safety Insurance Public Company Limited; and (b) an 80% stake In one of the largest M&A deals in the country, in Indonesia-based PT Asuransi Parolamas, both Allianz has sped up its growth in the region by from Insurance Australia Group Limited (IAG). acquiring a 100% stake in Janashakthi General The US$387 million deal will place Tokio Marine Insurance for US$106 million. Allianz has Holdings among the top three property and become one of the biggest non-life insurers in casualty insurers in Thailand. In addition to the Sri Lanka with a market share of around 20%. sale of its operations in Indonesia and Thailand, IAG further offloaded its operations in the region following the sale of its 73.07% stake in LIFE SECTOR Vietnam-based AAA Assurance Corporation to NORTH AMERICA AND BERMUDA another investor. Overview

Meanwhile, JMT Network Services Public Dispositions and block reinsurance Company Limited, a listed Thai company, has transactions of fixed and variable annuity also completed the acquisition of 55% of the businesses continued apace in 2018, as shares in Thai non-life insurer, Phoenix Insurance sellers sought to exit legacy portfolios of (Thailand) PCL for US$13 million. capital-intensive businesses. 2018 also witnessed significant long-term care and In December 2018, QBE Asia Pacific Holdings disability insurance transactions. Limited and Seaboard Eastern Insurance Co.,

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Sales of Annuity Businesses Private equity buyers also continued their interest in acquiring variable annuity businesses; In November 2018, Manulife Financial this appetite often converged with sellers’ announced that its US-based John Hancock desire to exit capital-intensive and more subsidiaries entered into agreements to volatile business lines. In a deal announced reinsure blocks of legacy annuity businesses: in December 2017, Voya Financial, Inc. approximately $8 billion of policy liabilities divested substantially all of its closed block related to legacy US group pay-out annuities variable annuity segment and its individual to Jackson National Life Insurance Company, fixed and fixed indexed annuity business and approximately $4 billion of policy liabilities through an agreement with a consortium of related to legacy US individual pay-out annuities investors led by affiliates of Apollo Global to RGA Reinsurance Company. (Manulife Management, LLC, Crestview Partners and concurrently announced that it had reinsured Reverence Capital Partners. Voya stated that the mortality and lapse risk on approximately $1 the transaction would allow it to reduce market billion of policy liabilities related to Canadian and insurance risk and to focus on its higher- legacy universal life business to RGA Life growth, higher-return, capital-light retirement, Reinsurance Company of Canada.) Manulife investment management and employee benefits announced that the transactions were expected businesses. As part of the transaction, Athene to release a total of over $1 billion in capital reinsured the business’ fixed annuity block. over the next year. Voya retained a minority ownership stake in the divested business, and Voya Investment Following their flow reinsurance treaty Management will serve as the preferred asset announced in 2017, Lincoln Financial and management partner for the sold business unit. Athene deepened their relationship in December 2018 through a block reinsurance In May 2018, The Hartford Financial Services transaction under which Athene’s Bermuda Inc. completed the sale (signed in May 2017) of Talcott Resolution, its run-off life and annuity affiliate, Athene Life Re Ltd. (“ALRe”), reinsured an 80% quota share of a $9.6 billion businesses, to a group of investors led by in-force block of fixed deferred and fixed Cornell Capital LLC, Atlas Merchant Capital indexed annuities, resulting in Lincoln ceding LLC, TRB Advisors LP, Global Atlantic Financial approximately $7.7 billion of statutory reserves Group, Pine Brook and J. Safra Group. The to ALRe. Athene reported that it deployed Hartford announced that the transaction approximately $700 million of capital in completed its exit from the run-off life and aggregate, including capital to support the annuity businesses and significantly reduces its block and a ceding commission paid by ALRe. capital markets exposure. Total consideration to The transaction is another example of Athene’s The Hartford was approximately $2.05 billion, appetite to acquire blocks of asset-intensive including cash paid by the buyers, a pre-closing businesses. cash dividend, debt included as part of the sale and a 9.7 percent ownership stake in the new company.

16 Global Insurance Industry Year in Review Long-term Care, Disability and Benefits Post agreed to initially purchase 7% of Aflac’s shares, on the open market or in block sales, Businesses for approximately $2.4 billion. Through their announced strategic alliance, the parties have Long-term care insurance has become a renewed their mutual commitment to the cancer significant drag on the earnings and capital insurance marketplace in Japan, under which position of a number of major life insurers, Japan Post will continue to offer Aflac’s cancer and exit strategies have proved challenging. products through postal outlets and managed Against this backdrop, a notable transaction sales offices across Japan. The shares will be occurred last summer, when CNO Financial acquired by a voting trust established for Group, Inc.’s subsidiary, Bankers Life and Japan Post’s benefit and will include limits on Casualty Company (“Bankers Life”), entered Japan Post’s maximum share ownership and into a reinsurance transaction with Wilton voting control. Reassurance Company (“Wilton Re”) to cede all of its legacy comprehensive and nursing home long-term care policies (with statutory Sale of Gerber Life to Western & Southern reserves of approximately $2.7 billion) through 100% indemnity coinsurance. Bankers Life paid In September 2018, Western & Southern a negative ceding commission of $825 million Financial Group agreed to acquire Gerber Life to reinsure the block. Wilton Re assumed Insurance Company, a leader in the juvenile administration for the business after a and family life insurance market, from Nestlé for transition period. $1.55 billion. The transaction allows Western & Southern to market insurance products under Interest in the group benefits marked continued the Gerber Life brand. The deal closed at in 2018, with Lincoln Financial Group’s the end of 2018 and reflects Nestlé’s ongoing acquisition of Liberty Mutual Insurance Group’s recalibration of its portfolio and exit from non- group benefits business for approximately core product markets. The transaction allows $3.3 billion. The transaction was structured as Western & Southern, for its part, to expand its an entity acquisition of Liberty Life Assurance policyholder base, enhance its product profile Company of Boston, with Lincoln Financial and increase its ratio of life insurance business retaining the group benefits business and to annuity business. reinsuring Liberty Life’s individual life and annuity business to Protective Life Insurance Fortitude Re Company. The transaction aimed to significantly increase Lincoln’s presence in the Group In a transaction with implications for both life/ Benefits market while diversifying its sources annuity and property/casualty M&A, American of earnings; for Liberty Mutual, the transaction International Group, Inc. announced in continues its efforts to focus on its property and November 2018 the creation of a new run-off casualty businesses. reinsurer, Fortitude Re, in collaboration with global alternative asset manager The Carlyle In December 2017, Japan Post Holdings Group. Fortitude Re operates as a “composite” Co. Ltd, which is majority-owned by the reinsurer, enabling it to write both life and P&C government of Japan, announced a strategic risks. Fortitude Re’s predecessor (DSA Re) alliance with Georgia-based Aflac Inc. Japan

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served as AIG’s Bermudian legacy reinsurance post-global-financial-crisis era has been for platform; Fortitude Re will now operate as a integrated banking and insurance groups to be standalone provider of reinsurance, offering broken up. Many banks across the globe have insurers tailored solutions to exit legacy disposed of their insurance operations, in many portfolios and operations, release capital and cases for regulatory and operational reasons. lower operating costs. The French state has retained an active interest across many industries and sectors, while the Outlook for 2019 trend in other European markets has been quite the opposite. As such, we see this transaction as peculiar to the facts and not likely part of Early signs indicate a strong market for life and an overall trend towards more banking and annuity deals during 2019. An early example insurance consolidation. was Protective Life Insurance Company’s announced agreement to acquire substantially In the UK market, possibly the stand-out deal all of the individual life insurance and annuity of the year was Standard Life Aberdeen’s business of the Colorado-based Great-West Life sale of its insurance business to the Phoenix & Annuity Insurance Co. for $1.2 billion. Group for £3.3 billion. Since the tie up between Standard Life and Aberdeen Asset UK AND EUROPE Management, the focus of the combined entity was the investments business and returning Unlike in prior years, 2018 began relatively capital to shareholders. However, as part of the strongly in terms of number and value of deal, Standard Life Aberdeen entered into a transactions announced across Europe. While strategic partnership arrangement and gained the aggregate value of transactions peaked in a 20% stake in the Phoenix Group, which is now the third quarter, the number of transactions Europe’s leading life fund consolidator. remained steady and evenly spread throughout the year. The largest deal by value across Elsewhere, some of the traditional big names in the European Life Sector in 2018 came at the the sector were selling operations in non-core beginning of the second half of the year with countries and product areas. For example, French state-owned investment fund La Caisse Aviva plc sold its Spanish divisions, Cajamurcia des Dépôts et Consignations exchanging its and Pelayo and Generali disposed of its Belgian 41% stake in CNP Assurance for shares in La business to Athora for EUR540 million, Generali Banque Postale, La Poste’s banking arm. The Worldwide to Utmost for EUR419 million and French government is targeting an integrated Generali Lebensversichering in Germany to financial services group to provide both Viridium. banking and insurance products and services to customers in rural areas. The rationale for Monument Re, a Bermuda-based reinsurance the deal is also aimed at addressing La Poste’s consolidator, had a busy 2018 closing a number decreasing revenues from its traditional postal of European transactions targeting runoff books services. It will be interesting to see whether of business and portfolios across the Continent. the plan bears fruit, given that the trend in the This is a strategy adopted by Enstar in the P&C

18 Global Insurance Industry Year in Review runoff sector, and it comes as no surprise to ownership, a “lock-up” provision and a standstill find Enstar as one of the principal shareholders provision and voting restrictions. of Monument, together with Hannover Re and Canadian EL Financial Group. Monument Nippon Life Insurance Company reached a bought businesses in Luxembourg, Guernsey deal to purchase approximately 85.1% of the and Belgium to add to those purchased in 2017 issued and outstanding shares of MassMutual in Ireland. As a life consolidation vehicle based Life Insurance Company from MassMutual in Bermuda, Monument is likely to be closely International LLC for US$985.2 million. They watched as it seeks to grow its asset base also announced the acquisition of the remaining throughout Europe. It also marks something 10% in Nissay Asset Management held by of a change in focus for Bermuda, which has Putnam Investments and the sale to Putnam of traditionally been, and remains still, a P&C their 20% stake in PanGora Asset Management. dominated market, but equally understands the need for diversification into new areas. Dai-Ichi Life Holdings, through its US-based subsidiary Protective, purchased the individual Finally, on the theme of life company life and annuity business of Boston-based consolidation, PE house Cinven won the auction Liberty Life for US$1.2 billion. Dai-Ichi Life for Axa’s Irish variable annuities business, paying Insurance purchased a 39.62% stake in Union book value of approximately EUR1.2 billion. Asset Management, a unit of Union Bank of The transaction is part of Axa’s refocus towards India. Meanwhile, Dai-Ichi Life’s Australian P&C and reinsurance lines with its purchase of subsidiary, TAL Dai-Ichi Life Australia, reached XL Catlin and reducing exposure to US lines. a deal to purchase Suncorp’s Australian Cinven expects to use Axa Life Europe as a life insurance business for AUD 725 million platform for further bolt-on acquisitions in the (approximately US$539 million). European closed life book space. Mitsui Sumitomo Insurance Co., Ltd reached a deal to purchase Australia-based ASIA Commonwealth Bank’s 37.5% equity interest in Japan China-based BoComm Life Insurance Company Limited for RMB3.2 billion (approximately Japanese insurers continue to expand into the US$502 million). overseas market in 2018, with many insurers entering new markets. Japanese insurers MS&AD Insurance Group Holdings, Inc. reached have also been more willing to move on from two deals with Swiss Re Ltd., which brings the investments which no longer fit within their core Japanese insurer’s shareholding in ReAssure focus. Jersey One Ltd. to 25%. ReAssure is a leading player in the closed book life business in the UK The largest deal of the year in the insurance and part of Swiss Re Life Capital. space by any Japanese company was the acquisition by Japan Post Holdings Co., Ltd. of a 7% stake in AFLAC for US$2.67 billion. The agreement includes a number of restrictions on Japan Post, including a 10% cap on share

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Hong Kong During the fourth quarter of 2018, the Insurance Authority (the “IA”) launched a public The year ended on a strong note with the consultation on draft regulation regarding acquisition of a Hong Kong insurance company insurance intermediaries – it is planned that announced during December 2018. Hong during 2019, the IA will take over the regulation Kong’s NWS Holdings Limited announced an of insurance intermediaries from three self- agreement to purchase FTLife Insurance Co. regulatory organizations. for approximately US$2.75 billion from Beijing- based JD Capital. FTLife was ranked as the Singapore 11th largest Hong Kong life insurance company by annual premium equivalent for the six Singapore-based life insurance provider, months ending 30 June 2018. Singapore Life, a new start-up, began the year by acquiring the business portfolio (comprising The rest of 2018 was spotty for Hong Kong deal approximately 5,000 policies) of Zurich Life making, however. The owners of Hong Kong Singapore. In December 2018, Singapore Life Insurance Ltd. terminated a US$914 million Life received further investment from British sale to China’s UCF Group Co. in October investor, Michael Spencer, who purchased a after waiting for more than a year for the deal further 33.8% stake in Singapore Life through to close. Also, it is reported that MetLife may his private company, IPGL, from Hong Kong- have shelved its effort to sell its Hong Kong based Chong Sing Holdings for US$52.7 million, business. Overall transaction activity may have increasing his total shareholding in Singapore been somewhat dampened by Chinese buyers Life to 63.2%. This was immediately followed struggling to move purchase funds offshore out by US insurer Aflac’s acquisition of a minority of China. stake in Singapore Life for US$20 million in the same month. There have been interesting developments in Hong Kong in connection with the continued focus on digitization of the insurance business Malaysia model. In December, Bowtie Life Insurance was granted Hong Kong’s first virtual insurance The B40 Health Insurance Fund is targeted to company license by the Insurance Authority be rolled out in 2019 with a view to providing under its Fast Track pilot scheme. (The Fast the poorest 40% of the population with certain Track was introduced by the IA in September medical protection and benefits. In November 2017 as an expedited licensing process 2018, Singapore-based insurer Great Eastern for new entrants seeking to operate solely Holdings announced its decision to contribute through digital channels.) Bowtie also secured US$483 million (RM 2 billion) to the B40 Health approximately US$30 million from a group of Insurance Fund, allowing it to retain its existing investors that included Sun Life Hong Kong. shares notwithstanding the 70% cap on foreign Blue, a digital insurer backed by Aviva Hong ownership. Kong (40%), Hillhouse Capital (40%) and Tencent (20%), was also launched to sell life and critical illness products online.

20 Global Insurance Industry Year in Review Indonesia ADDITIONAL TOPICS OF NOTE DELAWARE COURT FINDS A MAE FOR In June 2018, a Hong Kong-based life insurance THE FIRST TIME company China Life Insurance (Overseas) Company Limited expanded its operation in Southeast Asia by acquiring an 80% stake in On October 1, 2018, the Delaware Court PT Asuransi Jiwa Sinansari Indonesia for an of Chancery ruled for the first time that an undisclosed consideration. The transaction acquirer could terminate a transaction due to saw China Life becoming the first Chinese the occurrence of a ‘material adverse effect’ insurer in Indonesia. (“MAE”). Two months later, the Supreme Court of the State of Delaware reaffirmed the There were two other deals involving Indonesian Chancery Court’s findings on the existence of an insurers announced in 2018, which are expected MAE and the proper termination of the merger to close in the first half of 2019. Following its agreement by the acquirer. decision to concentrate on its core banking business, Commonwealth Bank of Australia Prior to this case known as Akorn, Inc. v. Fresenius Kabi AG (“Akorn”), it was a rule (“CBA”) entered into an agreement with a Hong of thumb among practitioners that proving Kong insurer FWD Limited (“FWD”) relating to the sale of an 80% stake in its life insurance the occurrence of an MAE under Delaware venture, PT Commonwealth Life for US$301 law was subject to an elusive high bar that million. As part of the transaction, FWD will had yet to be demonstrated to any Delaware enter into a 15-year life insurance distribution court’s satisfaction. In light of this, Akorn partnership with PT Bank Commonwealth (CBA’s provides welcome salient guidance as to how banking business in Indonesia). The other deal courts in Delaware will review and make MAE involved Great Eastern, through its wholly- determinations. While Akorn is a first-of-its-kind owned subsidiary, agreeing to acquire PT QBE ruling, it is important to note that the court General Insurance Indonesia for US$28 million in reaffirmed standards under pre-existing case law December 2018. and relied on a heavily fact intensive inquiry in reaching its decision. Below we describe some key takeaways from the court’s decision. India

Italy-based insurance provider, Generali, has Background completed its acquisition from the Future Group for an additional 23.5% stake each in India- On April 24, 2017, Fresenius Kabi AG based life insurer, Future Generali India Life (“Fresenius”), a German pharmaceutical Insurance Co. Ltd, and non-life insurer, Future company, signed a merger agreement Generali India Insurance Co. Ltd, for a total pursuant to which it agreed to purchase Akorn, consideration of US$140 million. The transaction Inc. (“Akorn”), a generic pharmaceutical increased Generali’s interest in each of the two company based in Illinois, for $34 per share Future Generali insurance ventures to 49%. (approximately $4.3 billion equity value). Soon after the merger agreement was signed, Akorn suffered a significant and sustained

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decline in its financial performance due to new and warranties in a manner that could competitors entering the market for four of reasonably be expected to have an MAE (the Akorn’s products and the loss of a key contract “Bring Down Condition”) and (3) breached with one of Akorn’s customers. In addition, after its covenants in any material respect (the conducting an investigation spurred by two “Covenant Compliance Condition”). In addition, separate whistleblower letters, Fresenius also Fresenius had the right to terminate in the discovered following the signing that Akorn event Akorn materially breached the merger had systematically failed to comply with US agreement so long as Fresenius was not also in Food and Drug Administration (the “FDA”) material breach of the merger agreement (the data integrity, product safety and other related “Material Breach Termination Right”). regulations and that Akorn had submitted falsified product data to the FDA. In exercising its right terminate the merger agreement, Fresenius asserted that (1) as a Despite these discoveries, Fresenius sought to result of its failure to comply with applicable continue to comply with its obligations under FDA regulations, Akorn had breached its the merger agreement and use the appropriate regulatory representations and warranties, level of efforts to close the transaction. Also, as which breach rose to the level of an MAE (a the drop dead date loomed, Fresenius offered “Regulatory MAE”), and as a result, the Bring to extend the drop dead date so that Akorn’s Down Condition could not be satisfied, (2) as regulatory issues could be further investigated a result of the “sudden and sustained drop and resolved, but Akorn rejected the extension. in Akorn’s business performance,” Akorn had After its offer was rejected, Fresenius exercised suffered an MAE (a “General MAE”) and, as its right to terminate the merger agreement. a result, the General MAE Condition could not be satisfied (3) Akorn had failed to use Terms of the Merger Agreement commercially reasonable efforts to operate its business in the ordinary course in all material respects (the “Ordinary Course Covenant”) and, The merger agreement reflected terms as a result, the Covenant Compliance Condition that were customary for a public company could not be satisfied. transaction. Among these customary terms were representations and warranties regarding Akorn’s compliance with applicable Court’s Decision FDA regulations and a covenant to use its commercially reasonable efforts to operate In the resulting decision, the court found that its business in the ordinary course following Akorn had suffered a General MAE and a the signing. Regulatory MAE and had materially breached the Ordinary Course Covenant. It also found Under the terms of the merger agreement, that Fresenius’s exercise of its Material Breach Fresenius’s obligation to close the transaction Termination right was valid. As such, the was subject to three conditions: that Akorn not precipitous dip in Akorn’s financial performance have (1) suffered an MAE (the “General MAE and its sustained failure to comply with Condition”), (2) breached its representations applicable regulations were sufficient reasons

22 Global Insurance Industry Year in Review for Fresenius to refuse to close and terminate reason to believe that Akorn will recapture the merger agreement. The court also found its lost contract.” that Fresenius was not barred from exercising its Material Breach Termination Right since it • Regulatory MAE. In determining had materially complied with its obligations to that Akorn’s breach of its regulatory take actions to obtain antitrust approval and representations and warranties constituted expeditiously consummate the deal. Below is a a Regulatory MAE, the court explained summary of the court’s findings in Akorn. that both the “quantitative and qualitative aspects” of the breach must be considered. • IBP MAE Standard Reaffirmed. In When considering the qualitative determining whether an MAE had significance of Akron’s regulatory issues, the occurred, the court relied on and court examined the nature of the breach reaffirmed the standard outlined in In re and the difference between Akorn’s as- IBP, Inc. Shareholders Litigation and Hexion represented state and its actual state of Specialty Chemicals, Inc. v. Huntsman Corp., affairs. The court found “overwhelming which subject MAE claims to a high standard evidence of widespread regulatory of proof. As the court noted in Akorn, an violations and pervasive compliance event, change or occurrence constitutes problems at Akorn” and, after signing, an MAE when they are “material when Akorn’s troubles worsened when it took viewed from the long-term perspective drastic action to cover up its problems, of a reasonable acquirer” because “it is including submitting false information and consequential to the company’s long- making misleading presentations to the term earnings power over a commercially FDA. This was in contrast to the language reasonable period, which one would in the merger agreement in which Akorn expect to be measured in years rather than represented that it was in compliance with months.” In other words, the downturn must applicable regulations. When considering material and “durationally significant.” the quantitative significance of Akorn’s regulatory issues, the court examined the • General MAE. With respect to the General magnitude of Akorn’s resulting decrease MAE, the court noted that every one of in value. After a fact-intensive inquiry, the Akorn’s financial metrics had declined year court determined that the economic impact over year for a sustained period – four of Akorn’s regulatory issues (which included straight quarters of year-over-year declines costs of remediating such matters) would in (1) revenue in excess of 25%, (2) operating result in a $900 million loss to Akorn, which income between 84% and 292% and (3) represents approximately 21% of the equity EPS between 96% and 300%. Furthermore, value of the transaction, and satisfied the the court found these changes arose as quantitative prong of the Regulatory MAE a result of new competitors entering the analysis. market for Akorn’s products and the loss of a key contract, and determined that they • Failure to Operate the Business in the were “durationally significant” and noted Ordinary Course. The court determined that that “[t]here is every reason to think that the Akorn had breached the Ordinary Course additional competition will persist and no Covenant by comparing Akorn’s practices

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to a hypothetical similarly situated generic The level of scrutiny remains high – the pharmaceutical company. The court cited court engaged in a very fact-intensive the following conduct by Akorn, among inquiry extending almost 250 pages in other things, as the bases for its decision order to reach its determinations. The which conduct the court determined court’s finding of an MAE inAkorn was would not have been undertaken by such particularly driven by the extreme set of a hypothetical company: (1) Akorn’s failure facts in the case. to maintain data integrity systems in compliance with FDA regulations, (2) Akorn’s • What is Material Remains Unclear. What failure to conduct regular audits and take constitutes “material” for purposes of an steps to remediate compliance deficiencies MAE under Delaware law remains unclear. it was aware of, and (3) Akorn’s submission The court pointed to multiple benchmarks of false information and making misleading as evidence that an issue is materially presentations to the FDA. adverse: a 40% decrease in earnings, a 50% decrease in earnings over two consecutive • Fresenius Could Exercise Its Material quarters and that a drop of 20% or more Breach Termination Right. At trial, Akorn results in a “bear” market. However, the argued that Fresenius could not exercise court was careful to disclaim that it was its Material Breach Termination Right establishing any sort of bright line tests since it was in breach of its covenant to and expressly noted that its inquiry was use its reasonable best efforts to close the fact-specific and that no undue attention transaction. However, the court rejected should be paid to specific thresholds cited this argument. While the court did find that in the opinion. In addition, in the course Fresenius was technically in breach of such of its decision, the court commented that obligation when it considered and pursued materiality for purposes of an MAE can be for a short period of time a course of action seen as a term of art drawing meaning from that would have delayed antitrust approval, Regulation S-K and Item 7, “Management’s Fresenius quickly reversed course and used Discussion and Analysis of Financial the appropriate level of efforts to satisfy its Condition and Results of Operations” and obligations under the merger agreement. noted that it “would have been helpful As such, Fresenius’s breach was not material to have [had] access to expert testimony and it properly exercised its Material Breach or studies about the thresholds” public Termination Right. companies use when reporting material events. Key Takeaways from Akorn • Risk Allocation. The court rejected the argument that Fresenius could not claim • MAEs are Still Difficult to Prove. Despite an MAE because it was aware of the risks being the first case to find an MAE in giving rise to that MAE. The court clarified Delaware, Akorn does not represent a that, under Delaware law, an MAE clause sea change from prior Delaware MAE does not implicitly shift the risk of “known jurisprudence. Rather, Akorn reaffirms and issues” from a seller to an acquirer. uses the test established in IBP and Hexion.

24 Global Insurance Industry Year in Review to seek antitrust clearance, proceeding with • No Difference in Efforts Standards. The integration planning and offering Akorn an Akorn decision reiterated that, under opportunity to extend the drop dead date Delaware law, there is no difference to allow Akorn to fix its compliance issues. between “best efforts,” “reasonable best The court also noted that this distinguished efforts” and “commercially reasonable Fresenius from acquirors in prior Delaware efforts” and all would be interpreted as cases who were characterized as pursuing requiring a party to take “all reasonable their MAE claims due to “buyer’s remorse.” steps” to comply with the terms of the Fresenius’s material compliance with its relevant agreement. obligations and steadfastness in pursuing the deal preserved its right to exercise • Ordinary Course of Business. The court its Material Breach Termination Right and interpreted “ordinary course of business” appeared to have left a favorable impression to mean the ordinary course of business of with the court. a similarly situated company and not the ordinary course of business of the party BANCASSURANCE required to comply with the applicable covenant. We do note, however, that the Asia Supreme Court explicitly did not address the Chancery Court’s finding that Akorn The bancassurance sector in Asia remained breached its ordinary course of business strong throughout 2018 with activity across covenant in its affirmation of the Chancery the region. A repeating theme was digital Court’s decision. innovation.

• “In All Material Respects.” The court On the first business day of 2018, DBS Bank clarified that the phrase “in all material Ltd (“DBS”) and Chubb Limited (“Chubb”) respects” corresponded with the level of announced the launch of a 15-year general materiality associated with federal disclosure insurance distribution partnership covering obligations rather than the level of Singapore, Hong Kong, China and Taiwan. materiality required to excuse performance Through this partnership, DBS will distribute (on under a contract. Therefore, a breach an exclusive or preferred basis) a wide variety “in all material respects” would occur if of Chubb’s insurance products (including home, the party’s knowledge of a such breach contents and selected personal accident and would “significantly alter” the “total mix of health products). The arrangements covers information” when compared to that party’s the DBS branch network as well as its digital reasonable expectations. banking platform. Indonesia is expected to be included in this arrangement, subject to • Clean Hands. The court took pains to note regulatory approval. that, despite increasing reason for concern about the transaction, Fresenius continued to materially perform its obligations under the agreement and generally acted in a forthright manner, including by continuing

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Other notable transactions from the first quarter Singapore, Indonesia, Thailand and Malaysia. In 2018 include: connection with this launch, CIMB and Sompo introduced an app-enabled travel insurance • Shinhan Card (a subsidiary of Shinhan product to be offered through CIMB’s chat- Financial Group) acquired a full stake in banking app (Enhanced Virtual Assistant or EVA) Prudential Vietnam Finance Company, – according to press reports, this is the first time Prudential’s consumer finance business in travel insurance can be purchased through a Vietnam, for over US$150 million. Shinhan chat-banking app in Malaysia. and Prudential have also entered into a partnership to sell bancassurance products Also in April 2018, the traditional bancassurance in Indonesia and Vietnam. model was further challenged by a new digital partnership formed between Metlife and • Siam Commercial Bank (“SCB”) and WeSure, the digital insurance agency platform Prudential Life Assurance (Thailand) of Chinese internet services provider, Tencent. entered into a bancassurance partnership Under this arrangement, MetLife and WeSure to offer Prudential Thailand’s three-unit- will offer insurance solutions to travelers through linked products to SCB’s wealth segment WeSure’s online insurance platform, and provide customers. both parties a platform to cooperate in big data analysis. • Robinsons Bank and Pru Life UK formed a bancassurance partnership where Pru Life In late May, Mitsui Sumitomo Insurance UK’s life insurance solutions will be provided Company Limited (“MSI”) announced it had to Robinsons Bank’s clients. re-entered the Chinese life market with the acquisition of a 37.5% stake in BoCommLife • Industrial and Commercial Bank of China Insurance Company Limited, a subsidiary of (Asia) (“ICBC”) and FWD Hong Kong China’s Bank of Communications Company (“FWD”) announced a bancassurance Ltd. A key driver of this deal was the rising partnership through which ICBC will sell importance of the bancassurance channel in a variety of FWD’s insurance products to China’s life insurance market (the third largest ICBC’s customers. in the world).

• Nippon Life Insurance acquired an 85% Sri Lanka was in the news in 2017 when AIA stake of MassMutual Japan for US$980 announced its exclusive strategic bancassurance million with the goal of boosting its partnership with DFCC Bank. In October bancassurance sales. 2018, Sri Lanka was in the news again when two domestic players, Union Bank (UB) and In April 2018, CIMB Group Holdings Berhad Union Assurance (UA), launched a preferred (“CIMB”) and Sompo Holdings (Asia) Pte bancassurance partnership enabling UA to Limited (“Sompo”) established a bancassurance expand its bancassurance channel and offer its partnership to distribute Sompo’s non-life life insurance products to UB’s broad domestic insurance products to CIMB’s customers in consumer base.

26 Global Insurance Industry Year in Review As discussed in the M&A-Life Sector-Asia Use of RWI in M&A transactions continues to chapter on page 19, in connection with grow; US underwriters remain the most active FWD’s agreement to acquire 80% of PT Bank Commonwealth Life in October 2018, FWD While there are no comprehensive market and PT Bank Commonwealth Life entered into studies that provide reliable figures on the a 15-year bancassurance arrangement for the numbers of RWI policies and aggregate RWI distribution of life products in Indonesia. policy limits written each year, data from several market studies and anecdotal evidence strongly Finally, also in October 2018, following a string suggest that both statistics have doubled of bancassurance distribution deals launched every two years since at least 2013. Issuance in South-East Asia (see above), Singapore’s of RWI policies continues to be greatest in the United Overseas Bank (UOB) announced that Americas, predominantly in the US. it was undertaking a review of its existing arrangements with the UK’s Prudential Whereas the market initially saw the greatest Group. This resulted in the January 2019 interest for private equity sponsors, 2017 data announcement that UOB and Prudential had from Marsh shows that private equity buyers and refreshed its partnership and entered into a new corporate/strategic buyers each represented 15-year bancassurance arrangement. Under roughly 50% of the RWI policies placed 2017. this new arrangement, UOB would receive US$850 million and will distribute Prudential’s US insurance markets – and insurance life insurance products through channels in coverage – have expanded and become Singapore, Indonesia, Malaysia, Thailand more sophisticated and Vietnam. In short, there are more markets with more TRANSACTIONAL LIABILITY insurers willing to write transactional liability insurance policies than ever before. As of INSURANCE the date of this publication, approximately 30 CORPORATE underwriters are currently writing RWI policies in United States the US, up from only five or six just a few years ago. While there are market norms that have evolved and some standardization in policies Transactional liability insurance – often in the and coverage, many insurers have developed form of representations and warranties insurance the flexibility and expertise – and willingness (“RWI”) – has evolved from a niche product – to step outside of those standard terms to into a common element in M&A practice. modify coverage to address specific transaction This evolution has accelerated in recent years issues on a case-by-case basis. While premiums and, while this type of insurance product is will often increase to reflect elevated or novel well known to many M&A practitioners, use risks, transactions that are truly uninsurable have of transactional liability insurance continues become relatively rare in the market. to expand across geographies, asset classes and industries. In 2018, existing trends in the RWI market strengthened and some new ones emerged.

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Risk sharing among buyer, seller and insurer with laws and material contracts – are the most has shifted frequent bases for claims, continuing a trend established over the last several years. In general, transactional liability insurance policies have fewer exclusions and broader Looking forward coverage than just a few years ago. A few of the customary exclusions remain almost universal The expansion and adoption of transactional – for example, known issues, uninsurable fines/ liability insurance has coincided with strong penalties and pension underfunding – most M&A and equity markets in the past five years. other risks may be covered if there is adequate As valuations continue to rise and business supporting diligence. In addition, more insurers synergies are achieved, there has not been are willing to underwrite deals in which there is a significant volume of claims that have minimal or no initial recourse against the sellers meaningfully tested underwriting practices. Of before the insurance policy can be invoked. course, throughout this period there have been One reason for this is that insurers are generally episodic claims for large amounts that have better at identifying potentially uninsurable risks tested individual insurers, including some claims early in the underwriting process. Candidly, that continue to be litigated. market forces are also at play in this risk shifting – as the number of insurers in the market has While it is not clear what effects a sustained increased, so too has competition and pressures downturn in stock markets or a significant on insurers to assume more of the risk in these economic disruption will have on the transactions. transactional liability insurance market, it is reasonable to expect that these types of events Claims data continues to reinforce will lead to a sharp increase in both the volume existing trends and size of claims under transactional liability insurance policies. Data reported by AIG for the last several years suggests that claims are made on roughly A downturn in the business cycle may also lead 20% of RWI policies, with a somewhat higher to increased numbers of RWI claims in other frequency for transaction with deal sizes over areas covered by representations, such as $1 billion. As M&A markets cooled in the litigation (and the basis therefor). second half of 2018, however, several market participants noted an uptick in claims. It remains Finally, the performance of RWI insurers in to be seen if this increase is an outlier or the the face of increased claims – and the claims beginning of a divergence from historical trend. experiences of the insureds – could impact the increased adoption of RWI. At the same time, In addition, studies and anecdotal evidence it seems unlikely that RWI will lose its place indicate that certain types of representations as a key component of risk allocation in M&A – for example, representations regarding the transactions. financial statements, tax matters, compliance

28 Global Insurance Industry Year in Review UK buy-side and sell-side. We are seeing insurers becoming increasingly comfortable with addressing certain “no go” risks and see this Warranty & Indemnity insurance (“W&I as a real area for growth. For example, insurers Insurance”) in the UK, like its transatlantic cousin, has developed into a staple of the UK who previously would have excluded difficult tax and European M&A market in recent years, now matters, such as transfer pricing risks, are now being seen as both a deal facilitator and tactical growing an appetite if adequate diligence is instrument in negotiations. In response to the undertaken, providing clients with more options. growing demand, the market has reacted to the increased use of the product in a number Expansion into non-traditional industries of ways over the past year. In this article, we highlight some of the trends and changes we Traditionally, insurers have been uncomfortable have seen when acting both for insurers when providing coverage to certain “riskier” industries underwriting W&I Insurance policies and acting (for example, heavy industries and energy) due for buyers of the product in M&A transactions. to the inherent risks involved in these sectors. We have increasingly seen more insurers providing a better scope of coverage to a Size of deals being insured is increasing and greater breadth of sectors, with data produced increased demand from corporate buyers by brokers reporting that, for example, policies With W&I Insurance becoming a staple of to the aerospace/defence and infrastructure certain types of deals, including corporate industries were provided in 2018, where real estate and private equity, and capacity none were in 2017. However there are certain of underwriters at an all-time high, the deal industries where we expect insurers would sizes being insured are growing and we are still be wary; upstream oil & gas being one, increasingly seeing W&I Insurance used on along with untested sectors, like companies deals with a purchase price of hundreds of developing CBD/cannabinoids-based products, millions and even billions of pounds. In addition, which are seeing increasing investment and sellers, even on these large transactions, are M&A activity. increasingly able to negotiate a £1.00 cap on liability. Corporate and strategic buyers are US-style policy enhancements becoming more increasingly turning to W&I Insurance to use common in UK deals the terms of the product as a means to make its offer more attractive, particularly in auction US clients operating within the UK market scenarios, whereas, historically, they have are increasingly pushing for their European tended to use a combination of self-insurance insurers to offer policy enhancements similar to and negotiation of meaningful seller caps on those they would get in the US. The position liability. is likely to evolve, but we are increasingly seeing UK insurers providing certain (but not all) enhancements on deals (sometimes at no Insurance uses diversified additional premium), such as in relation to non- Traditionally seen as a seller-friendly tool to disclosure of the Data Room or due diligence achieve a “clean-break,” the use of the product reports, which we expect to see more of in 2019 is becoming more diversified from both the as the insurance market remains competitive.

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Looking forward At present, the claims side of the W&I product remains in its infancy, so this increasing volume A trend to look out for in 2019 is the further of claims is presenting novel issues for insurers development of synthetic warranties and to grapple with. Crucially, there is currently no synthetic tax deeds. These are provided by case law in England and Wales in relation to the insurer and not the seller, allowing the the specific operation of W&I policies, which warranties and tax indemnity being covered means that insurers and their legal advisors have to sit outside of the SPA, thereby creating an little guidance beyond the general principles of even more competitive bid for the buyer. There insurance and contract law. Further, while the are, however, a number of untested issues we W&I market is growing, it is a small community see with this, including the interaction with of underwriters and brokers operating in the disclosure and diligence, which should be London market, and so any decisions in relation further developed in 2019. to coverage issues taken now, whether on a negotiated basis or by way of a more formal CLAIMS dispute resolution mechanism, could be precedent-setting, underscoring the critical UK importance of claims handling decisions being taken today in relation to W&I policies. W&I Insurance has historically been viewed as something of a novel product. However, We discuss a few key points below that in recent years, W&I insurance has become we anticipate will continue to impact the increasingly prevalent as a tool for parties in development of the scope – and drafting M&A transactions to manage investment risk, – of W&I policies. resulting in a tremendous increase in both the number of W&I Insurance policies being written Mechanisms for carving out liability from in the London market, and the number of the policy policies being underwritten. During the underwriting process, insurers will The effect of this increase in W&I business identify areas of risk that they do not have the is twofold: as the number of policies being business appetite to underwrite and will seek underwritten increases, the number of claims to agree that these fall outside of the scope of being faced by insurers inevitably also increases cover afforded by the policy. This delineation and, as the product “matures,” there is less of risks that are covered, or not covered, of an emphasis by insurers on the need to is typically achieved via one or both of the demonstrate that the product “works” by paying following mechanisms: (i) specific exclusions in claims, and a greater appetite to challenge the policy wording; or (ii) carving out specific claims brought by insureds under their W&I warranties from the scope of cover of the policy. policies by the more established players in the The particular approach that is taken can raise London market. questions of proper policy construction: if a breach falls squarely within the subject matter of a specific warranty (such as contamination of

30 Global Insurance Industry Year in Review land amounting to a breach of environmental indemnity for their out-of-pocket loss. By way warranties) which is carved out from the scope of illustration, the target company may have of cover, and if those circumstances also failed to make a provision for an accrued liability amount to a breach of another warranty which under a commercial contract in the amount of is expressly covered (such as the financial £100,000. An insured will often then look to statements warranties vis-à-vis the value of the W&I policy for a recovery of the £100,000; real estate set out in the balance sheet), the however, the measure of loss is the impact of question arises as to whether the policy should this failure, assuming it amounts to a breach respond to a breach of the more general of a covered warranty, on the value of the warranty, notwithstanding the apparent shares. On the one hand, if this is a business agreement of the parties to exclude the with an enterprise value of several hundred specific contamination issues. million pounds, it is perhaps unlikely that such an underpayment would impact the value of While the intent may be clear that an insurer did the shares and, arguably, the insured has not not, for example, intend to provide cover for therefore suffered a loss. On the other hand, if environmental risks in carving out the specific a target company has been consistently failing environmental warranties, it may be open to to make provisions for accrued liabilities in such an insured to argue that there is still cover a manner that it flatters its profit margin, which for breach of the broader warranty. This will has then fed into the business valuation, the loss depend on the specific wording of the policy may be greatly in excess of £100,000. and the stock purchase agreement (“SPA”), in addition to the governing law of the policy. In reality, with smaller claims, it may not be The admissibility of the underwriter’s evidence commercially viable to expend time or money as to intention will also vary according to on determining the precise impact of a breach the governing law of the policy, with many of warranty on the value of the shares and it jurisdictions not recognising subjective intent as may be commercially sensible for insurers to a basis for determining the proper construction make payment in the sum of the small out-of- of the policy wording. pocket loss the insured has suffered. However, with larger claims, insurers will increasingly Measure of loss require the assistance of independent experts in order to determine the impact of a breach Under English law, absent any contractual of warranty on the valuation of the shares and, variation of the position, the measure of loss given the significant element of subjectivity in for a breach of warranty under an SPA is the the valuation of shares, there is real room for difference in value of the shares had the disputes to arise in relation to quantum. warranty been true, versus the value of the shares on the premise that the warranty is false, We have also seen developments in the SPA and the measure of loss under the W&I policy and W&I policy wordings to “curtail” the scope will typically mirror this quantum determination. of recoverable loss so that the consequences of However, where there has been a breach of a breach of warranty are only recoverable to the warranty, insureds will often make a claim extent that the breach affects the immediate, on the W&I policy as though it provides an current financial position of the target business;

Mayer Brown 31 1 Mergers & Acquisitions

and no allowance is permitted to be made Protection Regulation (“GDPR”) which came for the longer-term impact (if any) of a breach into force on 25 May 2018. GDPR will expose across many financial periods or the value of a target companies to heightened risks related business if determined on some kind of price/ to how they manage and store personal data earnings or multiple basis. Frequently, the and data breaches, and cyber events, could language used in the SPA or the W&I policy in result in major fines (as well as significant costs). this regard is inelegantly expressed and creates GDPR authorizes fines of up to EUR20 million or uncertainty as to the contractual measure of 4% of a company’s annual worldwide revenue, loss recoverable under the SPA and/or the whichever is higher, for noncompliance with insurance policy. strict data collection and use requirements.

Going forward, we expect to see situations GDPR fines are administrative fines, which where the parties agree that there has been are civil in nature, and the UK legislation a breach of warranty and that the insured has giving effect to the Directive is silent as to suffered a loss, but where the amount of that the insurability of such fines. On the face loss remains in dispute (as happened in the only of it, coverage would not be excluded if the case that has come before the courts in relation fines exclusion were restricted in application to a W&I policy, where the coverage issues to criminal fines or criminal penalties. Public had all fallen away, leaving a dispute solely policy questions may still arise, although it over quantum. is widely thought that an English court may permit the insurance of a civil fine, at least to Fines and penalties the extent that it is imposed for a negligent or non-fraudulent conduct; this remains, however, Generally, a W&I policy would not be expected a point to be tested before the Court in the to provide coverage for criminal fines or criminal context of GDPR (and other non-criminal) fines. penalties on public policy grounds, namely, that the insured should not benefit (or be The insurability of tax penalties is also a live protected) against the risk of the consequences issue in the context of W&I Insurance, as of being found liable for criminal or deliberate frequently the target company will be identified or dishonest misconduct; save that if the as having under-declared income, giving rise insurance of criminal fines or criminal penalties to additional tax liabilities that are filed “late,” is established to be insurable in the “most thus attracting late-filing penalties and interest favored jurisdiction”, which is usually specified charges in addition to the principal tax amounts. to be the jurisdiction of the insured policyholder, In some jurisdictions, the nature of the these the insurer, or where, for example, the fine or penalties and interest charges may be clear if, penalty is issued, coverage may be agreed to be for example, it is a requirement, in order for a provided for such loss. criminal fine or criminal penalty to be issued, that there must first have been a criminal Interesting issues arise in the context of non- conviction; absent such a conviction, there traditional sources of penalties and fines, such would appear to be no prospect of successfully as fines issued for breach of the General Data arguing that the tax charges are criminal fines

32 Global Insurance Industry Year in Review or criminal penalties. In other jurisdictions, the nature of these tax charges may be considered to be administrative, such that although the question of insurability of fines may still raise issues of public policy (most tax charges being levied to deter taxpayers from failing to file tax returns on time, or at all), exclusions that are limited in application to criminal fines or criminal penalties would not appear to “bite.”

Mayer Brown 33

Corporate Finance

Equity Capital Markets | Debt Capital Markets

Mayer Brown 35 2 Corporate Finance

EQUITY CAPITAL MARKETS In Asia, the most active issuer in 2018 was AUB Group Limited with two offerings There were 24 equity offerings in 2018 by for an aggregate value of A$116 million North American and Bermuda insurers, raising (approximately US$85 million). In terms of size, approximately $12 billion, according to S&P the largest single completed transaction in 2018 Global Market Intelligence. This compares to was The People’s Insurance Company (Group) of only 12 equity offerings completed in 2017, China Limited’s offering of 1,800,000,000 shares raising approximately $4.5 billion. in the aggregate amount of US$897 million.

In contrast to 2017, there was a rise in issuers In 2018, PRC insurers faced new rules subjecting raising capital (instead of secondary sales by them to enhanced disclosure requirements. shareholders). One reason may be the increased Effective as of July 1, the China Banking and M&A activity seen in 2018, with issuers planning Insurance Regulatory Commission (the “CBIRC”) to use the proceeds for acquisition financing. released new rules requiring PRC insurers to Centene Corporation raised $2.86 billion, disclose more detailed information regarding intending to use the net proceeds of the their ownership structures, risk management offering to finance a portion of the purchase practices and products and major transactions. price of the proposed Fidelis acquisition and Specifically, the new rules require insurers reduce commitments under a bridge facility. to disclose information about their actual WellCare Health Plans, Inc. raised $1.38 controlling person and shareholding information billion for financing the consummation of the about their shareholders with more than a 5% acquisition of Meridian. ownership in the insurance company. The new rules also require a summary of related party There were three insurance company IPOs in transactions and a more comprehensive list of 2018 – AXA Equitable Holdings, Federal Life major events that must be disclosed. These new Group, Inc. and Goosehead Insurance, Inc. AXA rules were introduced in an attempt to resolve a Equitable is comprised of the US operations of lack of transparency in shareholding structure in AXA SA, and its spin-off represented the second the insurance industry, partly in response to the largest IPO in North America in 2018, raising recent sentencing of Anbang Insurance Group’s $2.75 billion. AXA SA followed the IPO with ex-chairman to jail for fraud and embezzlement. an additional sale in November (raising $1.2 billion), bringing its ownership stake in AXA Meanwhile, PRC insurers also observed a Equitable to less than 60% (taking into account regulatory development encouraging them to an agreement by AXA Equitable to buy back invest in the stock market. As part of the PRC 30,000,000 of its shares from AXA SA). government’s shore up the stock market, on October 25, 2018, the CBIRC issued a notice While in 2017 the majority of the issuers were addressed to insurance companies under which incorporated in Bermuda, in 2018 the majority the insurance companies can provide long-term, of equity capital markets activity involved United stable funding support for listed companies States-domiciled entities. through specialized investment products. Under this notice, only insurance asset management companies qualify for establishing specialized

36 Global Insurance Industry Year in Review investment products, including stocks of listed While the number of debt offerings in Asia companies, publicly issued bonds of listed increased from 28 in 2017 to 48 in 2018, the companies and their shareholders, and non- aggregate amount raised actually decreased publicly issued exchangeable bonds, provided from US$6.3 billion to US$3.4 billion. The that such insurance asset management most active issuer in 2018 was Reliance Capital companies have not been subject to Limited, with 32 offerings for an aggregate value administrative penalties in the past three years. of INR21.5 billion (approximately US$302.2 One of the incentives for the PRC insurers to million), followed by AIA Group Limited, which utilize these specialized investment products is completed four offerings for an aggregate value that the amounts they invest in equities through of US$1.1 billion from its global medium term these specialized products will not be subject to note and securities program. In terms of size, existing restrictions on equity investments based the largest single completed transaction in 2018 on insurers’ total assets, which impose a cap on was Hanwha Life Insurance Co., Ltd.’s offering investments at 30% of an insurer’s assets. of 4.7% subordinated capital securities in the aggregate amount of US$1.0 billion with a 30- year maturity. DEBT CAPITAL MARKETS In 2018, insurers raising offshore debt faced a key regulatory development regarding In North America and Bermuda, debt offerings the provision of guarantees to offshore by the insurance industry in 2018 raised an lenders. Effective as of February 13, 2018, aggregate amount of $43 billion (including the China Insurance Regulatory Commission 8 debt offerings by Canadian issuers with (the “CIRC”) and the State Administration for an aggregate value of $1.9 billion), which Foreign Exchange (the “SAFE”) issued a joint represented an increase from the $37 billion in circular imposing restrictions on PRC insurers 2017, but still lower than the $74 billion raised in their use of Nei Bao Wai Dai (“NBWD” or in 2016. This decline was expected, as many “Overseas loans under domestic guarantee”) issuers in 2016 took advantage of historically structures. PRC-based companies have widely low interest rates, which began to rise at the used the NBWD structures, as such structures end of 2016. enable them to provide security in relation to loans incurred by their offshore subsidiaries The most active issuers in 2018 were by providing guarantees to offshore lenders UnitedHealth Group Inc. (nine offerings with through domestic Chinese banks simply by an aggregate value of $7 billion, Aflac (four registering with SAFE. offerings with an aggregate value of $1.03 billion) and Assurant (four offerings with an Pursuant to the joint circular from the CIRC and aggregate value of $1.3 billion). the SAFE, insurers are now required to: (i) obtain approval from the Insurance Asset Management In the 2018 bond market, Midwest Holding Inc. Association for any NBWD debt transaction had four convertible bond transactions totaling that exceeds US$50 million, (ii) provide NBWD $19.1 million with the largest transaction valued guarantees only for the debt of companies in at $17 million in senior secured promissory which they have at least a 95% shareholding, notes due in 2028.

Mayer Brown 37 2 Corporate Finance

(iii) ensure the funds obtained through NBWD transactions do not exceed the group’s net assets as of the end of the preceding quarter, and (iv) report to the CIRC in relation to NBWD transactions, such as signing and occurrence of any material adverse events. This regulatory change is expected to lead to more scrutiny over debt transactions involving offshore vehicles and certainly enhances the reporting requirements for use of this increasingly common structure.

38 Global Insurance Industry Year in Review Mayer Brown 39

ILS and Convergence Markets

Property-Casualty Sector | Longevity and Pension De-Risking

Mayer Brown 41 3 ILS and Convergence Markets

PROPERTY-CASUALTY SECTOR from 2017 issuance levels demonstrates the continued importance of this sector of the Introduction market to the insurance industry. Additionally, for the first time since 2014, at least one deal In 2018, the convergence market, which came to market in every month of 2018. includes insurance-linked securities (“ILS”), sidecars, dedicated funds and collateralized US catastrophe risks (particularly US wind reinsurance vehicles, continued the growth and US earthquake) continue to dominate, trends of prior years, underscoring its representing approximately 40% of outstanding establishment as a key component of the global bonds at year-end. Japan risks (earthquake and insurance market. The volume of new risk-linked typhoon) represented approximately 10.3% security issuances in 2018 was the largest in the of outstanding bonds at year-end. European- history of the market, eclipsing even the record- only risks represented approximately 0.4% of shattering levels of 2017. In addition, 2018 saw outstanding bonds at year-end. However, multi- the introduction of several innovative new risks region bonds (typically covering the US and as well as the entry of significant new market Western Europe, but also Japan and Australia) actors. While the large number of catastrophe represented approximately 20% of outstanding events in 2017 did result in losses to several bonds at year-end, showing an investor appetite bonds, market interest in insurance-linked for European risks when they are bundled securities remained high. We review below the with other regions (thereby improving the markets for catastrophe bonds, sidecars and pricing). An interesting feature of the 2018 peril dedicated funds. distribution included the 10.7% of mortgage insurance risks, bolstered by nearly $1.3 billion Insurance-Linked Securities in mortgage insurance related issuances in the fourth quarter of 2018. Additionally, Latin 2018 saw approximately $13.9 billion of new American risks – namely earthquake exposure risk-linked securities issuances, compared in Chile, Colombia, Mexico and Peru – to $12.5 billion in 2017, an increase of represented approximately 3.8% of outstanding approximately 11%. This represents a new risks, brought to market through the World record in terms of annual issuances. 2018 Bank’s Pacific Alliance program. issuances resulted in approximately $37.8 billion of total aggregate principal amount of risk- Sponsoring companies in 2018 included linked securities outstanding at year-end, almost longtime annual participants (such as Everest 22% higher from the amount outstanding at the Re, State Farm and USAA), primary insurer end of 2017. sponsors (such as Allstate, Mitsui Sumitomo, Tokio Marine, United Property & Casualty, While the increase in issuance volume from Travelers and Nationwide) and new insurance 2017 to 2018 was not as dramatic as the sponsors (such as the US Federal Emergency increase from 2016 to 2017, which saw growth Management Agency (via Hannover Re), of approximately 76% year-on-year, the fact Transatlantic Reinsurance Co., Build America that 2018 maintained and continued to grow Mutual Assurance Company, PG&E Corporation

42 Global Insurance Industry Year in Review and Sempra Energy). State-sponsored insurance federal government entity into the catastrophe entities came back to the market in 2018, bond market and also represents the first flood including offerings sponsored by the California risk catastrophe bond (although restricted to Earthquake Authority, Louisiana Citizens, Florida flood events caused by named storms). Citizens and the Texas Windstorm Insurance Agency. 2018 also saw the first transfer of pure wildfire risk to the capital markets. PG&E Corporation Of particular interest in 2018 were breakthrough and Sempra Energy, both of which are California transactions that brought new risks to the ILS utility providers, each sponsored a catastrophe market (including non-property catastrophe bond covering third-party liability losses risks). While the ILS market is heavily weighted due to wildfires caused by their respective towards property catastrophe risks, these infrastructure. transactions demonstrate that the catastrophe bond technology is adaptable to cover a much Other significant transactions in 2018 included broader array of risks. the expansion of the World Bank’s Pacific Alliance catastrophe bond program, which Over the course of 2018, mortgage insurance- covers the four Pacific Alliance countries (Chile, linked securities totaling nearly $3 billion Colombia, Mexico, Peru) against earthquake were issued by a number of sponsors. Arch losses on a parametric basis. Four bonds, one Capital Group, an insurance, reinsurance and for each of the Pacific Alliance countries and mortgage insurance company with global totaling nearly $1.4 billion, were brought to operations, accounted for over half of these market in February 2018, offering geographic issuances through three separate offerings diversification to the market. by its special purpose insurer, Bellemeade Re Ltd. The Bellemeade bonds were issued with a In 2018, Ursa Re, which provides reinsurance 10-year term, significantly longer than property capacity to the California Earthquake Authority catastrophe ILS deals. Additionally, the separate (“CEA”), continued to utilize its “library” issuances provided protection for both seasoned program structure, which included six classes of loans, in the case of Bellemeade 2018-2, and notes that were fully structured and modeled in newer loans, in the case of Bellemeade Re 2018- May 2017. Under this “library” program, Ursa 1 and 2018-3, demonstrating the capacity of Re issued two classes of notes in May 2017, the capital markets to provide protection for a two classes of notes in November 2017, and variety of mortgage-related risks. an additional class in September 2018. The structure allowed Ursa Re to rapidly engage July 2018 saw the first catastrophe bond to in a series of issuances, thereby providing the provide reinsurance protection to the National CEA with efficient pre-modeled and structured Flood Insurance Program (“NFIP”), which is reinsurance layers. administered by the US Federal Emergency Management Agency (“FEMA”). The transaction In May 2018, French insurer SCOR re-entered had been anticipated for some time as part of the market for the first time since 2016. While FEMA’s expansion of its reinsurance protection. the transaction covered familiar perils, in the The transaction represents the first entry by a US form of US named storm, US and Canada

Mayer Brown 43 3 ILS and Convergence Markets

earthquake and European windstorm, SCOR The remainder consisted of multiple triggers or chose to utilize the UK’s recently enacted ILS bespoke arrangements. regulatory and tax regime (pursuant to the UK’s Risk Transformation Regulations 2017) Aggregate triggers continued to dominate for the transaction. The transaction was the catastrophe bonds, representing more than half first UK-domiciled cat bond transaction under of all transactions outstanding at year end 2018 the new legislation. Additional insurance and nearly 70% of bonds issued in 2018. With transactions under the regime in 2018 included these triggers, losses from multiple events are an insurance sidecar transaction sponsored by aggregated (typically over a 12-month period) Neon Underwriting and the launch of Sussex to determine whether the specified attachment Capital UK PCC Limited, a new collateralized level has been exceeded. This demonstrates reinsurance platform established by Brit one of the ways in which the catastrophe bond Insurance. It remains to be seen whether market has come closer to the traditional concerns about Brexit, particularly with reinsurance market (where aggregate protection respect to concerns about the UK’s Solvency II is more common). equivalency, will dissuade sponsors from future issuances under the framework. In 2018, in line with previous years, most sponsors came to market without a rating on Singapore, like the UK, is also seeking to catastrophe bonds. This continues a trend over establish itself as a new ILS domicile, but has the past few years and reflects a perception yet to see any catastrophe bond issuers take that the time and expense of the ratings up its offer of funding a portion of the upfront process outweigh the benefits to investors costs incurred in issuing catastrophe bonds in (and indirectly sponsors) to having the rating. the country. It will be interesting to see whether The proceeds of insurance-linked securities any transactions in 2019 are launched in this continue to be invested in high-quality assets, jurisdiction. such as money US treasury market funds. Many transactions in 2018 utilized putable Indemnity triggers (which calculate payouts notes issued by either the European Bank for based on the actual losses of the ceding Reconstruction and Development (“EBRD”) company) were used in a majority of transactions or the International Bank for Reconstruction in 2018, representing approximately 62.5% of and Development (“World Bank”), thereby all outstanding issuances at year end. Index potentially providing an improved investment transactions (using information from PCS return on the underlying notes. In addition, the and PERILS) were the next largest trigger- use of these putable notes helps to mitigate type, representing approximately 23.0% of the risks of negative interest rates arising from outstanding transactions at year end. Parametric holding money market funds denominated in triggers (which are based on measurable currencies with negative interest rates. physical phenomena, such as wind speed or earthquake magnitude), at 7.5% of outstanding 2018 saw the entry into the market of new transactions, represented the third largest sponsors, catastrophe bonds covering new category of trigger type. perils and the availability of new jurisdictions for ILS issuances.

44 Global Insurance Industry Year in Review Despite significant catastrophe losses in 2018 global property reinsurance risk portfolio and prior years, the continued growth and through the Bermuda-domiciled Lion Rock evolution of the market demonstrates Re Ltd. its importance in providing claims-paying resources and flexible solutions to sponsoring In addition to sidecars, insurance-linked insurance companies. securities funds continue to represent a critical component of the growth of the alternative Sidecars and Managed Funds capital market, providing an important source of capital in the reinsurance markets. At the end of 2018, there were over $100 billion In 2018, sidecars remained an important of assets under management in ILS funds, mechanism for providing additional an approximately 25% increase over 2017. collateralized capacity to the reinsurance Many newly formed funds give the investment market, while allowing sponsors to participate manager broad discretion to deploy capital as in a targeted fashion in the property casualty reinsurance opportunities arise, whether through market. Several reinsurers extended their the purchase of catastrophe bonds, the funding existing programs, including Brit (Versutus), of collateralized reinsurance for third-parties, Chaucer (Thopas Re), Everest Re (Mt. Logan Re) or the entering into of quota share agreements and Munich Re (Eden Re), while the market also with the sponsor or its affiliates. saw new entrants, such as Peak Re (Lion Rock Re). Reinsurers raised approximately $3.7 billion through sidecar issuances in 2018.

Sidecars are privately negotiated transactions that can be flexibly tailored to meet the sponsoring reinsurance company’s needs. They can be structured as market-facing vehicles (in which the sidecar directly enters into retrocession agreements with third-party reinsurers, with underwriting and management typically being performed by the sponsoring reinsurance company), and side-by-side vehicles (in which the sidecar enters into a retrocession agreement with the sponsoring reinsurance company, taking a quota share of a specified portfolio of risks of such company).

A significant transaction in 2018 was the launch of the first Asian sidecar transaction, sponsored by Peak Reinsurance Co., a Hong Kong-based reinsurer. The sidecar provides collateralized retrocession coverage for part of Peak Re’s

Mayer Brown 45 3 ILS and Convergence Markets

ILS and Emerging Markets the program in February 2018, exposed to earthquakes in each of Chile, Colombia, Mexico 2018 saw continued developments in the and Peru. utilization of catastrophe bonds for the provision of financing in the wake of disasters Other developments in the market suggest and disease outbreaks in emerging markets. increasing interest in ILS as a means for Outbreaks of Ebola and Lassa fever in the promoting resilience in emerging markets. In Democratic Republic of Congo and Nigeria October 2018, an innovative pilot program was came close to triggering the World Bank’s established by Blue Marble Microinsurance (a Pandemic Emergency Financing Facility startup backed by a consortium of eight large ILS market participants) and Nespresso, the (“PEF”), which, if certain thresholds are met, would see investor capital go towards coffee company, to provide weather-related preventing the outbreak and spread of insurance for smallholder coffee farmers infectious disease in certain Sub-Saharan in Colombia. In late 2018, the Philippines, Africa. While the bond itself was not triggered, supported by the World Bank, announced financing elements of the facility below the plans to renew and double parametric natural attachment level of the bond were drawn disaster insurance cover for the country, as well upon and resulted in payments to support the as confirming plans to issue a catastrophe bond. containment of an Ebola outbreak in In late 2018, it was reported that both India the Congo. and Jamaica were in talks with international organizations, including the World Bank, In September 2017, a magnitude 8.1 regarding disaster risk financing, potentially earthquake struck off the coast of Chiapas, including ILS. In October 2018, the United Mexico. The earthquake resulted in an Nations Development Program organized a absolute loss to the $150 million Class A Note conference for government officials of countries tranche of a catastrophe bond exposed to in the so-called ECIS region (Central Asia, Mexican earthquakes issued just weeks before Southern Caucasus, Eastern and South East pursuant to the World Bank’s Pacific Alliance Europe, and Turkey) to provide information program. The bond paid quickly and without on disaster risk transfer, including catastrophe any disputes, proving the effectiveness of the bonds and ILS. Additionally, both the UK and model in providing quick access to funding for Singapore have reportedly been trying to developing countries dealing with the aftermath encourage China to utilize their respective new of catastrophes. While unfortunate for investors, ILS regimes. Although only one Chinese entity the payout did not seem to affect interest in (China Re) has issued a catastrophe bond, the World Bank’s program, which went on administrations in the Chinese provinces of to successfully issue four more bonds under Hainan, Hunan and Shanghai have all launched

46 Global Insurance Industry Year in Review pilot catastrophe insurance programs in recent years.

In early 2019, it was also announced that the World Bank, which has been a key facilitator of the entry by developing countries into the ILS market, will double its funding for climate change adaptation and resilience-related projects, including the facilitation of financial protection instruments that can help countries respond to disaster events.

Given the apparent extent of discussions on the use of catastrophe bonds and other insurance solutions, it is likely that more transactions providing exposure to risks in developing countries are brought to market in the future.

Mayer Brown 47 3 ILS and Convergence Markets

LONGEVITY AND PENSION and Lockheed Martin 32,000. The Bristol-Myers Squibb transaction involves a full termination DE-RISKING of the company’s defined benefit plan and the UNITED STATES transfer of liabilities for active employees as well Deals as terminated vested employees, retirees, and beneficiaries, and covers 27,000 individuals, Showing no sign of slowing down, pension risk 4,800 of whom are active employees and 18,000 transfer transactions continued in 2018 with a of whom are terminated vested employees who number of large-scale group annuity purchases, have not yet commenced their benefits. The as well as the distribution of lump sums. plan termination is one of the largest transfers to According to the LIMRA Secure Retirement a private insurer of liabilities for individuals who Institute, as of the end of the third quarter of have not yet commenced benefits. 2018, year-to-date, single-premium buy-out product sales totaled $15.9 billion, compared The Lockheed Martin “buy-in” contract (under to $11.9 billion for the same period in 2017. which the plan remains liable for benefits and Sales of such group annuities for all of 2018 is reimbursed by the insurer) covers 9,000 are expected to be over $23 billion, just above retirees and their beneficiaries. In the case 2017’s $22.99 billion. Companies in the US that of a buy-in contract, the plan continues to be engaged in pension risk transfer transactions liable for all plan benefits and typically pays that included annuity purchases in 2018 include: and administers the retirement benefits of FedEx Corp. ($6 billion), Bristol-Myers Squibb the covered group, but is reimbursed by the Company ($3.8 billion), International Paper insurer for those benefit payments, eliminating ($1.6 billion), and Lockheed Martin ($1.8 billion the plan’s exposure to interest rate, asset and buy-out, and $800 million buy-in). The FedEx longevity risks. The plan remains subject to deal with insurer Metropolitan Life Insurance Co. Pension Benefit Guaranty Corporation (“PBGC”) was the largest pension risk transfer transaction premiums and bears the risk of default (i.e., in in the US since 2012. These blockbuster deals, the event of the insurer’s insolvency, the plan however, were not the only driver of buy-out would continue to have to pay the benefits even activity in 2018, with medium and small-sized if not reimbursed by the insurer). Some insurers group annuity sales returning in force in the have been marketing buy-in contracts as an third quarter. intermediate step in a de-risking solution that will ultimately result in a buy-out contract. The FedEx Corp., International Paper, and Lockheed Martin “buy-out” contracts (which Factors Driving De-risking involve a full transfer of pension liabilities to the applicable insurer) were structured as MetLife’s recently issued 2019 Pension “lift-out annuities” covering a segment of Risk Transfer poll reports that 76% of all the applicable plan’s population and did not plan sponsors with de-risking goals plan to involve full plan terminations. The FedEx completely divest their company’s defined transaction is reported to cover 41,000 retirees benefit plan liabilities at some point in the and beneficiaries, International Paper 23,000, future. As we have discussed in our prior

48 Global Insurance Industry Year in Review updates, plan sponsor motivations for engaging In addition, in the case of some plans, sponsors in pension risk transfer transactions include made accelerated contributions during 2018 volatility in pension obligations, accounting and (which under certain conditions could be treated funding rule changes, volatile capital markets, as relating back to 2017) to allow the sponsor rising interest rates, longevity risk issues and to take advantage of the closing window for escalating premiums paid to the PBGC, the deductions in 2017 against a 35% corporate tax federal agency that insures private sector bracket. Bloomberg and Barron’s report that pension benefits. (The PBGC’s own “Participant employers announcing pension contributions and Plan Sponsor Advocate’s 2018 Annual in excess of $1 billion during 2018 included Report,” discussed below, identifies past and FirstEnergy Corp., FedEx Corp., Verizon scheduled future rapid increases in PBGC Communications Inc., Lockheed Martin Corp., premiums as one of the primary drivers of Exxon Mobil Corp., and General Electric. de-risking activity. The MetLife poll indicates Some of these contributions were debt- that 55% of those surveyed cite “actions” by the funded presumably because the tax benefits PBGC as the primary catalyst for plan sponsors of accelerated funding (in addition to the to initiate a pension risk transfer to an insurance reduction, if any, in PBGC variable premiums on company. This apparently includes PBGC account of improved funding ratios) outweighed premium increases as well as the PBGC’s risk- the cost of borrowing. based premium structure, which varies with plan underfunding.) Following is a brief round-up of legal developments in this area in 2018. Another factor in the 2018 dynamic is improved plan funding status, which may facilitate a Internal Revenue Service Developments/ plan sponsor’s ability to pursue certain de- Class Actions risking strategies with no, or reduced, cash contributions. According to the Milliman Pension Funding Index, the top 100 largest Offers of Lump Sums to Participants in corporate pension plans ended 2018 with an Pay Status average funded percentage of 89.9%, up from On July 10, 2015, the Internal Revenue Service 87.6% as of the end of 2017 (with a total of (“ ”) issued Notice 2015-49, which “informs $56 billion year-end over year-end). Although IRS taxpayers that the Treasury Department and many plans suffered investment losses in 2018, the IRS intend to amend” certain regulations to the interest rates used to discount pension provide that qualified defined benefit plans are liabilities increased and generally caused an generally not permitted to replace any annuity overall improvement in plan funding ratios. currently being paid from the plan with a lump According to Milliman, “[t]he discount rate at sum or other accelerated form of distribution. year-end 2017 was the lowest year-end discount The Notice provided that the amendment to the rate and fifth lowest monthly discount overall regulations would be retroactive to the date of that has been recorded in the 18-year history of the Notice. the PFI; 2018’s discount rate improvement and associated pension liability decreases helped to offset the reductions in plan assets resulting from negative investment returns during the year.” Mayer Brown 49 3 ILS and Convergence Markets

Although an IRS official was reported to have also affect the premium charged by insurers stated in early 2016 that the regulations were in who issue group annuity contracts that cover a “fairly advanced stage of development,” the participants who have not yet commenced regulations were not issued in 2018. payment and have the option of electing a lump sum distribution. Mortality Tables Finally, as previously reported, the IRS in As discussed in last year’s update, in October 2017 issued Notice 2018-02, which provides 2017 the IRS finalized regulations that updated static mortality tables and mortality included a new mortality table and mortality improvement rates for purposes of applying improvement scale for purposes of minimum the minimum funding rules for 2019, and funding and PBGC premiums. The regulations a modified unisex version of the tables for took effect for plan years beginning on and purposes of calculating lump sums with annuity after January 1, 2018 and were based on starting dates occurring during stability periods tables issued by the Society of Actuaries in beginning in 2019. The tables reflect the the RP-2014 Mortality Tables Report and the mortality improvement rates in the Mortality improvement rates in the MP-2016 mortality Improvement Scale MP-2017 Report (issued by improvement scale, which reflect current the Society of Actuaries). and projected gains in longevity and apply for corporate financial accounting purposes. Class Actions in 2018 Under the new IRS tables, plan liabilities were generally expected to become larger, resulting Interestingly, the updates in mortality tables in increased employer contributions, although for financial accounting, minimum funding the actual increases in liabilities vary by plan, and lump sum distribution purposes may have depend on the demographics of the plan’s inspired certain class action complaints filed in population and could, of course, be offset by late 2018; these actions do not involve pension changes in interest rates, assets values and risk transfer transactions, but ultimately may other factors. have some bearing on them. In general, the Employee Retirement Income Security Act In addition, as previously reported, the IRS in of 1974 (“ERISA”) and the Code stipulate 2017 issued Notice 2017-60, which provided a the actuarial assumptions (interest rate and new mortality table for calculating the minimum mortality table) that must be used for purposes present value (under Internal Revenue Code of converting a participant’s accrued benefit (the “Code”) section 417(e)) of lump sum under a defined benefit plan to a lump sum distributions during stability periods in 2018, distribution or to certain very limited types of subject to certain transition rules. Lump-sum annuity forms of payment. With respect to the distributions to participants calculated under conversion of a participant’s accrued benefit to the new tables were generally expected to be most other forms of distribution (e.g., a joint and larger, holding other variables (e.g., interest survivor annuity), ERISA and the Code require rates) constant. Larger lump sums would make only that the assumptions be reasonable. In lump sum windows more expensive and could December 2018, four large pension plans were

50 Global Insurance Industry Year in Review hit with class action complaints alleging that Plan Sponsor Advocate 2018 Annual Report. they employ unreasonable actuarial factors and/ The PBGC publishes the “Annual Report of or assumptions, including “outdated” mortality the Participant and Plan Sponsor Advocate” tables, when calculating plan benefits payable in (the “Advocate Report”). Building on last various annuity forms of distribution or at early year’s Advocate Report, this year’s Advocate retirement. The complaints allege that, as a Report included an appendix with results of result of the use of such outdated assumptions, the second phase of a pension de-risking study participants received lower annuity payments commissioned by the Office of the Advocate. than required by ERISA. We note that no Overall, the two-phase study was commissioned decisions have been rendered in these cases to analyze the underlying causes and drivers and that the “reasonableness” standard in this of de-risking activity, focusing mostly on risk context is unsettled. Further, it does appear transfers, which, according to the report, have from IRS regulations that “reasonableness” the most significant effect on the viability of the is generally assessed based on the totality of voluntary defined benefit system. This year’s assumptions used, and, in many cases, one set phase of the study consisted of a qualitative of assumptions (e.g., plan interest rate used) evaluation of plan sponsors’ motivations for will offset or modify the effect of another (e.g., pension de-risking activity, based on interviews mortality rates). Hence, it is difficult to predict with a focus group of plan sponsor human how the courts will view these issues in general resources, accounting, and treasury decision- as well as in each fact-specific case. makers. This year’s study confirmed many of last year’s findings, including a strong link between Pension Benefit Guaranty Corporation PBGC single-employer premium levels and pension risk transfer activity. The Advocate Report noted that participating sponsors’ PBGC Premiums. PBGC premiums continue views of the value proposition for defined to increase. In October of 2018, the PBGC benefit plans continues to evolve, and with posted on its website premium rates for plan the exception of certain industries, concludes years beginning in 2019. The per-participant that industry and market trends are influencing flat premium rate for plan years beginning in sponsors’ decisions to not only de-risk but to 2019 is $80 for single-employer defined benefit terminate defined benefit plans. plans (up from a 2018 rate of $74) and $29 for multiemployer plans (up from a 2018 rate This year’s study also echoed last year’s finding of $28). For plan years beginning in 2019, that the most significant PBGC-related factor the variable-rate premium (“ ”) for single- VRP driving de-risking is PBGC premiums. The study employer plans is $43 per $1,000 of unfunded indicates that for some sponsors, the present vested benefits (“ ”), up from a 2018 rate UVBs value of future PBGC premiums outweighs of $38. The VRP is capped at $541 times the the cost of pension risk transfer activities, and number of participants (up from a 2018 cap concludes that reducing PBGC premiums or of $523). The PBGC website includes a table ”stemming their growth” would likely have “the showing that the flat-rate premium for single- positive effect of slowing de-risking activity.” employer plans has grown from $31 in 2007 to The study also found that sponsors of financially $80 in 2019, and the variable-rate premium has healthy plans often do not expect to benefit grown from $9 to $43. PBGC Participant and

Mayer Brown 51 3 ILS and Convergence Markets

from the PBGC’s insurance program, but instead action by annuity customers, Roycroft v. MetLife, feel as if their premiums are subsidizing other Inc., but that case was dismissed by a federal plans that are poorly funded or whose sponsors district court in early 2019 for failure to state have gone bankrupt. a claim for extra-contractual relief for interest allegedly owed on delayed annuity payments PBGC Legislative Activity. PBGC-related to early retirees. As noted in previous updates legislative activity in 2018 was primarily focused regarding the Lee v. Verizon pension risk transfer on the multiemployer plan insurance system, litigation, the selection of insurer in a pension with Congress establishing the Joint Select risk transfer transaction is typically a fiduciary Committee on Solvency of Multiemployer act under ERISA; going forward, a factor plan Pension Plans in February 2018. The results of fiduciaries may take into account when selecting this study, however, may provide the impetus for an insurer in a pension risk transfer deal is Congressional action to reduce PBGC premiums the insurer’s track record in dealing with lost in the single-employer plan insurance program participants. or at least to reject proposals to cross-subsidize the multiemployer program with premiums paid UK under the financially stronger single-employer PBGC insurance program. 2018 saw the highest ever levels of pension longevity risk transfer in the UK. On the bulk Missing Participants annuity front, activity levels exceeded £10 billion for the fifth year running, with a total deal Although long-requested guidance from the volume that is expected to approach £20 billion Department of Labor has not yet been issued compared to around £12 billion in 2017. 2018 regarding fiduciary standards for locating also saw an increase in individual deal sizes, missing participants, the DOL and PBGC with four reported transactions over £1 billion continue to focus enforcement and oversight compared to just one such transaction in 2017. efforts on the issue. In addition, 2018 saw These included a £4.4 billion buy-in with Legal state regulators taking up the issue of missing & General (“L&G”) for the Airways Pension participants from a different angle following Scheme, the largest ever bulk annuity policy announcements by several major group annuity entered into with a UK pension scheme. insurers that protocols for locating lost annuity contract holders were ineffective. In December As was the case in 2017 (and previous years), 2018, MetLife Inc. entered into a consent order there were far more buy-ins than buy-outs. with the Massachusetts Securities Division However, 2018 saw an increase in the number and agreed to pay a $1 million fine to resolve of buy-outs thanks to a combination of more allegations of securities fraud in its financial favorable buy-out pricing and improved scheme disclosures, stemming from the insurer’s funding levels, making buy-out more achievable inadequate procedures for keeping track of and for schemes than a few years ago. contacting individuals owed payments under group annuity contracts. The issue has also Bulk annuities covering deferred liabilities given rise to at least one potential class have historically been far more expensive than transactions covering pensioners due

52 Global Insurance Industry Year in Review to the cost for the insurer of obtaining the volume of around £7.7 billion. Reported matching assets required under Solvency II. deals included a £2 billion fully intermediated However, insurers are now sourcing assets to longevity insurance swap transaction for the back their bulk annuity policies whose yields National Grid Group of the Electricity Supply better match deferred pension liabilities such Pension Scheme with Zurich. The swap featured as social housing, equity release mortgages, sophisticated title transfer and fixed security infrastructure, and transportation. This, together collateral arrangements and was structured with a reduction in life expectancy improvement to ease conversion into a buy-in or buy-out if rates, has resulted in buy-out pricing becoming desired in the future – putting to bed the idea significantly more attractive. that longevity swaps are hard to convert to buy- outs. Zurich reinsured a significant proportion In addition, the last couple of years have seen of the longevity risk with Canada Life Re. High a period of relatively strong scheme asset levels of insurer reinsurance continued, with performance. At the same time, an increase Pension Insurance Corporation (PIC), Scottish in transfers-out following introduction of more Widows and Aviva entering into transactions relaxed rules on the way in which defined totaling around £5.4 billion to reinsure parts of contribution pension benefits can be taken and their back-books. a reduction in life expectancy improvement rates have reduced scheme liabilities. As a result, The number of active market participants many schemes have seen an improvement in remained at eight. Contrary to market their scheme funding levels. Reported buy-out commentators’ predictions, no new entrants transactions included the £2.4 billion buy-out by joined the market in 2018. PIC, L&G and Aviva L&G of the Nortel Networks UK Pension Plan. continue to have the largest market shares, but several of the newer market entrants expanded 2018 also saw some significant bulk annuity their market share over the course of the year, back-book transactions. Following its 2016 and six of the eight participants completed decision to withdraw from the bulk annuity their largest ever transactions – such as Scottish market, Prudential sold £12 billion of its Widows’ £880 million buy-in for the Littlewoods estimated £30 billion bulk annuity back-book Pension Scheme. Having joined the market in to Rothesay Life. In addition, having joined 2017, Phoenix Life completed its first external the bulk annuity market in 2017, Phoenix Life transaction, a £470 million buy-in for the Marks bought Standard Life Aberdeen’s insurance arm & Spencer Pension Scheme. which included a £5.5 billion bulk annuity back- book. Further back-book deals are expected Market commentators believe that the market in 2019, particularly since the lower regulatory remains attractive to new entrants, but that any capital requirements for back-book transactions potential entrants will need to overcome barriers entered into before Solvency II came into force to entry, such as current constraints on available in 2016 mean that insurers may well see a back- staff with the appropriate expertise, the required book deal as more attractive than a “new” bulk ability to source suitable assets to back bulk annuity transaction. annuity business, and the need to establish a “brand” within the market. The longevity swap and reinsurance market Insurer capacity and scheme demand is remained strong in 2018 with a total deal expected to remain high for both bulk

Mayer Brown 53 3 ILS and Convergence Markets

annuities and longevity swaps in 2019 with • Reinsurance capacity. Demand for market commentators anticipating that it will reinsurance is likely to remain high due to be another record-breaking year with a total the ongoing capital requirements of the deal volume in excess of £30 billion, including Solvency II regime which make reinsurance increased longevity swap activity of £10 billion. attractive, particularly given the substantial While market commentators expect to see an annuity back-books of some insurers. increasing number of £1 billion+ transactions, Reinsurance capacity currently remains the £100 million – £500 million range of the good with strong competition among a market is likely to also remain busy as all the high number of active reinsurers, but may currently active insurers operate in this space. be affected in the longer term by increasing global demand for reinsurance. However, concerns are being raised in the industry about the level of market capacity. • Regulatory capital capacity. Under Market commentators have identified four main Solvency II, insurers are required to hold potential constraints on capacity: a minimum level of regulatory capital to back their liabilities, and will also hold an • Insurer resource levels. Insufficient IT and additional level of voluntary capital. A lack staff resources may mean that insurers have of available capital could restrict insurers’ to be selective in which transactions they ability to enter into transactions. However, quote for. Market commentators expect market commentators do not anticipate a this to be the most significant immediate lack of capital capacity. constraint on insurer capacity, but equally expect it to be a largely short-term Whether or not capacity constraints bite, constraint. market commentators anticipate that the level of scheme demand may mean that insurers • Asset availability. As discussed earlier, become more selective about the types and size pricing is heavily driven by the type of of deals that they will target. Schemes that are matching assets that insurers can secure able to present a well-prepared proposition to back transactions. Over recent years, with properly cleansed data, rather than insurers have been successful in sourcing speculative approaches, will be more likely suitable matching assets from a wider range to attract insurer interest. of asset classes, in particular more illiquid assets which offer good yields over a long Pricing for bulk annuities and longevity swaps term. However, market commentators have improved significantly over the course of 2017, raised concerns about whether there will and this trend continued into the first half of continue to be sufficient illiquid asset supply 2018, reaching its lowest level for nearly a to meet demand. Market commentators decade. By the third quarter of 2018, buy-ins largely see asset availability as the most were 5-10% cheaper than the gilts required to significant capacity constraint in the match the same scheme liabilities. This level long term. of pricing makes a buy-in a significantly more attractive investment than gilts since a

54 Global Insurance Industry Year in Review buy-in will address risks that gilts do not, such required to equalize benefits for the effect of as longevity. The improvements in pricing were unequal guaranteed minimum pensions (GMPs). largely driven by the reduction in life expectancy GMPs are a minimum benefit that schemes improvement rates and insurer success in that were contracted-out of the state second sourcing illiquid assets that offer high yields and pension on a salary-related basis between 1978 a close match to scheme liabilities. The level of and 1997 are required to provide. The rules competition among insurers also played a role, governing the accrual and payment of GMPs as insurers who obtained assets in anticipation are set out in legislation. Those rules differ of securing some of the larger (i.e., over £1 as between men and women in a number of billion) market deals, but who did not end up respects. In particular, GMPs are payable at age getting those deals, were able to offer very 60 for women and age 65 for men. The Court’s competitive pricing for mid-range (i.e., £100 ruling will increase scheme liabilities and may million – £500 million) transactions using result in an increase in bulk annuity pricing. It those assets. may also require existing bulk annuity contracts to be revisited. Pricing weakened slightly during the second half of 2018, thanks to insurer appetite tailing off In December 2018, the UK government somewhat as a result of the high deal volume published a consultation on a proposed earlier in the year. However, buy-in pricing legal and regulatory framework for the remains cheaper than gilts. Going into 2019, authorization and supervision of defined benefit while market commentators expect pricing to (“DB”) commercial consolidation vehicles remain relatively attractive, thanks to continuing or “superfunds”. Commercial consolidation insurer competition and appetite, rising scheme vehicles offer a complete risk transfer alternative demand for longevity risk transfer is expected to to buy-outs. Essentially, they are occupational result in a pricing increase. pension schemes into which other DB schemes can transfer their assets and liabilities. As 2018 also saw the increasing use of member occupational pension schemes (and subject option exercises to simplify benefit structures to the final design of the authorization and and/or reduce scheme liabilities, thereby supervision framework), they will be subject improving transaction affordability. These to the same funding requirements as other include pension increase exchange exercises, occupational pension schemes and will not enhanced transfer value (“ETV”) exercises and have the same stringent regulatory capital small pot commutation exercises. For example, requirements as insurers. Transferring schemes PIC’s £850 buy-out of the PA Pension Scheme need to be well-funded, but the required involved an ETV exercise that was underwritten funding level will be lower than that required by PIC. Market commentators expect the use of for a buy-out. member option exercises in anticipation of, or in conjunction with, bulk annuity transactions to Any authorization and supervision framework for continue in 2019. commercial consolidation vehicles is unlikely to be introduced before 2020. However, a couple On the pensions legal front, the High Court of consolidation vehicles have already been set held in October 2018 that pension schemes are up – the Pension SuperFund and Clara-Pension.

Mayer Brown 55 3 ILS and Convergence Markets

The Pension SuperFund will target transferring invested over recent years and which have schemes with liabilities of £200 million – £10 contributed to the improvements in bulk annuity billion and will act as a long-term run-off vehicle, pricing. The new requirements could therefore while Clara-Pension will target schemes with have a negative impact on pricing. liabilities up to £500 million and will aim to ultimately secure liabilities via buy-out. The first Lastly, there is continuing uncertainty transactions with these vehicles are expected surrounding the impact and outcome of Brexit. in 2019. Market commentators anticipate that, At the time of writing, the terms on which the while there will be a substantial volume of UK will leave the European Union have yet to transfers to consolidation vehicles, the relatively be agreed, and the legal impact of Brexit (i.e., niche market that they will target (well-funded what regulatory regime (if any) will apply to schemes with weak sponsoring employers), and the financial services sector) remains unclear. the fact that consolidation vehicles do not offer Likewise, the financial impact of Brexit (i.e., the same level of security as insurance policies investment returns and asset values) is uncertain. will mean that the bulk annuity market is not This uncertainty could affect capacity and seriously impacted. demand, but, equally, any market volatility could create pricing opportunities for schemes that are In March 2018, the UK government published ready to transact quickly. In general, however, a white paper setting out detailed proposals in market commentators do not expect Brexit to relation to reform of the DB pensions sector. have a significant impact on the market. This announced that the Pensions Regulator will issue a revised code of practice on DB scheme funding with some of the funding standards in the revised code being given statutory force. While the revised code will not affect the ultimate funding level that schemes are required to achieve, it could impact the way in which they calculate their liabilities and the way in which they seek to fund those liabilities – both of which could impact scheme demand for longevity risk transfer. The Pensions Regulator is expected to consult on a draft revised code during 2019.

On the insurance legal front, in December 2018 the Prudential Regulation Authority announced new requirements in relation to equity reserve mortgages (“ERMs”). These will require insurers to hold greater capital in respect of ERMs than was required previously. ERMs are one of the illiquid asset classes in which insurers have

56 Global Insurance Industry Year in Review Mayer Brown 57

Insurance Regulatory

US/NAIC | UK and Europe | Asia

Mayer Brown 59 4 Insurance Regulatory

US/NAIC prone methods and some is collected from people who have a financial incentive to slant ARTIFICIAL INTELLIGENCE AND the results toward insurance reimbursement. ITS INCREASING IMPACT ON THE The spotty, inconsistent and unreliable quality INSURANCE INDUSTRY of insurance data limits the possibility for AI to generate accurate results. The sheer volume of personal data also raises serious data privacy The use of artificial intelligence (“AI”), which may be defined as the development and cybersecurity concerns. of computer systems able to perform tasks normally associated with human intelligence, Not surprisingly, state insurance regulators, has grown exponentially across various while generally receptive to the benefits industries over the past decade. This trend that can be derived from increased use of is expected to accelerate due to declining AI by insurance companies, are sensitive to technology costs, improving AI software, and the potential risks and negative effects. For expansions in the amount of data available. example, regulators have concerns about how policyholder information will be safeguarded. The insurance industry, perhaps reflecting its In addition, the use of AI for insurance cautious conservatism, has been slower than underwriting raises questions about whether many other industries to leverage AI platforms the algorithms may generate results that would and solutions to replace previous industry be unfairly discriminatory. The results might practices. Accordingly, the insurance industry be unfairly discriminatory because the AI is is ripe for change, as the use of AI increasingly trained based on data that includes unfairly becomes the norm in other industries. Industry discriminatory decisions, because the AI might leaders are focusing on uses in marketing make decisions that in fact reduce risk but do so (making it faster and easier to buy insurance), in a way that adversely affects a protected class policy design (with premiums more focused or because the AI’s algorithms are flawed. The on risks such as driver behavior), underwriting reasons for the AI decision may be so complex analytics (using nontraditional data sets), claims or involve so many rating factors that ultimately (with more rapid settlements based on historical the decision becomes incomprehensible and data), and fraud detection (by identifying inexplicable. Other regulatory concerns raised patterns indicating fraud). by AI include:

Needless to say, the implementation of AI within • How do vicarious liability principles work the insurance industry presents challenges. when an AI platform breaks the law? From a practical perspective, insurance companies utilize a wide array of different • Can an AI act “intentionally,” “knowingly,” programs and methodologies to conduct or “recklessly”? their current operations. Insurance data is thus poorly tracked and generally collected • When is failure to supervise a machine haphazardly for reasons other than the new AI negligent; or, how would a “reasonable uses. Much of the data is collected by error- person” monitor an AI?

60 Global Insurance Industry Year in Review • What is bias or discrimination for an AI? (A In order to address these concerns, it is mathematical algorithm implemented on a likely that state insurance regulators will seek computer wouldn’t have “intent.”) enhanced oversight over the use of AI by insurance companies. In fact, in connection • How do disparate impact principles apply in with the monitoring of the impact of new the AI context? technological developments, including the increased use of AI, on the insurance • How do you monitor a computer for bias or industry, the National Association of Insurance discrimination? Commissioners (“NAIC”) has established an Innovation and Technology (EX) Task • What records does a financial institution Force, reporting to the NAIC Executive need to retain with respect to an AI system’s Committee. As AI is increasingly being used activities? within the insurance industry, that task force is expected to consider methods by which • What is an acceptable format for those state insurance regulators can regulate such records? use, which may include the drafting of model laws or regulations.1 Although such regulatory • How must regulators be able to access developments have yet to materialize, insurance them? companies would do well to stay alert to any such initiatives by insurance regulators. • How should regulators supervise AI? To what extent do they need to understand the Just as this publication was going to press, the inner workings of a system? New York Department of Financial Services (“DFS”) issued a circular letter on the use of • What replaces asking a human decision- unconventional and alternative data. See the maker for his or her reasons for a decision? next article for a closer look at that first-of-its- Does the output of AI need to be kind regulatory initiative. “explainable” and, if so, to whom? Of course, the adoption of AI by insurers would • How might regulators use AI in RegTech also involves numerous non-regulatory issues. applications? Such issues include, for example, intellectual property rights in AI systems, rights in data, • Should the consent of the insured or contracts with technology providers, technology potential insured be required for automated due diligence in acquisitions and investments, profiling? and laws governing privacy and data security.

1 Indeed, the NAIC’s interest in artificial intelligence even expands beyond its creation of the Innovation and Technology Task Force – in a charge to its the Producer Licensing (D) Task Force of the Market Regulation and Consumer Affairs (D) Committee, the NAIC requested such task force draft a white paper in 2019 on the role of chatbots and artificial intelligence in the distribution of insurance and the egulatoryr supervision of such technologies.

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NEW YORK DFS PROVIDES THE data transparency, the Circular Letter imposes specific requirements governing how insurers NATION’S FIRST DIRECTIVE ON THE must mitigate these risks. Although the financial PROPER USE OF UNCONVENTIONAL services industry often desires clear compliance AND ALTERNATIVE DATA guidance from its regulators, in this case, some may find the guidance to be too explicit and Last month, the New York DFS became the first challenging to satisfy. US regulator to impose specific, substantive requirements on the use of “unconventional The Circular Letter applies only to life insurers sources or types of external data” in financial operating in New York. However, since New services. The new requirements are set forth York is the second largest life insurance market in Insurance Circular Letter No. 1 (2019) (the in the United States, that will encompass a lot “Circular Letter”), a guidance document that of companies. Moreover, given widespread applies to insurers authorized to write life concerns over the use of large, frequently insurance in New York. unregulated data sets in financial services, the Circular Letter may pave the way for similar The Circular Letter tackles two frequently guidance from other regulators. A more detailed cited concerns regarding the use of external discussion follows. data2 in financial services – the risk of unlawful discrimination and a lack of data transparency. Background Although many government publications have raised potential concerns about these In response to reports about the use of 3 issues, the Circular Letter stands out in two unconventional sources or types of external data key respects. First, it uses unusually strong in insurance underwriting, the DFS conducted language to warn insurers about the “significant an investigation into New York life insurers’ potential negative impact” that external underwriting guidelines and practices. This data use may have on “the availability and investigation revealed that external data used affordability of life insurance for protected by New York life insurers includes geographical classes.” Furthermore, in addition to describing data (e.g., community-level mortality, addiction, concerns about unlawful discrimination and and smoking data), homeownership data, credit

2 The Circular Letter defines “external data” as “any data or information sources not directly related to the medical condition of the applicant that is used – in whole or in part – to supplement traditional medical underwriting, as a proxy for traditional medical underwriting, or to establish ‘lifestyle indicators’ that may contribute to an underwriting assessment of an applicant for life insurance coverage.” The Circular Letter uses the terms “external data,” “external data sources,” “external tools or data sources,” “external data sources, algorithms or predictive models” and “underwriting ratings or guidelines that are derived, in whole or in part, from external data sources.” For ease of reference, we refer to these collectively as “external data.”

3 See, e.g., GAO, “Agencies Should Provide Clarification on Lenders’ Use of Alternative Data” (Dec. 2018); FDIC, “On the Rise of the FinTechs—Credit Scoring using Digital Footprints” (Sept. 2018); GAO, “Additional Steps by Regulators Could Better Protect Consumers and Aid Regulatory Oversight” (March 2018); Fed. Reserve Sys., “Keeping Fintech Fair: Thinking About Fair Lending and UDAP Risks” (Dec. 2017); CFPB, “Request for Information Regarding Use of Alternative Data and Modeling Techniques in the Credit Process” (Feb. 2017); OCC, Fed. Reserve Sys., FDIC, “Community Reinvestment Act; Interagency Questions and Answers Regarding Commu- nity Reinvestment; Guidance,” 81 Fed. Reg. 48506 (July 2016); FTC, “Big Data: A Tool for Inclusion or Exclusion?” (Jan. 2016); Exec. Office of the President, “Big Data: Seizing Opportunities, Preserving Values” (May 2014).

62 Global Insurance Industry Year in Review information, education attainment, licensures, Guidance for Avoiding Unlawful and court data. The DFS’s investigation also Discrimination revealed models and algorithms that “purport to make predictions” about consumer health based To address concerns about potential unlawful on factors that are not intuitively connected to discrimination, the Circular Letter sets forth two health, including retail purchase history, social guiding principles for New York insurers that use media, internet and mobile device usage, and external data in underwriting. how the consumer appears in photographs. First, insurers using external data must The investigation prompted the DFS to flag two independently confirm that the sources of principal issues. First, the DFS is concerned such data do not “collect or utilize prohibited that insurers may lack a sufficient rationale for criteria.” The Circular Letter stresses that using these data to underwrite life insurance, insurers may not use a vendor’s claim of and that doing so may violate applicable non-discrimination or the proprietary nature 4 anti-discrimination law. Second, the DFS of a third party process to justify failing to indicated that the use of external data “is often independently determine compliance with accompanied by a lack of transparency for anti-discrimination laws. This requirement will consumers.” create practical challenges for both life insurers and external data providers. Among other Despite concerns about unlawful discrimination things, independently verifying the absence and a lack of transparency, the DFS of prohibited criteria will require insurers to acknowledges the potential benefits of using evaluate (or retain third party service providers external data for underwriting insurance. The to evaluate) very large volumes of data. This Circular Letter notes that innovation and will likely involve significant time and expense. technology can help improve access to financial Furthermore, to facilitate compliance with the services, and that in the insurance industry, Circular Letter, external data providers will using external data can simplify and speed up need to give third parties access to proprietary the underwriting process, and may help insurers information. It’s possible that some companies price life insurance more accurately. In light of will opt out of doing business in New York to these potential benefits, the Circular Letter does avoid having to make their trade secrets so not prohibit the use of external data in insurance widely available. underwriting, but rather advises insurers on how they should manage some of the related risks.

4 The Circular Letter states that the New York Insurance Law, Executive Law, General Business Law, as well as the “federal Civil Rights Act” prohibit using “race, color, creed, national origin, status as a victim of domestic violence, past lawful travel in any manner,” sexual orientation, or inclusion in any other protected class in underwriting. Under New York Insurance Law, insurers also cannot make coverage decisions solely on the basis of disability, impairment or disease, except as permitted by law or regulation. Even when permitted, such decisions must also be based on sound actuarial principles or actual or reasonably anticipated experience.

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Second, insurers should not use external data a single or limited number of unconventional unless they can establish that it is not “unfairly criteria also raise significant concerns...” discriminatory” in violation of applicable law. To This statement suggests that life insurance do this, the Circular Letter says that an insurer underwriting based on a small number of must consider whether: unusual or counterintuitive factors is likely to attract scrutiny. • the use of the external data is supported by generally accepted actuarial principles, or Transparency actual or reasonably anticipated experience; and The Circular Letter explains that the New York Insurance Law requires insurers to notify • there is a valid explanation or rationale for consumers of their right to receive the “specific how and why the external data differentiates reason or reasons” for a declination, rate mortality risk. differential, or other adverse underwriting decision6. According to the Circular Letter, if In other words, insurers using external data an insurer uses external data to underwrite should be confident that the use of the data insurance, the reason(s) provided to the is demonstrably predictive of mortality risk, consumer for any adverse action “must include and that they can explain how and why this is details about all information” underlying the the case. The Circular Letter emphasizes that decision, including the specific source of the the second part of the inquiry “is particularly information.7 Satisfying this requirement may important where there is no demonstrable present a significant challenge when an insurer causal link between the [external data] and underwrites using complex algorithms and large increased mortality,” and the use of the volumes of external data. external data has a disparate impact on protected classes. This appears to mean that Finally, the Circular Letter states that an insurer when external data is not intuitively related to “may not rely on the proprietary nature of increased mortality risk,5 and disproportionately a third-party vendor’s algorithmic processes disfavors protected classes, the insurer needs to justify the lack of specificity related to an to be able to explain why the use of the data is adverse underwriting action.” In other words, as justified. is the case with an insurer’s obligation to ensure that external data does not include prohibited The Circular Letter also states that external data criteria, the DFS’s position is that insurers are that “purport to predict health status based on directly liable for failures to adequately disclose

5 For instance, it may not immediately clear how a consumer’s retail purchases or social media use relates to the consumer’s expected mortality.

6 The Circular Letter states that this would include the “inability of an applicant to use an expedited, accelerated, or algorithmic underwriting process in lieu of a traditional medical underwriting.”

7 The Circular Letter also says that failure to disclose the “material elements” of an accelerated or algorithmic underwriting process and the related external data may be an unfair trade practice under Article 24 of the New York Insurance Law.

64 Global Insurance Industry Year in Review the reasons for adverse actions, even when the effort to bring the NAIC models into line the reasons are based on third party data or with the Covered Agreement is becoming rather analytics. time sensitive.

Conclusion Background of the Covered Agreement

The DFS’s two focal points – unlawful In contrast to direct insurance, where an insurer discrimination and transparency – are familiar generally needs to be licensed in a state in themes for institutions that use external data order to do business in the state, a reinsurer and artificial intelligence in consumer-facing does not need to be licensed in a state in decision making. However, the Circular Letter order to provide reinsurance to insurers in the presents the most pointed guidance issued to state. However, if the reinsurer is not licensed date for addressing these issues. Compliance in the state, then it historically has needed to questions and practical challenges are sure collateralize its reinsurance obligations in order to arise as institutions seek to implement the for the insurer purchasing the reinsurance (called Circular Letter’s requirements. the “ceding insurer”) to take credit for the reinsurance on its balance sheet. As reinsurers MAJOR NEW DEVELOPMENTS RELATED are providing backing to the insurers that are directly protecting American policyholders, TO CREDIT FOR REINSURANCE requiring them to maintain collateral in the US is intended to ensure that claims-paying resources One of the most important regulatory are available and accessible to US ceding developments of 2018 was the ongoing effort insurers and regulators should it be needed, by the NAIC to amend its model law and particularly in the wake of a natural disaster. regulation governing credit for reinsurance in order to facilitate the implementation of the US- In 2011, the NAIC passed amendments to its EU Covered Agreement at the state level. Credit for Reinsurance Model Law and Credit for Reinsurance Model Regulation (collectively, The US-EU Covered Agreement, which was the “NAIC Models”). In states that have signed on September 22, 2017 by the US amended their laws and regulations to adopt Department of the Treasury, the Office of the those amendments, non-US reinsurers that have US Trade Representative and the EU, gives completed a prescribed certification process US states five years to eliminate reinsurance can post significantly less than 100% collateral collateral requirements for EU reinsurers that to secure their US reinsurance obligations. satisfy certain stipulated qualifications – or risk To date, 48 states have passed legislation to federal preemption of state laws. Because implement the revised NAIC Models, which will changes to the NAIC model law and regulation become a requirement for NAIC accreditation as will need to be adopted by state legislatures of January 1, 2019.8 and regulators before they can go into effect,

8 In 2016, the NAIC adopted changes to the model law with respect to captive reinsurance transactions, specifically with respect to XXX/AXXX life reinsurance transactions. At this time, 22 states have taken action to adopt the 2016 revisions to the model law in some form.

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Under the revised NAIC Models, individual certain stipulated qualifications within five reinsurers are certified based on criteria years or else the preemption provisions of that include, but are not limited to, financial Dodd-Frank will potentially come into effect. In strength, timely claims, payment history and the exchange, the EU will not impose local presence requirement that a reinsurer be domiciled and requirements on US firms operating in the EU, licensed in a “qualified jurisdiction.” The NAIC and effectively must defer to US group capital has established a comprehensive process to regulation for US entities of EU-based firms. evaluate jurisdictions’ oversight of reinsurers to designate five “qualified jurisdictions” for this NAIC Response to the Covered Agreement purpose. Currently, Bermuda, France, Germany, Japan, Ireland, Switzerland, and the UK, among Following the signing of the Covered others, have been so designated. The NAIC Agreement, the NAIC’s Reinsurance (E) Task has also established a peer review system to Force held a public hearing on February oversee the certification of non-US reinsurers 20, 2018 to address issues relating to the by states, which enables non-US reinsurers that implementation of these reinsurance collateral become certified in one state to “passport” that reform provisions. Among the issues raised certification throughout the US. were how implementation of the Covered Agreement would interface with the certified The Covered Agreement reinsurer regime that the NAIC had already put in place and whether reinsurers from “qualified The Dodd-Frank Wall Street Reform and jurisdictions” outside the EU would be granted Consumer Protection Act of 2010 (“Dodd- benefits similar to those in the Covered Frank”) established the legal framework for Agreement. In the months following the public the United States to enter into bilateral or hearing, the Task Force drafted proposed multilateral “covered agreements” with foreign amendments to the NAIC Models to address jurisdictions that addresses regulatory measures both of these issues, among others. The with respect to the business of insurance or proposed amendments have received numerous reinsurance. If state laws are inconsistent with a comments from regulators and the industry and covered agreement and provide less favorable have undergone a number of revisions. treatment to non-US insurers or reinsurers than US companies, then the covered agreement Comment letters on the proposed amendments will preempt state law. A covered agreement reflected a number of issues raised by interested can serve as a basis for preemption of state parties including: (i) concerns about the degree law only if the agreement relates to measures of discretion that individual state insurance substantially equivalent to the protections regulators would have (including the ability afforded consumers under state law. to determine whether EU jurisdictions are in compliance with the Covered Agreement and As noted above, the Covered Agreement that to request additional information from EU was signed on September 22, 2017 requires reinsurers that is not required under the Covered US states to eliminate reinsurance collateral Agreement), (ii) concerns about the potential requirements for EU reinsurers that satisfy for disparate treatment of non-EU jurisdictions

66 Global Insurance Industry Year in Review and (iii) a desire for greater conformity of the Current Status of the Proposed language of the proposed amendments to the Amendments language in the Covered Agreement. The proposed amendments generally received Key Elements of the Proposed a positive response at the NAIC Fall National Amendments to the NAIC Models Meeting held in November 2018 and, after some further revisions presented by the The proposed amendments, in their current Reinsurance (E) Task Force, were adopted on form, would allow a US ceding insurer to take November 17, 2018 by the Task Force and its 100% credit for reinsurance for transactions with parent committee, the Financial Condition (E) non-US reinsurers that meet all of the following Committee, despite objections from the EU requirements: asserting that some provisions were inconsistent with the Covered Agreement. The proposed 1. The assuming reinsurer has its head office, amendments were expected to receive final or is domiciled, in a “reciprocal jurisdiction.” approval from the NAIC Executive Committee A “reciprocal jurisdiction” includes: (i) any and Plenary on December 19, 2018, but were non-US jurisdiction that has entered into a pulled from the agenda to allow the NAIC Task treaty or international agreement with the Force to address concerns expressed by the US US regarding credit for reinsurance; and Treasury and Trade Representative about certain (ii) any “qualified jurisdiction” (for certified provisions of the proposed amendments. Those reinsurer purposes) that is not a party to concerns related to potential inconsistencies such an agreement with the US and that between the proposed amendments and the satisfies requirements comparable to those Covered Agreement that have been noted imposed by the Covered Agreement with by the EU and other commenters, including respect to the treatment of US reinsurers provisions that grant state insurance regulators operating in such jurisdiction. discretion that could result in reinsurance collateral requirements that are inconsistent 2. The assuming reinsurer maintains minimum with the Covered Agreement or with similar capital and surplus (or its equivalent) of not agreements that might be negotiated in the less than $250 million. future.

3. The assuming reinsurer maintains a prescribed minimum solvency or capital ratio.

4. The assuming reinsurer agrees to be subject to US jurisdiction for certain limited purposes and to make certain informational filings with state insurance regulators.

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The latest development is that on February 9, • Service of process. Whether any additional 2019, the four officers of the NAIC, plus the revisions are necessary requiring assuming Chair of the NAIC’s International Insurance reinsurers to submit the confirmation of Relations (G) Committee and Reinsurance consent to service of process to each state (E) Task Force, wrote a letter to the Financial in which the reinsurer intends to operate. Condition (E) Committee, in which they called upon the Reinsurance (E) Task Force to draft • Other potential inconsistencies. Whether revisions to the proposed amendments to any additional technical revisions are address the following issues: necessary to make the amendments to the NAIC Models more consistent with the • Recognition of reciprocal jurisdictions. Covered Agreement. Whether any additional revisions are necessary regarding a state insurance • Additional requirements for qualified commissioner’s discretion to make a jurisdictions. Whether any additional determination as to whether an EU revisions are necessary and appropriate with jurisdiction should be recognized as a respect to requirements that are applicable reciprocal jurisdiction. to qualified jurisdictions but are not applicable to EU jurisdictions. • Determination of compliance with the Covered Agreement. Whether any • Recognition of US state regulatory system additional revisions are necessary regarding by qualified jurisdictions. Whether any a state insurance commissioner’s discretion additional revisions are necessary with to determine whether each EU member respect to the requirement for qualified state is in compliance with the Covered jurisdictions to recognize aspects of the Agreement. US state regulatory system in order to be considered a reciprocal jurisdiction. • Commissioner discretion to impose additional requirements. Whether any • Recognition of NAIC accredited jurisdictions additional revisions are necessary regarding as reciprocal jurisdictions. Whether US any additional requirements being imposed jurisdictions that meet the requirements on EU reinsurers. for accreditation under the NAIC Financial Standards and Accreditation Program • Effective date. Whether any additional should be recognized as reciprocal revisions are necessary regarding the jurisdictions. effective date provision governing which reinsurance agreements and policies will be Furthermore, the writers of the letter urged covered by the amendments to the NAIC the Financial Condition (E) Committee and Models. the Reinsurance (E) Task Force to resolve the above issues and release new drafts of the amendments to the NAIC Models by mid-March in anticipation of a full discussion at the NAIC’s

68 Global Insurance Industry Year in Review Spring National Meeting in April, with a goal of Agreement will apply to the US-UK relationship the amendments being adopted by the NAIC even if the UK ceases to be a member of the Executive Committee and Plenary by early May. EU. Given the rapidly approaching date for Brexit, and the required 90-day Congressional Once adopted in their final form, the proposed review period before a final covered agreement amendments will modify the NAIC Models to can be effective in the US, the Federal Insurance comport with the US-EU Covered Agreement. Office is aiming to have a final negotiated That means that states that have already agreement by mid-December of this year. While adopted the most current versions of the NAIC the US-UK Covered Agreement is unlikely to Models could simply adopt those revisions in trigger the need for any additional revisions to order to implement the Covered Agreement. the proposed amendments to the NAIC Models, the entry into a second agreement similar to the However, while the majority of US states have US-EU Covered Agreement will likely incentivize adopted versions of the NAIC Models, a small the NAIC to expedite its efforts to finalize the number of states have not adopted them, some proposed amendments. states have adopted outdated versions of the NAIC Models and some states have made or are CORPORATE GOVERNANCE GAINING in the process of making their own modifications to the versions of the NAIC Models they have GROUND: AN UPDATE ON THE NAIC adopted. It is unclear whether the prospect of CORPORATE GOVERNANCE ANNUAL federal preemption will be a sufficient incentive DISCLOSURE ACT for states to adopt the revised versions of the NAIC Models in their totality, or to take other The past ten years have resulted in numerous actions to bring their laws into conformity with changes to the corporate governance the US-EU Covered Agreement. And given requirements for insurance companies and, the time required for new legislation to be as appropriate, their parent companies and introduced, deliberated on and passed by state affiliates. In response to the 2008 financial legislatures, there is realistically not a lot of time crisis and increased federal scrutiny of the left for the states to act. insurance industry, the NAIC undertook a comprehensive comparative analysis of the A US-UK Covered Agreement Now, Too! existing statutory and regulatory framework relating to corporate governance among US In a related development, it was announced on state insurance departments, international December 19, 2018, that the US Department supervisors, other US functional regulators of the Treasury, the Office of the US Trade and the insurance industry itself. The results Representative and the UK had signed their own of that study led the NAIC to the conclusion covered agreement, which effectively replicates that insurance regulators generally needed to the terms of the US-EU Covered Agreement for collect additional information from insurance the UK. The obvious motivation for the US- companies in order to more effectively UK Covered Agreement is to ensure that the assess their corporate governance practices. arrangements embodied in the US-EU Covered Accordingly, in November 2014, the NAIC

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adopted the Corporate Governance Annual addition, regulators have the ability to request Disclosure Model Act (the “CGAD Model Act”) additional information as deemed material and and Corporate Governance Annual Disclosure necessary to provide a clear understanding of Model Regulation (the “CGAD Model a company’s or group’s corporate governance Regulation” and, together with the CGAD policies, reporting and information systems and Model Act, “CGAD”). controls implementing those policies.

CGAD provides insurance regulators with the Unlike other NAIC model laws and regulations, ability to receive information necessary to review CGAD does not provide for exemptions or an insurance company’s governance structure thresholds based upon size or type of entity. and practices and to identify potential issues Given the variety in organizational structures with respect to such practices. CGAD requires among US insurance companies, such entities an insurance company (or the affiliated group of are afforded latitude in determining the which it is a member) to provide a confidential appropriate format for the filing and the disclosure of its corporate governance level of the specific company responsible practices to its lead state regulator and/or for submitting such reports (for example, domestic regulator by June 1 of each year. whether it is more appropriate for an ultimate Importantly, CGAD does not mandate specific controlling person to submit the report or governance standards – rather, it requires an intermediate holding company or even insurance companies to report on their existing an individual insurance company). The governance practices. determination of the appropriate reporting entity is based upon where: (i) risk appetite is An insurance company or group has discretion determined; (ii) the earnings, capital liquidity, regarding the content of its CGAD responses, operations and reputation of the insurance so long as its CGAD contains the material company are overseen; or (iii) liability for failures information necessary to permit regulators in governance will be placed. The decision of to gain an understanding of its corporate which is the correct reporting entity within an governance structure, policies and practices. insurance holding company structure, while At a minimum, CGAD requires information left to the discretion of such entities, requires on, among other subjects: (i) the insurance a careful analysis and any changes to such company’s corporate governance and structure; reporting practices would require an explanation (ii) the policies and practices of the insurance to be provided along with the requisite company’s board of directors and significant corporate governance report. committees; (iii) the policies and practices directing senior management; (iv) descriptions On October 24, 2018, Pennsylvania became of board committees and senior management the latest (and twenty-sixth) state to adopt the personnel; and (v) and the processes by which CGAD Model Act, as of the date of this report. the board of directors, its committees and At this time, the CGAD Model Regulation has senior management ensure an appropriate level been adopted by eighteen states. However, of oversight to the critical risk areas impacting the NAIC has made adoption of the CGAD the insurance company’s business activities. In Model Act and the CGAD Model Regulation

70 Global Insurance Industry Year in Review an “accreditation standard” with an effective connection with the Fiduciary Rule, the DOL date of January 1, 2020. Accordingly, a wave of also published two new administrative class adoptions of CGAD by US jurisdictions over the exemptions from the prohibited transaction next year is expected, in order to comply with provisions of ERISA and the Internal Revenue this required effective date. Code – the Best-Interest Contract Exemption and the Principal Transactions Exemption – as Generally speaking, the costs of complying well as amendments to Prohibited Transaction with the requirements of CGAD are likely to Exemption (PTE) 84-24, commonly relied on for be limited, as many insurance companies sales of insurance contracts to ERISA plans. already summarize and describe their corporate governance practices to various stakeholders Even as the insurance industry braced itself on a regular basis. Further, the CGAD contains for major changes as a result of the Fiduciary strong confidentiality protections to safeguard Rule, the DOL itself shifted gears as a result of sensitive information which may be submitted new leadership at the DOL under the Trump with the report. Accordingly, the widespread Administration. That shift was noted by the adoption of CGAD should be viewed as a low- courts and on March 15, 2018, the United States cost measure that will improve communications Court of Appeals for the Fifth Circuit struck between insurance companies and their down the Fiduciary Rule in a 2 to 1 decision, regulators, by allowing tailored, confidential holding that the Fiduciary Rule had been assessments that internal oversight mechanisms invalidly promulgated. The US Department are in place and effective for those companies. of Justice, on behalf of the DOL, declined to appeal the decision. Accordingly, on June 21, NEW YORK DFS FINALIZES “BEST 2018, the Fifth Circuit issued its order officially vacating the Fiduciary Rule in its entirety. INTEREST” REGULATION AFTER DEMISE OF THE DOL FIDUCIARY RULE – AND SEC However, as we also described in our 2017 ALSO WEIGHS IN Year in Review, the New York DFS was already working to adopt its own “best interest” standard for sales of life insurance and annuity As discussed in our 2017 Year in Review, in April products. And on July 17, 2018, New York DFS 2016, the US Department of Labor (“DOL”) Superintendent Maria T. Vullo promulgated the published a final regulation (the Fiduciary“ new “best interest” regulation as a replacement Rule”) defining who is a “fiduciary” of an for New York’s preexisting annuity suitability employee benefit plan under section 3(21) regulation (Insurance Regulation 187, Part (A)(ii) of the Employee Retirement Income 224 of Title 11 of the New York Compilation Security Act of 1974 (“ERISA”) as a result of of Codes, Rules and Regulations). Titled giving investment advice. The new regulation “Suitability and Best Interests in Life Insurance treated persons who provide investment and Annuity Transactions,” the new regulation advice or recommendations for compensation establishes a “best interest” standard for all with respect to assets of a plan or IRA as sales of life insurance and annuity products. A fiduciaries in a much wider array of relationships transaction is considered in the best interest than was true under the 1975 regulation. In

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of a consumer when it is in furtherance of a other party” and specifies that producers may consumer’s needs and objectives and only the not state or imply that the recommendation to interests of the consumer are considered in purchase an annuity or a life insurance product making the recommendation. The regulation is part of financial planning, financial advice, also requires insurance companies to establish investment management or related services standards and procedures to supervise unless the producer has a specific certification or recommendations by agents and brokers to professional designation in that area. consumers with respect to life insurance policies and annuity contracts issued in New York. Although it would not apply to insurance and annuity products other than variable products Since it was first proposed in December (which are regulated as securities in addition 2017 (and as confirmed in the press release to being regulated as insurance products), accompanying the adoption of the final the US Securities and Exchange Commission regulation) the New York “best interest” (“SEC”) proposed a package of rulemakings regulation has been viewed as a way to fill the and interpretations on April 18, 2018 that vacuum created by the delay and demise of are designed to enhance the quality and the Fiduciary Rule. Unlike the Fiduciary Rule, transparency of investors’ relationships with however, the New York regulation applies investment advisers and broker-dealers. Under to recommendations outside of retirement proposed Regulation Best Interest, a broker- accounts but not to those to buy or sell mutual dealer would be required to act in the best funds or other securities (except to the extent a interest of a retail customer when making a recommendation would be tied to the purchase recommendation of any securities transaction of annuity or life insurance product). or investment strategy involving securities to a retail customer. Broker-dealers are As described in our 2017 Year in Review, in currently subject to suitability standards when extending its scope to include sales of life recommending investment products to clients. insurance as well as annuity products, the New York regulation goes farther than the The SEC also proposed an interpretation to NAIC Annuity Suitability (A) Working Group’s reaffirm and, in some cases, clarify the SEC’s December 2017 draft revision to the NAIC’s views of the fiduciary duty that investment Suitability in Annuity Transactions Model advisers owe to their clients. As a fiduciary, an Regulation (the “Draft NAIC Model”). investment adviser must act in the best interest Moreover, the New York regulation and Draft of its client. This fiduciary obligation, which NAIC Model define “best interest” differently. includes an affirmative duty of utmost good The Draft NAIC Model defines “best interest” faith and full and fair disclosure of all material as “acting with reasonable diligence, care, skill facts, is established under federal law, and the and prudence in a manner that puts the interest SEC believes that an adviser’s fiduciary duty of the consumer first and foremost.” The New serves as a key component to the SEC’s investor York regulation also requires the producer or protection efforts. insurer to act “without regard to the financial or other interests of the producer, insurer, or any

72 Global Insurance Industry Year in Review The SEC also proposed that broker-dealers important challenges facing insurance industry and investment advisers prepare and distribute participants today. a new short-form disclosure document – a customer or client relationship summary (Form As discussed in our 2017 Year in Review, due to CRS). Form CRS would provide retail investors the unique regulatory framework that governs with summarized information about the nature the insurance industry, utilization of innovative of their relationship with their investment technology, particularly where use of such professional, and would supplement other more technology could potentially present a security detailed disclosures (such as the investment risk for consumer information, can often run adviser’s Form ADV). Comments on the above into distinct regulatory hurdles that have the SEC proposals were due on August 7, 2018, potential to ultimately hinder the innovation but no further action has been taken by the process. Accordingly, as the past five years SEC as yet. have seen a growing trend of increasingly sophisticated cyberattacks which have, in NAIC INSURANCE DATA SECURITY many ways, outpaced current data security technology, regulatory authorities are beginning MODEL LAW PROGRESSES SLOWLY to turn to compliance regimes to combat these THROUGH STATE LEGISLATURES threats.

The past five years have seen a massive In an effort to address some of the concerns acceleration in the amounts of data being raised around both increasing cybersecurity generated, processed and stored in virtually risks and use of new technology, two major every industry, including insurance. As with events occurred during 2017. The New York most industries, insurance data increasingly DFS adopted a comprehensive cybersecurity resides in flexible networks, utilizing, for regulation, and the NAIC adopted an Insurance example, virtual machine storage, which allows Data Security Model Law. Both the New York for increased accessibility by support staff DFS cybersecurity regulation and the NAIC and consumers. While doubtlessly providing model law build on existing data privacy and benefits for insurance companies and producers consumer breach notification obligations by on an operational level, such flexibility comes requiring insurance licensees to comply with at a price, as such practices also expose data to detailed requirements regarding maintaining an increased security threats. information security program and responding to and giving notification of cybersecurity events. The consequences of data breaches are particularly pronounced in the insurance Thus far, US states have been slow to enact the industry, where insurers and insurance producers Insurance Data Security Model Law. On May 3, are custodians of highly sensitive information, 2018, South Carolina became the first state to including personal financial and health enact the NAIC model law. Ohio followed suit information obtained as part of their services on December 19, 2018 and Michigan did so to consumers. It is no exaggeration to on December 31, 2018. In other words, more conclude that developing a strategy to counter than a year after the adoption of the model law, the threat of cyberattacks is one of the most only three states have enacted it. Bills have also

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been introduced in the Mississippi, Nevada, UPDATE ON INSURANCE BUSINESS New Hampshire and Rhode Island legislatures TRANSFER AND DIVISION LEGISLATION to adopt versions of the model law, and more are likely to follow. Importantly, the model law IN THE UNITED STATES has been well received at the federal level, with the Department of the Treasury, in its October 2018 saw a significant upswing in the adoption 2017 Report on Asset Management and of legislation by US jurisdictions to allow for the Insurance, strongly endorsing the model law and voluntary restructuring of solvent insurers. Since recommending that Congress consider adopting 2000, the UK Financial Services and Markets Act federal legislation that would preempt state law (“FSMA”) has provided a statutory mechanism if the model law is not adopted within five years. permitting certain voluntary restructuring Accordingly, one can expect that cybersecurity activities by solvent insurers, including allowing will remain a crucial topic for the insurance such insurers to transfer a portfolio of insurance sector throughout 2019. (See Technology- business to another entity. Governed by Cybersecurity & Data Privacy chapter on sections 104-116 of Part VII of FSMA, such page 106.) transfers (commonly referred to as “Part VII Transfers”) allow an insurer (or reinsurer) to Generally speaking, US state insurance transfer blocks of insurance business from regulators seek to strike a balance between one legal entity to another, subject to court fostering an environment that encourages approval. This procedure has been used in a innovation while simultaneously protecting variety of contexts, including to give effect to the interests of policyholders – especially their group reorganizations. personal data. Given the rapid evolution of insurtech innovations, the insurance industry However, while popular in the UK for nearly is absorbing, state regulators are facing a two decades, the use of an insurance business challenge in analyzing these new technologies transfer by a solvent insurer has historically and regulating the uses of those technologies. been resisted in the United States. Indeed, with To address this concern, the State Ahead certain exceptions, the concept has only begun strategic initiative of the NAIC (see separate to gain ground in the US insurance sector in the article, “State Ahead – the NAIC’s Continuing past five years. In the United States, legislation Modernization Program: 2018 Initiatives Focus in this area has taken two related but distinct on Data Collection and Data Management” on forms: page 86), plans to provide resources for state insurance regulators to evaluate developments 1. Insurance business transfer legislation, which in technologies impacting the insurance is more closely related to Part VII Transfers industry. and allows insurers to transfer blocks of insurance business to another legal entity; and

74 Global Insurance Industry Year in Review 2. Insurance division legislation, which allows Rhode Island for an insurer to divide itself into two or more companies, with assets and liabilities Rhode Island was the first US state to (including insurance policies) being divided adopt legislation allowing for the voluntary among the resulting companies. restructuring of solvent insurers, as a result of its enactment of Chapter 14.5 of the Rhode Island There has been considerable variation in how Insurance Code in 2002. The implementing legislation in this area has been adopted. While regulation (called “Regulation 68”) was issued approval by the insurance regulatory authority in by the Rhode Island Department of Business the insurer’s domiciliary jurisdiction is invariably Regulation (the “Rhode Island Department”) required, different approaches have been taken in 2004. The statute and Regulation 68 as to whether policyholder or court approval is originally provided a process for extinguishing also required. the outstanding liabilities of a commercial property and casualty insurer in runoff pursuant The NAIC has begun to consider how to to a commutation plan that was approved evaluate and monitor the growing adoption by the Rhode Island Department, a requisite of this type of legislation. At its Fall National percentage of creditors (including policyholders) Meeting in 2018, the NAIC’s Financial Condition and the Superior Court of Providence County. (E) Committee initiated the process to form This process was patterned on the “solvent a new working group to specifically review scheme of arrangement” permitted under adoption of this type of legislation by US states. UK law and the laws of other countries that This is a timely move by the committee, given follow English law. To date, only one such that a number of states enacted legislation with commutation plan has been implemented in respect to insurance business transfer statutes Rhode Island, and that was completed in 2011 or insurance division statutes in 2018. While (after the Rhode Island Superior Court ruled proposed insurance division statutes were against the claim by several creditors that the vetoed by the governor in two states (Georgia Rhode Island statute was unconstitutional). and Iowa), four states enacted or amended insurance business transfer statutes or insurance In 2015, the Rhode Island Department division statutes during the past year. We amended Regulation 68 to add procedures discuss each of those initiatives below. for insurance business transfer plans – the complete transfer of closed blocks of property Insurance Business Transfer Legislation and casualty business from any commercial in 2018 insurers (regardless of domicile) to a Rhode Island domiciled assuming insurer. In order to consummate such a transfer, the transferring Two states that took significant steps with insurer must submit a plan outlining the transfer respect to insurance business transfer legislation to the Rhode Island Department for approval. in 2018 were Rhode Island, which amended its Additionally, this plan must be approved by longstanding insurance business transfer statute the domiciliary regulator of the transferring and regulation, and Oklahoma, which enacted insurer. The Rhode Island Department may only its own insurance business transfer legislation. approve such plan if it determines that the plan

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would not have a material adverse impact on insurer. While the domiciliary regulator of the policyholders, reinsureds or claimants. Following transferring insurer needs to approve the plan the receipt of the required approvals, the Rhode prepared by the transferring insurer, approvals Island Department will allow the assuming are not required from the insurance regulatory company to apply to the Superior Court of authorities of each state where a transferred Providence County for approval of the plan. No policy has been issued. To date, no insurance policyholder approvals or opt-out provisions are business transfer has taken place in Rhode included in the Rhode Island insurance business Island. transfer process, although policyholders must receive advance notice and the Superior Court Oklahoma of Providence County must hold a public hearing with respect to approval of the plan. Effective as of November 1, 2018, Oklahoma’s Insurance Business Transfer Act represents a In 2018, Rhode Island revisited its insurance more broadly applicable insurance business business transfer regime, in light of the fact that transfer regime than the process currently it had not been utilized since it was established offered by Rhode Island. Under the provisions in 2015. The concern was expressed that the of the Oklahoma statute, any US insurer provisions added to Regulation 68 in 2015 (whether domiciled in Oklahoma or not) or relating to insurance business transfers were any non-US insurer may transfer and novate a not sufficiently well-grounded in the statute block of business to an Oklahoma-domiciled, for insurers to feel comfortable relying on assuming insurer. The Oklahoma statute applies them. Accordingly, on July 2, 2018, the Rhode to both active and closed blocks of business, Island legislature amended the statute to applies to both insurers and reinsurers and clearly distinguish a commutation plan (where covers property, casualty, life, health and any liabilities of the insurer are extinguished – and other line of insurance that the Oklahoma policyholders have a right to vote on the Insurance Commissioner finds to be suitable. plan) from an insurance business transfer plan (where the liabilities are transferred to a new Similar to the requirements in Rhode Island, or existing Rhode Island-domiciled insurer a transferring insurer must submit a plan – and policyholders do not have a right to outlining the transfer to the Oklahoma Insurance vote on the plan) and to expressly authorize Department for approval. In addition, the plan the Rhode Island Department regulations must receive either approval or non-objection governing insurance business transfers. With from the domiciliary regulator of the transferring those statutory revisions, a significant concern insurer. The Oklahoma Insurance Department regarding the Rhode Island insurance business may only approve such plan if it determines transfer process has been addressed. that the plan would not have a material adverse impact on policyholders or claimants, and a The Rhode Island insurance business transfer component of its review is required to include process assumes an authority on the part of the an opinion report on the transfer by a qualified Rhode Island statutory regime to bind non- independent expert. As with Rhode Island, no Rhode Island policyholders of the transferring affirmative policyholder consent for the plan

76 Global Insurance Industry Year in Review is required, nor is there a policyholder opt-out Illinois provision, though notice must be provided to the policyholders.9 Following the receipt of the The Illinois Domestic Stock Company Division required approvals, the Oklahoma Insurance Law, which was enacted on November 27, 2018 Department will grant permission for the and became effective on January 1, 2019, transferring insurer to apply to the District Court allows an Illinois-domiciled insurer to divide of Oklahoma County for approval of the plan, itself into two or more companies, with which then must hold a public hearing with assets and liabilities, including insurance respect to the plan. policies, being divided among the resulting companies pursuant to a plan of division that Similar to the Rhode Island statute, the has been approved by the Illinois Department Oklahoma statute provides broad authority to of Insurance. The Illinois statute applies to the Oklahoma Insurance Department, including both active and closed blocks of business as with respect to non-US insurers. As a brand-new well as to all lines of insurance. The law does law, the Oklahoma insurance business transfer not include a policyholder opt-out provision, process has yet to be utilized to date. but approval of the plan of division by the shareholders is required (with the same voting Insurance Division Legislation in 2018 requirements as would be required to approve a plan of merger). In addition, although approval of the Illinois Department of Insurance In the latter half of 2018, Illinois and Michigan is required, it need not take into account any enacted legislation permitting divisions of review of the division by an independent domestic insurers. Illinois and Michigan join expert. Furthermore, unlike the Rhode Island Arizona, Connecticut and Pennsylvania, which and Oklahoma statutes discussed above, no already had division statutes in place. Although court approval is required as part of the Illinois division statutes were passed by the legislatures division process. Though not required, the in Georgia and Iowa10 in 2018, in both states Illinois Department of Insurance may hold a the proposed legislation was vetoed by the public hearing on the division if it deems such a governor. hearing to be in the public interest.11

9 In addition to policyholders, certain affected state regulators and guaranty associations must receive notice of the insurance business transfer under the Oklahoma statute.

10 We note that, in Iowa, the proposed division statute was vetoed as a result of unrelated legislation which was added to the proposed statute in the final stages of its passage. Accordingly, we would expect that a new version of the proposed division statute, removing the problematic additional legislation, will likely be reintroduced in this legislative session.

11 Additionally, under the terms of the Illinois statute, the Illinois domestic insurer which is requesting approval of the division may also request a public hearing be held.

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Michigan NAIC Developments

Chapter 55 of the Michigan Insurance Code The emergence of insurance business transfer of 1956, pertaining to the division of domestic mechanisms and division mechanisms in stock insurers, became effective on December various states has raised concerns about 20, 2018. In many ways, the Michigan statute lack of uniformity among the states and has is similar to the Illinois statute. The Michigan attracted the attention of the NAIC Financial statute allows a Michigan-domiciled insurer Condition (E) Committee. On February 19, to divide itself in an identical manner to that 2019, that committee established a new working permitted by the Illinois statute pursuant to a group and subgroup to address both types of plan of division that has been approved by the restructuring mechanisms. Michigan Department of Insurance and Financial Services (the “Michigan Department”). The The new Restructuring Mechanisms (E) Working Michigan statute also resembles the Illinois Group has been charged with evaluating and statute in the following respects: (i) applicability preparing a “white paper” that: to both active and closed blocks of business as well as to all lines of insurance; (ii) requirement • addresses the perceived need for for the plan of division to be approved by a restructuring statutes and the issues those shareholder vote, (iii) lack of a policyholder opt- statutes are designed to remedy, as well out provision; (iv) no requirement for review by as alternatives that insurers are currently an independent expert; and (v) no requirement employing to achieve similar results; for court approval. • summarizes the existing state restructuring The Michigan statute differs from the Illinois statutes; and statute in two important respects. First, if the one of the companies resulting from a division • addresses the legal issues posed by a court is to be sold to an acquirer, then the Michigan order (or approval by a state insurance Department cannot approve the proposed department) in one state affecting the division until the potential acquirer has received policyholders of other states. the required approvals for that acquisition. In addition, the approval standards in Michigan The new Restructuring Mechanisms (E) for a plan of division include certain standards Subgroup has been charged with: with respect to such a potential acquisition that are not found in the Illinois statute. Second, • considering the development of financial while the Illinois statute allows a public hearing surveillance tools that are specifically with respect to a proposed division to be held designed for companies in runoff; at the discretion of the Illinois Department of Insurance, the Michigan statute requires a public • considering the need to make changes to hearing to be held by the Michigan Department the NAIC’s risk-based capital (RBC) formula prior to the approval of a proposed division. to better assess the minimum surplus requirements for companies in runoff; and

78 Global Insurance Industry Year in Review • reviewing the various restructuring wide supervision. The IAIS began developing mechanisms in order to develop minimum ComFrame in July 2010, while still developing standards of review, minimum capital the ICPs, in recognition of the specific need requirements, specific actuarial guidance for an internationally coherent framework for in determining initial reserving levels, the supervision of IAIGs. With IAIGs exerting protected cell reporting requirements and growing influence on the global insurance proposed accreditation standards. marketplace, ComFrame is intended to provide insights on how IAIGs function as well as RECENT DEVELOPMENTS IN generally improve efforts at group supervision by insurance regulatory authorities. INTERNATIONAL GROUP SUPERVISION AND GROUP CAPITAL REQUIREMENTS What is an Internationally Active Insurance Group? As with many industries, the insurance sector has become increasingly more complex An IAIG is defined as an insurance group that and internationally connected over the past meets two criteria: (i) the group’s premiums decade. More than ever, international insurance are written in three or more jurisdictions and supervisory authorities are recognizing a need gross written premiums outside of the home to facilitate the exchange of information in jurisdiction are at least 10% of the group’s total order to efficiently perform regulatory functions. gross written premiums; and (ii) total assets of The International Association of Insurance the group are at least $50 billion or gross written Supervisors (“ ”), a voluntary membership IAIS premiums are at least $10 billion (on a rolling organization of insurance regulators and three year average basis). supervisors from more than 200 jurisdictions, has worked in recent years to promulgate One of the foundational principles of the Common Framework for the Supervision ComFrame is that home and host insurance of Internationally Active Insurance Groups regulatory authorities are to supervise IAIGs (“ ”), as a set of international ComFrame in a collaborative fashion. In general, the supervisory requirements which can provide a group-wide supervisor of an insurance group basis for the effective groupwide supervision of or an insurance legal entity operating through internationally active insurance groups (“ ”). IAIGs branches will determine if an entity meets the requirements for an IAIG in cooperation with ComFrame Background other insurance regulatory authorities through a supervisory college. While the criteria for In 2011, the IAIS adopted a set of Insurance IAIGs as proposed by the IAIS focus on size and Core Principles (“ICPs”) to provide a high-level, international activity, they are considered by globally accepted framework for the regulation the IAIS to have an amount of elasticity, and a and supervision of the insurance sector. The significant degree of discretion is reserved to ICPs are intended to provide guidance for all insurance regulatory authorities as to whether jurisdictions and are routinely reviewed for to consider an insurance group to be an IAIG, necessary updates. One of the important regardless of whether the criteria are technically aspects of the ICPs is an emphasis on group- met. Accordingly, the IAIS does not itself intend

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to develop a list of IAIGs, but rather seeks to intended to replace any existing capital provide the framework for insurance regulatory standards for legal entity supervision in any authorities to periodically assess whether jurisdiction, but aims to provide a comparable ComFrame should be applied to a particular measure of capital across jurisdictions. The insurance group. goal of the IAIS in developing the ICS is that establishing a comparable measure of capital Consistent with its desire to make the across jurisdictions will facilitate a common identification of IAIGs the responsibility of understanding of IAIG capital adequacy and insurance regulatory authorities, the IAIS has enhance cooperation and coordination among refrained from producing substantial guidance insurance regulatory authorities. to interpret the criteria for IAIGs. Though field-testing has identified a number of insurance groups which may meet the criteria Adoption of ComFrame – Looking Toward and be considered IAIGs, it is unclear whether 2019 and 2020 these interim results will be maintained once the actual application of ComFrame begins. The IAIS’s current timeline for ComFrame Accordingly, there are a number of material envisions its finalization and adoption in the operational questions with respect to the latter half of 2019. To meet this timeline, application of the criteria which may need to a public consultation of ComFrame was wait until the implementation of ComFrame launched by the IAIS in July 2018. In order begins in earnest to be resolved. to contextualize ComFrame with respect to the ICPs, it is envisioned that the guidance provided by ComFrame with respect to IAIGs Structure of ComFrame will be embedded directly within relevant ICPs in separately demarcated blue boxes. ComFrame seeks to provide specific guidance These affected ICPs collectively make up the to IAIGs derived from the ICPs and is organized public consultation package issued by the in two categories: IAIS. In 2019, the IAIS will review consultation comments and further refine the proposed • ComFrame Standards, which provide elements in order to finalize them by the end of outcome-focused, specific requirements for the year and begin implementation in 2020. insurance regulatory authorities built on the ICPs; and The IAIS intends for the ICS to be finalized and adopted on the same timeline as the rest • ComFrame Guidance, which is intended to of ComFrame, although it is envisioned that facilitate the understanding and application the ICS will be presented as a stand-alone of specific ComFrame Standards and does document for adoption in 2019 and will not be not include or represent any requirements. immediately integrated into the ICPs at that time. In 2017, the IAIS adopted the ICS Version As part of ComFrame, the IAIS has also been 1.0 for extended field testing and, following the developing a risk-based, global insurance conclusion of that testing, published the ICS capital standard (the “ICS”). The ICS is not Version 2.0 consultation document in 2018. The

80 Global Insurance Industry Year in Review IAIS has agreed that implementation of the ICS The BBA was first previewed in an Advance Version 2.0 will be conducted in two phases: Notice of Proposed Rulemaking in June 2016, and Governor Quarles’s speech provided an • In the first phase, referred to as the important window into the Federal Reserve’s “monitoring period,” which will last for thinking as it prepares to issue a proposed five years, the ICS Version 2.0 will be used rulemaking. The BBA will constructs “building for confidential reporting to group-wide blocks” – or groupings of subsidiaries of supervisors and discussion in supervisory an insurance holding company – that are colleges. The ICS will not be used as a covered by the same capital regime. These prescribed capital requirement (“PCR”) in building blocks are then used to calculate this phase. combined, enterprise-level capital resources and requirements. In each building block, the • The second phase will be implementation of BBA will generally apply the capital regime the ICS as a group-wide PCR. for that block to the subsidiaries in that block. For instance, in a life insurance building block, Accordingly, the next two years could see the subsidiaries would be treated in the BBA the beginning of a shift in group supervision of way they would be treated under the NAIC’s life IAIGs as IAIS members implement ComFrame insurance capital requirements. In a depository and the ICS. Whether this regime lives up to institution building block, subsidiaries would be the hopes of the IAIS will be a question for the subject to bank regulatory capital requirements. next decade. To address regulatory gaps and arbitrage risks, like those made manifest in the financial crisis, Emerging US Approaches to Group Capital the BBA generally would apply bank regulatory Standards capital requirements to nonbank/non-insurance building blocks.

Dodd-Frank gave the Federal Reserve After all of a holding company’s subsidiaries regulatory responsibilities for insurance holding have been grouped into building blocks, and companies that choose to own a federally capital resources and requirements have been insured depository institution and those computed for each building block, the holding designated by the Financial Stability Oversight company’s capital position would generally Council (“ ”) as systemically important FSOC be produced by totaling the capital positions financial institutions. On January 9, 2019, of each building block, after appropriate Randal K. Quarles, Vice Chairman of the Board adjustments (including scalar adjustments to of Governors of the Federal Reserve System, reconcile capital positions between the NAIC’s gave a speech to the Executive Roundtable of risk-based capital regime and federal bank the American Council of Life Insurers, in which capital rules). Once the insurance holding he provided an update on the Federal Reserve’s company’s aggregate capital position is forthcoming proposal on insurance holding calculated, the BBA would impose a minimum company capital requirements, often referred to requirement that is designed to be consistent as the Building Block Approach (“ ”). BBA with the Federal Reserve’s role to ensure that

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the risks of the enterprise do not present NEW YORK ADOPTS PRINCIPLE-BASED undue risk to the safety and soundness of the RESERVING depository institution.

Governor Quarles explained that the Federal On December 10, 2018, Superintendent Maria Reserve’s goal in developing the BBA is to T. Vullo announced that the New York DFS had capture all material risk of each supervised promulgated an emergency regulation to begin organization, leverage existing legal-entity the implementation of principle-based reserving standards and minimize burden. He noted (“PBR”) to become effective on January 1, 2020 that the Federal Reserve has chosen not to (the “Emergency Regulation”). The Emergency follow the valuation-centered approach of the Regulation follows the passage on June 18 ICS because of the proneness to volatility and and 19, 2018 by the New York State Assembly procyclicality of that approach, which has the and Senate of substantially identical bills to potential to influence a firm to veer away from a implement PBR for life insurance companies in long-term perspective and concentrate instead New York and the subsequent signing of that on the short term. The Federal Reserve believes legislation into law by Governor Andrew M. this could interfere with the ability of insurers to Cuomo. provide long-term life insurance and retirement planning products, which are so important The purpose of PBR is to provide a principle- to the US insurance market. In contrast, a based approach to the methods used by life capital standard that is stable in its valuation, insurance companies to establish reserves for conservative in its design and appropriately their policy liabilities. Theoretically, PBR allows reflective of financial soundness can influence for a more flexible approach than mechanical firms to plan for the long term, consistent with reliance on specific formulas, thereby enabling the nature of life insurance and retirement life insurance companies to give greater weight products and similarly invest for the long term to actuarial judgment and actual risk experience. through assets like government and municipal The NAIC has developed and encouraged bonds, corporate bonds and infrastructure. adoption of PBR for over a decade in response to concerns that formulas do not always Under the leadership of the NAIC’s Group accurately reflect the risks or the true cost of Calculation (E) Working Group, the NAIC has the liability or obligations of a life insurance also been working to develop a group capital company. The NAIC has also expressed standard, called the Group Capital Calculation concerns that the formulaic approach results in the “locking-in” of certain assumptions, which (“GCC”). The GCC is essentially an aggregation approach, building on the NAIC’s existing risk- itself results in reserves that do not change as based capital regime and focusing on the assets economic conditions change or as life insurance within an insurance group that are available to companies accumulate actual experience. satisfy the claims of policyholders. The NAIC has announced plans to begin field-testing Historically, the New York DFS had not been the GCC in the spring of 2019 with insurance in favor of adoption of PBR. In fact, under its groups that volunteer to participate. previous Superintendent, Benjamin M. Lawsky, the DFS strenuously opposed the adoption

82 Global Insurance Industry Year in Review of PBR by the NAIC, stressing instead the the New York life insurance industry, although benefits of reserving formulas that could easily no such deviation is permitted to result in be policed by insurance regulatory authorities. reserve valuations that are lower than minimum However, that view was not widely shared by standards prescribed in the Valuation Manual. insurance regulatory authorities in other US jurisdictions and, following its adoption by 42 Second, the New York legislation provides US states, the NAIC implemented PBR, effective that a principle-based valuation of reserves as of January 1, 2017. Following that step, the “shall” include a prescribed formulaic reserve NAIC subsequently made PBR an “accreditation component, in contrast to the NAIC model standard” with an effective date of January 1, law pertaining to PBR, which provides that a 2020, which means that all US states need to principle-based valuation of reserves “may” adopt PBR by this date in order to maintain their include a prescribed formulaic reserve accreditation in good standing. component.

Superintendent Vullo reversed the New York Third, the New York legislation provides that DFS’s position on PBR. In July of 2016 she no amendment to the Valuation Manual shall announced that the DFS intended to adopt take effect in New York until the Superintendent PBR for New York domestic life insurers and expressly finds that such amendment is in the immediately convened a working group best interests of the holders of life insurance consisting of six domestic life insurers and policies and annuity contracts in New York. consumer representatives with respect to In virtually all other jurisdictions which have such adoption. Over the past two legislative adopted PBR, any changes to the Valuation sessions, the DFS has provided input on Manual will become effective automatically legislation to facilitate the adoption of PBR. upon their adoption by the NAIC.

The enacted New York legislation which It remains to be seen how the Emergency implements PBR in many respects mirrors the Regulation will be implemented in practice. NAIC model law, but with three important Based on the language of the New York differences. legislation, it is likely that the New York DFS will utilize its regulatory authority to deviate from First, the New York legislation authorizes the the reserve standards and methods set forth in DFS to issue regulations that would result in the Valuation Manual, at a minimum, to establish deviations from the reserve standards and a prescribed formulaic reserve floor. However, methods utilized in the valuation manual it is unlikely that the impact of such a minimum developed by the NAIC (the “Valuation reserve floor on life insurance companies Manual”), which includes the framework and licensed in New York will be significant, because minimum reserve requirements for insurance the DFS will try to ensure that such companies products subject to PBR. The Emergency are not placed at a disadvantage with respect to Regulation expressly affirms the statutory their competitors licensed elsewhere. authority of the Superintendent to deviate from the Valuation Manual (following its adoption in New York), to adjust reserves, if necessary, in order to protect New York policyholders and

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Moreover, the New York legislation allows bodies, provide a preview of areas likely to a life insurance company that is licensed see significant activity in the coming year. and does business only in New York to Highlights of the charges for 2019 include the request a company-specific exemption from following: PBR requirements from the DFS. If such an exemption is granted, the life insurance Innovation: Innovation continues to be a company would be able to continue to utilize major focus for the NAIC, as evidenced by the the methods and assumptions used prior to the continued realignment of certain NAIC task implementation of PBR in New York to compute forces under the purview of the Innovation its reserves. and Technology (EX) Task Force (“ITTF”), in line with the trend over the past few years The adoption of PBR by New York brings the to consolidate such task forces under ITTF’s state into conformity with the overwhelming authority. Additionally, the ITTF has received majority of US jurisdictions that have already new charges, specifically (i) to provide a forum enacted PBR (as of the date of this report’s for regulator education and discussion of publication, PBR remains pending solely in innovation and technology in the insurance Massachusetts). While it retains significant sector; (ii) to monitor technology developments flexibility to take action to protect consumers that impact the state insurance regulatory and the life insurance industry in New York framework; and (iii) to expand and update under the Emergency Regulation, the New regulatory model guidance with respect to York DFS now joins with insurance regulators technological developments. Additionally, the nationwide in agreeing that PBR provides the Speed to Market (EX) Working Group, which best approach to capture the risks of many oversees the NAIC’s System for Electronic complex life insurance and annuity products Rate and Form Filings (“SERFF”), will consider offered by life insurance companies. enhancements to SERFF features or functionality presented by the SERFF Advisory Board and will LOOKING AHEAD – NAIC PRIORITIES direct and oversee the implementation of any such projects. FOR 2019 While not overseen by the ITTF, the Producer Each year following the Fall National Meeting, Licensing (D) Task Force of the Market the NAIC adopts a series of charges to its Regulation and Consumer Affairs (D) Committee various committees, working groups and task added the charge in 2019 to draft a white paper forces, and collectively those charges comprise on the role of chatbots and artificial intelligence the NAIC’s agenda for the coming year. Many in the distribution and sale of insurance of these charges involve ongoing reviews products and the regulatory supervision of such and surveillance of issues of interest to state technologies. regulators and remain relatively unchanged from year to year. However, the creation of Global Capital Calculation: The Group new task forces and working groups, as well Capital Calculation (E) Working Group of the as the appearance of new charges to existing Financial Condition (E) Committee continues

84 Global Insurance Industry Year in Review to work on constructing a US group capital Care Act (“ACA”), including short-term, limited- calculation using risk-based capital (RBC) duration insurance, association health plans, aggregation methodology. The 2018 and 2019 and packaged indemnity health products in charge remains the same for this Working coordination with the Market Regulation and Group – namely to construct a US group Consumer Affairs (D) Committee. Additionally, capital calculation using a risk-based capital the Regulatory Framework (B) Task Force aggregation methodology, to liaise as necessary added a new subgroup to review and consider with the ComFrame Development and Analysis amendments to the Accident and Sickness (G) Working Group on international capital Insurance Minimum Standards Model Act and developments, and to consider group capital its companion regulation, the Model Regulation developments by the Federal Reserve Board, to Implement the Accident and Sickness both of which may help inform the construction Insurance Minimum Standards Model Act. In of a US group capital calculation. addition, a new subgroup was created by the Regulatory Framework (B) Task Force to consider Life Insurance and Annuities: The Life developing for the first time a new NAIC model Insurance and Annuities (A) Committee to establish a licensing or registration process established two new working groups for 2019: for pharmacy benefit managers (“PBMs”) the Annuity Suitability (A) Working Group and and, if appropriate, include provisions on PBM the Life Insurance Online Guide (A) Working prescription drug pricing and cost transparency Group. The former will review and revise for the new NAIC model. the Suitability in Annuity Transactions Model Regulation and consider how to promote Accreditation: The Financial Regulation greater uniformity across NAIC-member Standards and Accreditation (F) Committee jurisdictions while the latter will develop an oversees the NAIC accreditation program, online resource on life insurance, including the which is designed to allow non-domestic evaluation of existing content on the NAIC state regulators to rely on domestic state website, to be published digitally for the benefit regulation by assuring them that the domestic of the public. Additionally, the Life Actuarial (A) state has adopted certain baseline standards Task Force has a new charge to report progress of regulation. When the committee adopts on and provide updates to the Financial a new accreditation standard, it effectively Condition (E) Committee on all life insurance requires all states to adopt that measure (by company solvency-related matters. statute or regulation) in order to maintain their accreditation in good standing. The Health Insurance and Managed Care: The “F” Committee has adopted the following NAIC continues to be actively focused on accreditation standards with an effective date of developments in the health insurance and January 1, 2020: managed care space, as evidenced by its 2019 charges for several of its committees and task • 2014 Revisions to the Insurance Holding forces. For example, the Health Insurance and Company System Regulatory Act, which Managed Care (B) Committee has included an provide the authority to a designated state additional charge to collect uniform data and to act as a group-wide supervisor for an monitor market conduct trends on plans that internationally active insurance group. are currently not regulated under the Affordable

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• 2014 Revisions to the Annual Financial and Casualty Insurance (C) Committee to collect Reporting Model Regulation, which relate and analyze National Flood Insurance Program to new requirements for an internal audit data, and create a best practice document function for insurance companies with such to help facilitate the private flood insurance internal audit function being added as a market. Additionally, the Market Regulation new significant element in the CPA Audits and Consumer Affairs (D) Committee added standard. a related charge to the Antifraud (D) Task Force to coordinate activities and information • 2009 Revisions to the Standard Valuation with state and federal fraud divisions to Law, which authorize a PBR methodology determine guidelines that will assist with for life, annuity and accident and health reciprocal involvement concerning antifraud contracts (See article on “New York Adopts issues resulting from natural disasters and Principle-Based Reserving” on page 82). catastrophes.

• Corporate Governance Annual Disclosure STATE AHEAD – THE NAIC’S Model Act and the Corporate Governance Annual Disclosure Model Regulation, CONTINUING MODERNIZATION which require an insurance company (or PROGRAM: 2018 INITIATIVES FOCUS group of insurance companies) to provide ON DATA COLLECTION AND DATA a confidential disclosure regarding its corporate governance practices to the lead MANAGEMENT state and/or domestic regulator annually by June 1 (See article on “Corporate The NAIC was formed in 1871 and is the Governance Gaining Ground” on page 69). standard-setting and regulatory support organization for the insurance industry, created • Part B1: Financial Analysis, Timing and governed by the chief insurance regulators Guidelines for Analysis of ORSA Summary from the 50 US states, the District of Columbia Reports, which require (i) group Own Risk and five US territories. Generally speaking, Solvency Assessment (“ORSA”) Summary however, the NAIC – for all the benefits it offers Reports that cover multiple insurance as a forum for such insurance regulators and companies domiciled in various states to the body which promulgates model insurance be reviewed and shared by the lead state laws and regulations to provide a degree of within 120 days of receipt, and (ii) legal uniformity in a state-governed system – has entity ORSA Summary Reports that do not tended to be a reactive organization, adapting cover insurers domiciled in various states to to the shifting currents of the insurance be reviewed within 180 days of receipt. sector but rarely choosing to chart a clear, comprehensive path forward as an organization. Catastrophe Insurance: With the onslaught of natural disasters in 2018, the NAIC has In recent years, the NAIC has begun to provided an updated charge to the Catastrophe recognize the need for a more proactive Insurance (C) Working Group of the Property approach, in response to pressures from an array of forces, including: (i) rapid technological

86 Global Insurance Industry Year in Review advances and the impact of such advances a collaborative regulatory environment that on consumers, the insurance industry and fosters stable financial markets and reliable and state regulators; (ii) the use of “big data” to affordable insurance products. The NAIC has tailor insurance product design, pricing and two main objectives to meet this goal. delivery; (iii) concerns about retirement security and changing population demographics; (iv) First, the NAIC seeks to optimize its financial cybersecurity as a major risk factor for insurers data and information for regulator-focused and state insurance regulators; and (v) the analytics, including predictive analytical tools. influence of foreign jurisdictional approaches to Achieving this objective will require the NAIC insurance standard-setting. restructuring and modernizing the way its data is organized to make it more relevant and user- Cognizant of such pressures, the NAIC launched friendly for state insurance regulators, staff, in January 2017 a structured process to industry and general consumers. develop a strategic plan, soliciting input from a range of interested parties, including state Second, the NAIC will evaluate regulatory insurance regulators, NAIC senior leadership opportunities arising from macroprudential and other stakeholders. Through this process, surveillance, including analyzing how the which concluded in January 2018, the NAIC insurance sector is affected by, reacts to and developed a three-year approach to focus the contributes to financial, economic and other scope and impact of its most important work common risk exposures. for the period of 2018 to 2020. Titled “State Ahead”, this strategic plan provides a roadmap THEME II – CONSUMER PROTECTION for the NAIC’s future operations, and outlines AND EDUCATION steps for the NAIC to develop and harness new tools, talents and technologies. State Ahead The second goal of the NAIC under its strategic recognizes that the long-standing focus on plan is to ensure that consumer protection solvency monitoring and consumer protection keeps pace with changes in the marketplace must remain at the forefront of the NAIC’s and that consumers have the information and efforts, while simultaneously accepting that education they need for informed decision- the landscape of the insurance industry has making. In order to achieve this goal, the NAIC fundamentally changed. has set out three major steps.

State Ahead is organized under three First, the NAIC will optimize the use of its overarching themes, overlapping with four goals market data and regulatory processes to that will govern how the NAIC seeks to achieve enhance consumer protections, including its plans. updating or building new technological functions, such as a business intelligence tool THEME I – SAFE, SOLVENT AND with self-service capabilities, and creating an STABLE MARKETS enterprise market data strategy and analytics data warehouse. The first goal of the NAIC underState Ahead is to provide state insurance regulators with Second, the NAIC will create effective and the data, training and tools needed to support accessible consumer education and financial

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literacy tools, including developing and regulatory issues introduced in committees updating tools for state insurance departments and task forces, including setting expectations, to use directly in promoting consumer education defining deliverables and establishing time in their respective jurisdictions. deadlines, and is planning on incorporating a review of its current committee structure and Third, the NAIC will seek to position itself and the development of appropriate governance its members as thought leaders in insurance factors to ensure a balance between effective regulatory innovation, including creating engagement and efficiency. opportunities for state insurance regulators to share information and stay current on the In 2018, the NAIC demonstrated its evolving dynamics of the global insurance commitment to expeditiously implement the marketplace. State Ahead plan. For example, in March 2018 and again in July 2018, the NAIC released fiscal THEME III – SUPERIOR MEMBER SERVICES impact statements that represented key first AND RESOURCES steps for implementing the strategic plan for public comment. Theme III of State Ahead includes the third and fourth goals of the plan, specifically: (i) the third The fiscal impact statement released in March goal, to provide optimal services to support 2018 focused on the NAIC’s goal in transitioning state insurance regulators and equip them with its applications to the cloud (with the public the necessary talent and resources; and (ii) comment period for this statement concluding the fourth goal, to optimize the efficiency and on April 5, 2018). effectiveness of the NAIC structure to focus on member priorities and maximize member The three fiscal impact statements issued in July engagements. In order to meet these goals, the 2018 (with the public comment period for these NAIC has several objectives built into its plan. statements concluding on August 1, 2018) were the following: With respect to its third goal, the NAIC will expand ongoing training for regulators at all • The Enterprise Data Strategy, Governance levels of state insurance departments, including and Management – Phase I fiscal impact conducting outreach to members to identify statement, which represents the first phase training needs. Additionally, the NAIC will of the initiative to establish advanced data ensure that it provides state insurance regulators management processes for the NAIC and with technical services that are secure, reliable will mandate the NAIC staff to enhance and and flexible, including improving the user modernize the NAIC’s data management experience of the NAIC technology services and and governance policies to standardize how fostering a culture for innovation and continuous data is handled as an asset and develop an improvement. enterprise data catalog.

With respect to its fourth goal, the NAIC intends to focus on better management of

88 Global Insurance Industry Year in Review • The Enterprise Data Platform and Data (under the McCarran-Ferguson Act of 1945), Warehouse – Phase I fiscal impact albeit subject to periodic congressional review. statement, which represents the first phase of the NAIC centralizing data-collection One of the consequences of the 2008 financial across business areas, including establishing crisis was a decision by the federal government a central “warehouse” to serve as the to revisit the system enshrined in the McCarran- primary location for data analysis and Ferguson Act, in part because of the federal synthesis. bailout of one particular company that was the holding company of an insurance group • The Dynamic Content Website – Phase (although the insurance company members of II fiscal impact statement, which includes the group remained healthy during the crisis). the continuing development of a content Dodd-Frank, which was enacted in the wake of management system on a vendor-hosted the financial crisis, gave increased systemic risk cloud platform that will host the NAIC regulatory authority to both the Federal Reserve website, and additionally seeks to establish and the newly formed FSOC. In addition, governance policies and standards for Dodd-Frank also created a Federal Insurance online content, and provides tools and Office within the Department of the Treasury, policies to address the needs of users with in addition to enacting the “Nonadmitted and disabilities. Reinsurance Reform Act” to establish greater uniformity among the states with regard Over the past year, the NAIC has proved itself to excess and surplus lines insurance and willing to rapidly produce concrete products to reinsurance. expedite its implementation of the State Ahead plan. Accordingly, we can look forward to Since the enactment of Dodd-Frank, the federal the NAIC continuing to produce fiscal impact government has occasionally considered statements and additional products for review legislation that touches on insurance regulation. by members and consumers as 2019 begins. The 115th Congress, which met from January 3, 2017 to January 3, 2019, reviewed a number of such bills, though only two of them were actually INSURANCE-RELATED LEGISLATION IN enacted. Various other bills passed either the THE 115TH CONGRESS House of Representatives or the Senate (but not both) and, while currently stalled, they could Given that the business of insurance in the provide the springboard for similar insurance United States is regulated primarily at the state regulatory initiatives at the federal level during level, it is not surprising that the majority of the 116th Congress. regulatory initiatives in the insurance industry tend to originate with state legislatures or state Enacted Legislation insurance regulators or, in some cases, with the NAIC. State insurance regulators continue to 1. The Financial Stability Oversight Council be the primary regulatory authorities for the Insurance Member Continuity Act of 2018, insurance industry – with congressional blessing signed into law on September 27, 2018,

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amends the Dodd-Frank provision regarding careful and respectful consideration to the the appointment of an independent preferences expressed by the Congress in member with insurance expertise to serve section 211(a) and will consult with State on FSOC. Specifically, this law added officials as appropriate.” language allowing the independent member to serve up to 18 months after Legislation Passed by the House of the end of his or her six-year term, or until Representatives But Not the Senate a successor is appointed or confirmed.

Summarized below are two bills that were 2. The Economic Growth, Regulatory Relief passed by the House of Representatives, but not and Consumer Protection Act, signed acted upon by the Senate. into law on May 24, 2018 (the “Economic Growth Act”), includes a number of 1. The State Insurance Regulation Preservation financial services provisions, though these Act (H.R. 5059) was passed by the House largely deal with topics other than insurance. of Representatives on September 12, 2018. However, Section 211 of the Economic This bill would define a new category of Growth Act provides that the Department “insurance savings and loan companies” of the Treasury, the Federal Reserve and consisting primarily of (1) savings and loan the Director of the Federal Insurance Office holding companies that hold 75% or more shall support transparency in international of their assets in insurance underwriting fora and shall “achieve consensus positons companies, or (2) savings and loan holding with state insurance regulators” when companies that have maintained that status taking positions in such fora. Additionally, continually since July 21, 2010 and held the law creates an “Insurance Policy 25% or more of their assets in insurance Advisory Committee of International Capital underwriting companies and were thus Standards and Other Insurance Issues” exempt from the Federal Reserve’s Basel at the Federal Reserve made up of 21 III capital requirements (promulgated in members with expertise on various aspects October 2013). of insurance. Those provisions reflect the concerns of state insurance regulators In the Federal Reserve’s oversight of such to have a “seat at the table” when companies, the Federal Reserve is directed international bodies consider international to align record keeping and coordinate capital standards and other international examinations with the state insurance supervisory measures. However, after regulators and, to the extent possible, signing the Economic Growth Act into law, not duplicate the supervision of insurance President Trump released a statement in companies by such regulators. The bill which he found that the directions included would also require the Federal Reserve to in Section 211 of the law intrude upon promulgate rules specifically tailoring its the President’s “exclusive constitutional supervisory framework to the unique risks authority to determine the time, scope and and operations of insurance companies and objectives of international negotiations”, would exempt insurance assets (except while still allowing that he would “give

90 Global Insurance Industry Year in Review for those assets associated with credit risk UK AND EUROPE insurance) from supervisory assessment fees. Brexit and the Temporary Permissions Regime 2. The Financial CHOICE Act (H.R. 10) was passed by the House of Representatives on June 8, 2017 and includes certain provisions Much of the recent focus of the UK government pertaining to the insurance industry, though and regulator has been on contingency planning such regulation is not the central focus of for the possibility of the UK failing to conclude the bill. Title X of H.R. 10 would amend a withdrawal agreement with the EU before exit Dodd-Frank to merge the Federal Insurance day on March 29, 2019, i.e. a No-Deal Brexit. Office of the Department of the Treasury In such an event, the UK will leave the EU on and the independent insurance expert exit day without a transitional period. One of position on FSOC, creating the Office of the ways this would impact insurance firms is Independent Insurance Advocate, a new that their permission to use the “passporting” independent bureau within the Department system would cease. This system allows an of the Treasury. Under the terms of the bill, insurance firm regulated in one EEA state to the Independent Insurance Advocate would undertake a particular regulated activity to do be a voting member of FSOC, would be so freely across the EU and (by virtue of the appointed by the President and confirmed provisions of the agreement on the EEA) the rest by the Senate. If the bill were to be passed of the EEA. Upon a No-Deal Brexit, this would by the Senate and signed into law, the cease to be the case; insurance firms regulated Office of Independent Insurance Advocate in the UK would no longer be entitled to rely on would generally assume the current the passport to offer their services in the EEA, responsibilities of the Director of the Federal and vice versa. Insurance Office with a few key differences, such as: (i) it would only have the authority EU Insurance Firms Operating in the UK to “observe” (rather than “monitor”) the insurance industry; (ii) it would not The UK government and financial regulators be required to monitor the access of are concerned to ensure that EEA insurance underserved communities to insurance; and (and other financial services) firms currently (iii) it would not have the authority to require operating in and out of London can continue the submission of data from the insurance to do so after a No-Deal Brexit and have industry. The bill also has a few additional therefore introduced a temporary permissions provisions that could impact the insurance regime (“TPR”) to ensure that these firms will be industry, including (A) adding an additional permitted to continue to operate in the UK for public notice and comment period for any a three year transitional period after a No-Deal covered agreement and (B) repealing Title II Brexit, in which time they may seek direct UK of Dodd-Frank (giving the Federal Reserve authorization. The regime therefore provides orderly liquidation authority over non-bank confidence that a back-stop will be available in financial companies) and replacing it with such an event. a new chapter of the bankruptcy code to apply to financial firms – but one that would not apply to insurance companies.

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Insurance firms intending to make use of the to be ready for a No-Deal Brexit. Where the TPR should notify the PRA using the form authorization approach is taken, it may also available on the FCA Connect system between be possible for the EEA entity to outsource January 7, 2019, and March 28, 2019. To be certain activities from that entity back to the eligible for entry, a firm must be authorized to UK, although the various European Supervisory carry on a regulated activity in the UK under Authorities have urged local regulators in their the current EU passporting regime at the point assessment of applications for authorization of exit. A firm that has notified under the TPR to be vigilant against the establishment of will obtain a deemed permission to carry on “empty shell” subsidiaries (i.e., those without performing regulated activities in the UK for a substance) established purely to gain access maximum three year period, subject to the UK to the Single Market. It may also be possible government’s power to extend the duration of for certain services to be provided without the the regime by increments of 12 months. The need for local authorization where “reverse deemed permission will cover any activities the solicitation” can be relied upon. This is the firm was permitted to carry on via passporting concept recognized across various areas of immediately before exit day. Insurance firms financial services regulation that a firm may that have had Solvency II approval(s) from an market and provide financial services to a client EEA regulatory prior to entering the TPR will where approached by the client on its own likewise be deemed to have corresponding initiative. However, the value of this approach approval from the PRA while they remain in the will be limited given the requirement for a client TPR. Firms in the regime will then be allocated to have initiated contact, as well as the varying a “landing slot” within which they will need to interpretation across Member States of what submit their application for full UK authorization. constitutes reverse solicitation. The FCA will issue a direction shortly after exit day to confirm firms’ landing slots. It will Insurance Distribution Directive enters also write to firms confirming their landing into force slot. It expects the first one to be October to December 2019, and the last to be January to The EU’s Insurance Distribution Directive (“IDD”) March 2021. repeals and replaces the EU’s framework for regulating insurance (and reinsurance) brokers, UK insurance firms operating in the EU agents and other intermediaries, which was previously contained in the 2002 Insurance The EU is not offering the same hospitality to Mediation Directive (“IMD”). While it entered UK insurance firms that at the moment rely on into force on February 22, 2016, with member the passport to operate in other parts of the states originally required to transpose it into EEA. Upon a No-Deal Brexit, these firms will domestic law by February 23, 2018, concerns need to comply with local laws to continue to around its implementation by member states operate there, including, where applicable, and firms resulted in this date being pushed by obtaining authorization in the relevant EEA back to July 1, 2018, with a revised date of states or transferring business to affiliates October 1, 2018 being set for its application authorized in the EEA. Many UK firms have to firms. been progressing these alternatives in order

92 Global Insurance Industry Year in Review As background to the IDD, a European 2. Cross-border entry to insurance markets. Commission review had found the insurance The IDD simplifies the procedure for cross- market to be very fragmented despite the border entry to insurance markets across existing passporting regime for insurers the EU with the aim of increasing the use and intermediaries trading across borders, of passporting rights in the industry. One among other reasons due to inconsistent way it does this is by requiring member implementation of the IMD. With this in mind, states to establish a “single information one of the aims of the new directive is to point” which gives public access to their facilitate cross-border trade in the insurance registers for insurance, reinsurance and sector, alongside its other key aims of ensuring ancillary insurance intermediaries. The a level playing field among all participants in the European Insurance and Occupational sale of insurance products and strengthening Pensions Authority (“EIOPA”) is to maintain policyholder protection. In a number of a single electronic database with links areas, the requirements are broadly brought to each such single information point. into alignment with those applicable to the Member states will also now be subject to investment services sector under the markets in new disclosure obligations in relation to any financial instruments directive (“MiFID II”), with “general good” rules, i.e., measures that a view to achieving cross-sector harmonization. host member states may impose on firms passporting into their territories, where Some of the key changes that the IDD makes to those measures serve a general good the existing IMD regime are set out below: (e.g., consumer protection, social order, among others). 1. Scope. Whereas the IMD applied only to agents and brokers, the IDD extends the 3. Professional and organisational scope of the IMD to cover “distributors,” requirements. In recognition of the i.e., all participants in the sale of insurance importance of guaranteeing a high level of products, including insurers and reinsurers professionalism and competence among that sell directly to customers without the firms involved in insurance distribution and intervention of an intermediary (i.e., direct their employees, the new regime requires writers). Other market players that sell stricter and more specific professional insurance products on an ancillary basis requirements. Member States now have to (e.g., travel agents) are included within establish and publish mechanisms to control the scope of the IDD, subject to a limited effectively and assess the knowledge and exemption. The IDD also extends to competence of insurance intermediaries and others who assist in the administration and employees of insurance undertakings and performance of insurance contracts, such as intermediaries, based on at least 15 hours loss adjusters. The European Commission of professional training or development per has estimated that the extension of the year, taking into account factors such as the regime will result in the IDD covering about nature of the products sold and the type of 98% of the market, compared to about 48% distributor. of the market that is currently covered by the IMD.

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4. Information and conduct of business. impose on current practices. The IDD significantly amends the IMD information and conduct of business 6. Insurance-based investment products. requirements, taking the equivalent MiFID The IDD defines an insurance-based II standards into account to ensure cross- investment product (“IBIP”) as an insurance sector consistency. Detailed requirements product which offers a maturity or surrender apply in respect of the information to value which is wholly or partially exposed, be disclosed by distributors before the directly or indirectly, to market fluctuations, conclusion of an insurance contract, with certain exceptions (e.g., non-life including identity, address and registration products, or life products payable only on detail. Insurance intermediaries are now death or incapacity). The IDD states that also subject to remuneration disclosure IBIPs are often offered as an alternative obligations, requiring them before the to investment products regulated under conclusion of an insurance contract to MiFID II. It therefore imposes an additional provide details of, among other things, layer of conduct of business standards the nature of the remuneration received (aligned with the MiFID II standards) on the and its basis (i.e., whether in the form of distribution of these products as against a fee, a commission or otherwise). In the other insurance products, as a means of UK, remuneration disclosure was already cross-sector harmonisation to avoid the risk required of intermediaries acting as the of regulatory arbitrage. Those requirements agent of the insured under common law include maintaining effective arrangements principles, although new consideration will to prevent conflicts of interest, providing need to be given to the nature and basis information on the IBIP before conclusion of of remuneration and the way in which such the contract (in the form of a standardized disclosures are made. insurance product information document) and carry out an assessment of the product’s 5. Cross-selling and bundled products. suitability for the customer. The IDD states that “bundling” (i.e., cross selling) insurance products, though Although the IDD substantially raises the potentially beneficial to customers, can minimum standards of the IMD, it is a “minimum result in their interests not being adequately harmonising” directive. This means that member considered. As such, new disclosure states implementing the IDD may “gold-plate” requirements apply to distributors in relation it by imposing stricter requirements, with to such practices. Though broadly aligned the result that implementation differs across with the bundling rules for the investment member states. As such, it is important that all sector under MiFID II, the IDD goes further firms in scope consider the implications of the by banning the “tying” of different products IDD in their distribution strategy on a country- (in requiring customers to be given the by-country basis. option of buying any bundled goods or services separately), despite industry concerns about the limitations this will

94 Global Insurance Industry Year in Review ASIA (2) reputation, character, reliability and integrity, and (3) financial status or solvency. The IA HONG KONG has also published a guideline on continuing professional development and holds the view In mid-2019, the current self-regulatory regime that this is highly relevant to the determination for insurance intermediaries will be replaced of the fit and proper requirement. with direct regulation by the Insurance Authority (“IA”), which is an independent regulatory The IA has issued an Explanatory Note on body established by the Insurance Companies Licensing for Employees to clarify that the (Amendment) Ordinance (“ICO”) enacted exemption from the licensing requirement for in mid-2015. The IA has been proactive in an authorized insurer does not extend to its working with industry groups through public agents. Therefore, employees of an authorized consultations on the development of industry insurer should apply for a license if they carry rules, codes and guidelines which should apply on a regulated activity (such as direct sales to intermediaries and expects to conclude the staff), or hold themselves out as carrying on a process before the commencement of the new regulated activity, unless they are responsible for statutory licensing regime. underwriting or risk assessment, claims handling or solely clerical or administrative duties. The true substance of this new licensing regime is the expansion of regulation beyond existing Other public consultations on guidelines brokers and agents to encompass any person conducted by the IA include pecuniary penalty, carrying on “regulated activities” in the course the maximum insurer rules for insurance agents of business or employment or for reward, and financial rules for insurance brokers. The IA subject to exemption. There will be a three-year have also dedicated to drafting other guidelines grandfathering period for brokers and agents and it is expected to have public consultation registered with the current self-regulating on matters including financial needs analysis, organizations when the new regime begins, cooling-off periods, use of gifts, and the sale of whereby they will be deemed to be licensed. investment-linked assurance schemes. The new regime will capture a broader range of activities than are currently regulated and Given the wide investigative and enforcement seeks to shut down the grey area within which powers under the new regime that are akin unregistered “pure introducers”, who are not to the Securities and Futures Commission registered as insurance intermediaries, operate. (“SFC”), it is likely that the IA will adopt a more proactive role in investigating and taking The new regime imposes an ongoing obligation disciplinary action for regulatory breaches. on regulated persons to be fit and proper The IA is also likely to place focus on senior to carry on regulated activities in the lines of management accountability because the new business concerned. Based on the new section regime also regulates persons “concerned in 64ZZA of the ICO, the IA has published a the management of regulated activities” and guideline setting out the non-exhaustive criteria extends the insurance company’s liability to in the determination of the fit and proper personal liability on individual members of requirement, which can be broadly grouped into senior management beyond Directors and the three categories: (1) professional competence, Chief Executive Officer.

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CHINA An additional significant Chinese regulatory development occurred in March 2018 when On July 17, 2018, the China Banking and the State Council announced a plan to merge the China Insurance Regulatory Commission Insurance Regulatory Commission (“CBIRC”) published a notice to confer a preferential (“CIRC”) and the China Banking Regulatory treatment to mainland insurers by reducing Commission (“CBRC”) to create an integrated its capital risk requirement under the “China regulator across the banking and insurance sectors. Market commentary suggests that this Risk-Oriented Solvency System” (“C-ROSS”) when the mainland insurer cedes business to could lead to more stringent supervision over a qualified Hong Kong professional reinsurer bancassurance transactions in China. authorized by the Hong Kong Insurance Authority (“HKIA”). INDONESIA

The preferential treatment is based on the The Indonesian government issued Government Equivalence Assessment Framework Agreement Regulation No. 14 of 2018 on Foreign on Solvency Regulatory Regime signed Ownership in Insurance Companies (“GR”) between the former China Insurance Regulatory which became effective on April 18, 2018. Commission and the former Office of the The GR reiterates certain requirements which Commissioner of Insurance on May 16, 2017, in a foreign legal entity must fulfill in order to be which the two insurance regulators agreed to eligible to invest in an Indonesian insurance recognize temporarily the insurance solvency company. For example, the foreign investor regulatory regime of each other as the same or must itself be (or be a parent company of a similar to that of another during the four-year subsidiary which is) in the same line of business transitional period before the completion of the as the Indonesian insurance company and have equivalence assessment. Accordingly, based equity of at least five times the amount of its on the “mutual equivalence recognition”, both direct capital participation in the Indonesian sides will consider giving each other’s industry insurance company. preferential treatment to strengthen cooperation between the insurance sectors in two places. The GR also confirms that foreign ownership is capped at 80% (whether directly or indirectly), The preferential treatment substantially but such restriction does not apply to listed facilitates the cooperation in cross-border Indonesian insurance companies. If the existing reinsurance business between China and Hong foreign shareholding was above 80% prior to Kong. On one hand, Chinese enterprises can the issuance of the GR, the foreign shareholder diversify and manage risks more effectively, is not required to sell down so as to comply particularly in their participation in infrastructure with the 80% cap, but such shareholder may not and investment projects under the Belt and increase its shareholding any further. Road Initiative. On the other hand, the Hong Kong reinsurance industry will be able to compete on an equal footing with its Chinese counterpart and consolidate Hong Kong’s position as a reinsurance hub in Asia.

96 Global Insurance Industry Year in Review MALAYSIA MYANMAR

The Bank Negara Malaysia (“BNM”) (the Foreign insurance companies are largely barred country’s central bank and regulator for from operating in Myanmar (except the three the insurance sector) had ordered foreign foreign insurers that have already been licensed insurance companies in 2017 to reduce their to operate in the Thilawa Special Economic shareholdings to a maximum of 70% by June Zone). However, in September 2018, the 30, 2018 in order to comply with the foreign Insurance Business Regulatory Board outlined ownership cap originally introduced in 2009. the country’s intention to liberalize the However, given the apparent lack of interest insurance market. from domestic investors to purchase the foreign insurers’ stake, BNM has now given foreign In January 2019, the Ministry of Planning and insurers the choice between (a) reducing their Finance issued announcement No.1/2019, equity stakes in their respective companies to paving way for foreign insurers with the 70% ceiling through a sale or a listing on representative offices in Myanmar to operate the stock exchange, or (b) contributing to a in the country by entering into a joint venture proposed national “B40 Health Insurance Fund” arrangement with local insurers. Interested while maintaining their existing shareholdings. insurance providers are invited to submit expressions of interest and/or requests for THE PHILIPPINES proposals to conduct insurance businesses in Myanmar.

Six non-life insurance firms in the Philippines For more on this topic, please reference our have voluntarily surrendered their licenses to February 2019 Legal Update. act as insurers, primarily due to their inability to fulfill the minimum capital requirements set out in the Philippines Insurance Code. The Philippine Insurance Commission has further ordered five other non-life insurance companies to cease operation for the same reason in March 2018.

Under the Insurance Code, insurance companies are required to increase their capital every three years until 2022, achieving a minimum capital of (a) PHP550 million by December 31, 2016; (b) PHP900 million by December 31, 2019; and (c) PHP1.3 billion by December 30, 2022.

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Technology Insurtech | Technology Transactions Cybersecurity & Data Privacy

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INSURTECH Strategic and Corporate Investors INSURTECH INVESTMENTS CONTINUED Combine to Drive Deal Volume TO SET RECORDS In the past several years, strategic and corporate venture capitalists have steadily increased their According to data compiled by CB Insights share of insurtech financing rounds. According and FT Partners, insurtech equity funding to data from FT Partners, corporate and transactions set records in 2018 for number of strategic investors participated in almost half of transactions and aggregate proceeds; 2018 the insurtech financing rounds in 2018, up from also saw a record number of $50 million+ deals. 39% in 2017 and just 15% in 2014. Some of the One of the largest deals of the year was health most active corporate investors in 2018 included insurance upstart Oscar, which returned to the XL Innovate, MassMutual Ventures and AXA market and raised $375 million in a deal led by Venture Partners. Each led or co-invested in Alphabet. To date, investors have given Oscar several venture financing rounds for companies approximately $1.3 billion and, in the most such as Slice Labs and LimelightHealth. In many recent round of fundraising, Oscar was valued at cases, these financing rounds had multiple $3.2 billion. strategic or corporate participants investing at the same time.

Investments Across Industry Sectors Was At the same time, traditional venture capitalists Uneven but Consistent with Existing Trends continue to show strong interest in insurtech investments. VC firms such as Accel Partners, Investments were robust in the health insurance NEA Ventures Ribbit Capital continue to be and P&C sectors, while substantially fewer deals among the most active investors putting money and dollars were directed toward companies to work in this space. in the life insurance space. This story – of a disproportionately high level activity in INSURTECH COMPANIES CONTINUE health/P&C sectors as compared to the life TO ATTRACT ATTENTION – AND LARGE insurance sector – has been consistent over the past several years. While there are insurtech AMOUNTS – FROM INVESTORS companies that continue to develop their businesses in the life insurance space – such as Some of the largest financing deals of 2018 Ladder Life, Sureify and Haven Life – this trend were landed by familiar names in the insurtech may also be evidence that the life insurance ecosystem. Insurtech companies that returned puzzle is a more challenging nut to crack. At to the headlines with significant fundraising the same time, this trend may also provide an rounds included Metromile, which raised outsized opportunity for investors and insurers $90 million in a funding round from investor that can build a better life insurance mousetrap. Tokio Marine Intact Financial. To date, the car insurance platform has raised almost $300 million in financing. Other noteworthy fundraisers include digital insurance distribution

100 Global Insurance Industry Year in Review platform Next Insurance, with an $83 million On the strategic side, Munich Re (through its Series B funding led by Nationwide Ventures, subsidiary Hartford Steam Boiler) acquired Munich Re/HSV Ventures and Redpoint Ventures Internet of Things (“IoT”) start-up, relayr, for (total raised to date: $131 million), HR/benefits $300 million. Berlin-based relayr’s software platform Namely, with a $60 million Series platform enables industrial companies to E funding led by Sequoia Capital and GGV develop data insights from existing machinery Capital (total raised to date: $231 million), and and production lines using sensors and similar US payroll and benefits platform Gusto, with a devices. The data collected and used by relayr $140 million Series C funding led by CapitalG has the potential to provide new and improved (Alphabet’s growth equity fund), MSD Capital underwriting data, as well as new options and Ribbit Capital (total raised to date: $316 for developing products and services using million). this data.

Many of the largest funding rounds in 2018 COLLABORATION AMONG NEW AND went to providers of software platforms that streamline, enhance or improve a critical part ESTABLISHED PLAYERS – INSIDE AND of the insurance value chain. In addition to OUTSIDE THE INSURANCE INDUSTRY those platforms mentioned already, Policybazaar – CONTINUED TO BE A DRIVER OF attracted a $238 million investment from Japan’s Softbank and Singapore’s Temasek. India’s INNOVATION largest insurance aggregator website provides information and comparisons on life, health and Collaboration remains robust between and auto insurance products, among others. among incumbent carriers, start-ups, venture capitalists and leading technology companies (among others) in the insurtech ecosystem. INSURTECH M&A CONTINUED TO BE DRIVEN BY BOTH STRATEGIC AND These collaborations can take different forms, PRIVATE EQUITY BUYERS such as the cross-border alliance between Sompo Japan Nipponkoa and Chinese While industry heavyweights continued to insurer ZhongAn International. As part of this expand their insurtech endeavors through arrangement, which was announced in late acquisition, at the same time private equity 2018, ZhongAn will provide an IT insurance buyers and other financial investors continued platform to be developed for the Japanese to compete for controlling or 100% stakes in market and Sompo will support ZhongAn’s insurtech businesses. One of the largest deals expansion into Japan. of the year was the purchase by private equity sponsor the Carlyle Group of a majority stake Insurtech collaborations are also stretching in Sedgwick Claims Management Services across industries. For example, 2018 also saw Inc. The interest in Sedgewick was sold by the announcement of Swiss Re’s partnership KKR & Co. for $6.7 billion; the exact size of the BMW, which will enable Swiss Re to use BMW’s interest was not reported publicly. Sedgwick is driver-assistance systems in its development of a provider of technology-enabled risk, benefits bespoke insurance products and its calculation of car insurance premiums. and integrated business solutions.

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Collaborations accelerate the pace of innovation the DFS cybersecurity regulation and the NAIC by putting together the respective strengths model law build on existing data privacy and of collaborators. In addition, collaborations consumer breach notification obligations by also pave the way for the development of requiring insurance licensees to comply with ecosystems that align complementary services. detailed requirements regarding maintaining an In the year ahead, insurance companies that information security program and responding to invest in collaborations like these may have the and giving notification of cybersecurity events. opportunity to define their roles in ecosystems, which may look very different from the roles that Throughout 2018, US states have been hesitant insurance companies have typically played in to adopt the Insurance Data Security Model the market and with their customers. Law – on May 3, 2018, South Carolina became the first state to enact the NAIC model law and REGULATORS CONTINUED TO ADAPT legislation. Ohio followed suit on December 19, 2018 and legislation to enact the model law TO INSURTECH INNOVATIONS AND THE was also introduced in 2018 in Rhode Island, PACE OF CHANGE but has not yet passed. While it is perhaps expected that South Carolina and Rhode Island, Due to the unique regulatory framework that who had led the development of the model law, governs the insurance industry, utilization of would be among the first to seek its adoption, innovative technology, particularly where use we would expect to see similar bills to enact of such technology could potentially present the model law introduced in additional states in a security risk for consumer information, can 2019. The Insurance Data Security Model Law often run into distinct regulatory hurdles that has been well received at the federal level, with have the potential to ultimately hinder the the Department of the Treasury, in its October innovation process. Accordingly, as the past five 2017 Report on Asset Management and years have seen a growing trend of increasingly Insurance, strongly endorsing the model law and sophisticated cyberattacks which have, in recommending that Congress consider adopting many ways, outpaced current data security federal legislation that would preempt state law technology, regulatory authorities are beginning if the model law is not adopted within five years. to turn to compliance regimes to combat Accordingly, one can expect that cybersecurity these threats. will remain a crucial topic for the insurance sector throughout 2019. (See Technology- In an effort to address some of the concerns Cybersecurity & Data Privacy chapter on raised around both increasing cybersecurity page 106.) risks and use of new technology, two major events occurred during 2017. The New York Generally speaking, US state insurance Department of Financial Services (“DFS”) regulators are faced with the challenge of adopted a comprehensive cybersecurity striking a balance between providing an regulation, and the National Association of environment which encourages innovation while Insurance Commissioners (“NAIC”) adopted simultaneously protecting sensitive policyholder an Insurance Data Security Model Law. Both data. Given the rapid evolution of insurtech

102 Global Insurance Industry Year in Review innovations the insurance industry is absorbing, include full ERP, HR, policy management and such regulators may have trouble analyzing claims processing systems. Critical legal risks and regulating these new technologies and flow from dependence on cloud providers technology uses. To address this concern, the and the provider’s access to data. Systems State Ahead strategic initiative of the NAIC (see integration providers play a vital role in bridging article, “State Ahead – the NAIC’s Continuing from old to new systems. Modernization Program: 2018 Initiatives Focus on Data Collection and Data Management” in Customer expectations of fast, seamless the Insurance Regulatory-US/NAIC chapter on interfaces is driving licensing and development page 86), plans to provide resources for state of mobile applications and applications program insurance regulators to evaluate developments interfaces (“APIs”). APIs, which allow systems in technologies impacting the insurance to interconnect directly without a human bridge, industry. can establish not only faster and cheaper but “stickier” connections with insureds, reinsurers, and others. APIs, because of their roles at the TECHNOLOGY TRANSACTIONS corporate border, require specialized licensing terms and commercial terms appropriate to The industry’s strong investment in insurtech automated commerce. companies paralleled continued strong investment in digital transformation of existing A type of software called “robotic process platforms. Facing a risk of disruption from automation” (“RPA”) allows companies to fintech companies and more agile competitors, quickly and easily automate repetitive, rules- insurance companies are engaging end-to- based functions such as checking web sites, end digital transformation. Data, digital, transferring data across systems, and creating outsourcing and software transactions are a reports. RPA software from companies like Blue critical part of that transformation. Technology Prism and Automation Anywhere appears to is evolving too quickly for any company to go software applications and cloud tools to be a it alone. human user, so it knits together legacy systems and third party clouds with little programming. DIGITAL TRANSFORMATION OF The RPA “bots” work faster and more accurately than human at appropriate tasks. EXISTING PLATFORMS All of this automation had a transformative Legacy system modernization is driving deals in effect on outsourcing in 2018. Outsourcers software, implementation services and cloud. offered integrated packages of automated and By moving critical functions to cloud platforms, human services with new pricing models based, insurers are reducing costs and developing not on time expended, but on work done or the fast, agile platforms that win business and outcomes achieved. Those deals required sustain customer relationships. The technology fundamentally different terms than the prior transactions range from “Infrastructure as a generation of deals to address the new risks of Service” (“IaaS”) deals with cloud providers the automations and avoid paying for people such as Amazon Web Services and Google to who are no longer part of service delivery. “Software as a Service” (“SaaS”) deals that

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However, the benefits will be substantially In this technology-saturated business greater leveraging a vendor’s “human + environment, companies faced an expanding machine” model as compared to traditional number of digital connections and an explosion outsourcing. Insurers renegotiated, retrofitted, of data. As a result, value shifted to how rationalized and replaced deals to gain the companies integrate, orchestrate and curate benefits. their connections and how they gather, store and exploit data to achieve their missions. As noted above, traditional players have been collaborating with fintech companies. This shift in value naturally shifted the focus for Collaborative “white label platform” deals technology transactions lawyers. Increasingly, allowed established companies to rapidly technology transactions lawyers looked beyond establish a customer-friendly, cloud-enabled technology services, requirements and rights to platform. In the “white label” deals, the integration, governance, decision rights, platform provider agrees to interface in and outcomes. There was continued focus a traditional manner with legacy systems on data governance, privacy compliance and at the insurer such as underwriting, policy cybersecurity risk management to protect the management and claims processing and in an value that companies have created in data. advanced digital manner with customers and prospects. These types of transactions raise all of the issues of traditional outsourcing deals but BIG DATA ANALYTICS also novel issues related to having a third-party technology supplier at the customer interface. In 2018, insurers continued to unlock the value The suppliers often seek rights in the data of data with machine learning and other big generated or the customer relationships and data analytics tools. Those tools are delivering the insurers find themselves at risk for decisions business value by producing actionable insights made by providers with newer technology and and augmenting human skills in judgment- higher risk tolerance. based functions. One key fact is that it is often difficult or even impossible to limit how these tools use data or to explain why they deliver DATA AT THE CORE the insights that they deliver. That means that “build to spec” contracts are difficult to write, In 2018, the hottest technologies were focused driving collaborations priced on a sharing of on new ways to gather, store, analyze, and value created. exploit data. Connected devices gathered vast amounts of new data, which was then stored The exponentially growing power and wider on new cloud-based database platforms and implementation of big data tools demanded analyzed using new advanced analytics tools, attention in related technology transactions. often to deliver products and services that didn’t The input data, tuning parameters, models, exist a few years ago. These new technologies and the resulting predictions may not be are, of course, at the core of insurtech. protected by intellectual property laws at all and therefore must be protected contractually and

104 Global Insurance Industry Year in Review by technical protections designed to preserve BLOCKCHAIN AND DISTRIBUTED secrecy. Thus, new attention was focused on LEDGER TECHNOLOGIES how to allocate control and use rights for those new outputs. Blockchain and other distributed ledger Big data technologies increase the value of technologies (“DLTs”) hold immense promise new data flows, including those from sensors for reducing fraud and administrative costs and other connected devices, that allow usage- throughout the insurance supply chain. based insurance products, more accurate Industry blockchains could act as a “single underwriting, and better fraud detection. source of truth” for our fragmented industry Insurers obtain data from an increasing number with immutable records updated only with of sources. Some of these sources are under cryptographic keys. As an easy example, DLT contracts titled “data license agreements,” could reduce recordkeeping and dispute but most are under other types of agreements. resolution risk and cost in multi-party insurance Those other agreements might include contracts. As bitcoin has demonstrated for the subscription agreements, website terms of use, blockchain DLT, a workable DLT can facilitate outsourcing agreements, purchase and sale “trustless” transactions on a global basis. agreements, alliance agreements and other commercial agreements. Data acquired from To do that, though, there will need to be third parties generally come with license and an immense amount of coordination and use restrictions, and may come with restrictions investment by industry participants to build DLTs that attach to personal data. Thus, insurers are for insurance use cases. A major development looking at these types of contracts as data and in 2018 was the incorporation of the Blockchain technology contracts. Insurance Industry Initiative, or B3i, with the intent of launching its first product, a property Insurtech companies and industry leaders catastrophe excess of loss product called continue to work to use “big data” to provide Property Cat XOL, in January 2019. Founding the fast digital experience that consumers want, shareholders of B3i include Allianz, Generali, including smarter chatbots and faster insurance Hannover Re, Liberty Mutual, Munich Re, SCOR, decisions. Deals in this area are still limited by Swiss Re, Tokio Marine, XL Catlin and Zurich the emerging state of artificial intelligence as Insurance Group. Meanwhile, The RiskBlock applied to insurance decisions. Insurers also Alliance, the distributed ledger technology have to navigate the emerging US insurance consortium formed in 2017 by The Institutes regulatory landscape for use of big data as in Malvern, Pennsylvania, announced that has discussed in the article “Artificial Intelligence 30 members and is focusing on use cases in and Its Increasing Impact on the Insurance first notice of loss, subrogation and parametric Industry” in the Insurance Regulatory-US/NAIC insurance are being developed. chapter on page 60. As of 2018, a DLT project involves numerous technology transactions, including a license to the foundational blockchain software, a cloud services contract for running the platform,

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software development agreements, licenses GDPR defines personal data as “information and services agreements among the consortium relating to an identified or identifiable and the participants. Technology providers are natural person,” and establishes a number seeking to develop “one stop shop” products, of protections for and restrictions on the which could accelerate the use of DLT. use and transfer of such personal data. Crucially, GDPR sets a very low bar for what is CYBERSECURITY & DATA PRIVACY considered “identifiable”: if a natural person can be identified using “all means reasonably THE EU’S GDPR HAS GLOBAL EFFECTS likely to be used,” the information would be considered “personal data.” Accordingly, The European Union’s General Data Privacy data may be considered personal data even Regulation (“GDPR”) went into effect on May if the organization holding such data cannot 25, 2018 and establishes what is probably the itself identify the natural person to whom such most rigorous data protection regime currently data pertains. Indeed, the name of a natural in existence. As adopted, GDPR includes person would not be required to establish that numerous restrictions on the use of individual information is “personal data” – any identifier, personal data, coupled with an expansive including an identification number, location extraterritorial reach that makes compliance with data, online identifier or other similar factor its provisions a concern for many businesses may be considered an identifying factor for a who maintain even relatively minor connections natural person. with the European Union. As a regulation, it is directly binding and applicable in all Member While the GDPR includes many requirements, States of the European Union and need not be most relevant to insurance organizations may transposed into each Member’s national law. be the significantly enhanced rights provided to individuals, and these enhanced rights are GDPR and the heightened restrictions it coupled with specific provisions that make it establishes regarding the use of personal easier for such individuals to claim damages information will have a major effect on insurance for compensation for violations of such rights. industry participants that are subject to GDPR. These rights include, with exceptions: The collection and use of personal information is a core business practice of the insurance i. a right to access personal data in a concise, industry worldwide. Personal information is transparent and easily accessible form; obtained by insurers, producers and other service providers in order to design, underwrite ii. a right in certain circumstance to have and distribute insurance products and services personal information erased; to consumers. Consequently, a data protection regime that could restrict such entities in iii. a right to receive or have transmitted to accessing and processing personal information another controlling entity all personal data would require significant reevaluation of their concerning them in a structured, commonly foundational operational practices. used and machine-readable format;

106 Global Insurance Industry Year in Review iv. a right to object to the processing of iii. perform data protection impact assessments personal data; and for high-risk processing; v. a right not to be subject to automated iv. designate a data protection officer to advise decision-making processes, including on compliance with GDPR and generally profiling. monitor data protection efforts;

As a practical matter, the extremely expansive v. maintain a comprehensive record of data definition of “personal data” means that breaches, including notifying individuals organizations that must comply with GDPR where necessary; have needed to institute compliance practices across a far wider range of data processing and vi. impose specific contractual requirements utilization practices than ever before. Further, on third parties that personal data is shared even if an organization is not established within with; and the European Union, it can still be subject to GDPR if it processes the personal data of vii. implement “data protection by design and individuals who are in the European Union by default.” where the processing activities are related “to the offering of goods or services” to such Ultimately, laws such as GDPR represent a individuals in the European Union or “the paradigm shift for data-centric industries, like monitoring of their behavior” to the extent insurance, which are anchored in the use of that their behavior takes place within the personal information. While many insurance European Union. industry participants have begun to adjust for the increased restrictions of GDPR, these In order to comply with GDPR, organizations regimes present more than cosmetic legal need to be in a position to affirmatively and compliance challenges, but require demonstrate to supervisory authorities organizations to overhaul their thinking on the and data subjects that they have affirmatively way that they collect, process, store, share and complied with the relevant provisions of discard personal data. the regulation. GDPR particularly sets out enhanced governance obligations, including If regimes similar to GDPR are adopted more requirements to: widely, basic services provided by insurance companies, producers and other service i. keep a detailed record of processing providers, down to the issuance of policies and operations; processing of claims, will have to be reevaluated in the light of the enhanced protections for ii. provide a fair processing notice to personal data and increased consent rights individuals whom personal data is being for individuals. processed about that explains the purposes and legal basis of the processing as well as For more on this topic, please see our other information; GDPR Portal.

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CALIFORNIA ADOPTS GDPR-LIKE Similarly, the CCPA grants consumers who are California residents a number of rights, some REGULATION of which are broadly analogous to the rights established by GDPR, including (with certain On June 28, 2018, the State of California exceptions): enacted the California Consumer Privacy Act (“CCPA”), which is intended to establish a data 1. a right for consumers to receive affirmative protection regime that is, in many ways, inspired disclosures from organizations covered by GDPR, and will come into effect on January by the CCPA of such organizations’ sale, 1, 2020, with regulations to be issued by the collection or disclosure of such individuals’ California Attorney General no later than July 1, personal information, and the requirement 2020. that such organizations respond to requests for information from such individuals; For purposes of the CCPA, “personal information” is defined as “information that 2. a right for consumers to access specific identifies, relates to, describes, is capable of pieces of information collected about them being associated with, or could reasonably be by an organization; linked, directly or indirectly, with a particular consumer or household,” a definition that has 3. a right for consumers to request the a similar broad scope to the definition utilized deletion of their personal information from by GDPR. The CCPA, like GDPR, imposes a organizations that hold such information; number of restrictions on organizations beyond the physical borders of California, including on 4. a right for consumers to opt-out of the sale any organizations that control personal data and of personal information to third parties; and do business in California, albeit only subjecting those organizations to the extent that they 5. a right for consumers not to be subject to process data of California residents. However, discrimination for exercising their rights the CCPA has not set out any principles under the CCPA. regarding the lawful processing of personal data – though given how recently the CCPA The Attorney General may sue to enforce these was passed, there is a significant likelihood that rights with penalties of no more than $2,500 per California regulatory authorities, including the violation or $7,500 for each intentional violation. Attorney General, may issue guidance on this Private citizens may only sue to redress the point. Indeed, the CCPA requires the Attorney unlawful exfiltration or disclosure of limited General to issue regulations implementing categories of personal information (name, social certain of its provisions (for example, instructing security number, driver’s license number and how businesses can “reasonably verify” certain financial, medical and health insurance consumer requests) and authorizes the adoption information) regardless of whether any actual of additional regulations as necessary to further injury can be proven. the CCPA’s purposes.

108 Global Insurance Industry Year in Review While the CCPA exempts from its coverage The requirements for which compliance was personal information covered by certain federal required as of September 4, 2019 are: laws, including the Gramm-Leach-Bliley Act and the Fair Credit Reporting Act, the exemption • Audit Trail (Section 500.06); does not extend to the covered businesses maintaining this information (e.g., no blanket • Application Security (Section 500.08); exemption for insurance companies). • Limitations on Data Retention (Section For more on this topic, please see our July 2018 500.13); Legal Update. • Monitoring of Authorized Users (Section NY DFS CYBERSECURITY COMPLIANCE 500.14(a)); and

REQUIREMENTS EXPAND • Encryption of Non-public Information (Section 500.15). On February 16, 2017, the New York Department of Financial Services (“DFS”) Regarding the Audit Trail requirements, Covered finalized the Cybersecurity Regulation for Entities must secure and maintain systems that Financial Services Companies (“Rule”) (1) are designed to reconstruct material financial mandating cybersecurity standards for all transactions sufficient to support normal institutions authorized by DFS to operate in New operations and obligations of the Covered York (“Covered Entities”). Under the DFS Rule, Entity, and (2) include audit trails designed to Covered Entities include insurance companies detect and respond to cybersecurity events that are licensed to do business in New that have a reasonable likelihood of materially York, as well as New York-licensed insurance harming any material part of the normal producers and claim-adjusting firms/third-party operations of the Covered Entity. The records administrators. However, the DFS Rule exempts required by this section must be retained for five accredited reinsurers, certified reinsurers, non- years and three years respectively. New York risk retention groups, and charitable annuity societies from the definition of Covered Regarding the Application Security Entity. Excess and surplus line insurers are also requirements, Covered Entities must adopt not Covered Entities. written procedures, guidelines and standards that will ensure the use of secure development The Rule became effective on March 1, 2017 practices for applications developed in-house and compliance with a significant portion of that are used by the Covered Entity. In addition, the regulation was required on August 28, Covered Entities must implement procedures 2017. Compliance with certain provisions for evaluating, assessing or testing the security became required in 2018, with additional a final of externally developed applications used by compliance date on March 1, 2019 for the third- the Covered Entity. These procedures, guideline party service provider requirements. and standards must be periodically reviewed, assessed and updated by the Chief Information Security Officer (“CISO”) (or qualified designee).

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Regarding the Limitation on Data Retention Act gives companies that take certain steps to requirements, Covered Entities must implement create, maintain and comply with a written cyber policies and procedures for the secure disposal program an affirmative defense to data breach of nonpublic information that is no longer claims sounding in tort (such as negligence) necessary for business operations or for other brought under the laws or in the courts of Ohio. legitimate business purposes of the Covered It remains to be seen whether the Act will have Entity. There is an exception for information a practical impact on companies’ approaches to required to be retained by law, or when the cyber risk management or their liability exposure disposal of such information is not feasible after a data breach. The Act nonetheless is because of the manner or form in which the important because it suggests a new approach information is stored. to the regulation of cybersecurity practices and liability after a data breach (a similar provision Regarding the Monitoring of Authorized Users was included in the Ohio implementation of the requirements, Covered Entities must implement NAIC Model Law in December 2018). risk-based policies, procedures, and controls to monitor the activity of authorized users The Act does not “create a minimum and detect their unauthorized access, use, or cybersecurity standard” or “impose liability tampering with, of nonpublic information. upon businesses that do not … maintain practices in compliance with the act”. Finally, regarding the Encryption of Nonpublic Instead, the Act enables companies to Information, Covered Entities must implement assert an affirmative defense based on their encryption controls to protect their nonpublic implementation of a written security program. information stored or transmitted. Where encryption of such nonpublic information is not To successfully maintain such a defense, a feasible, the Covered Entity may secure such company would have to show that its security information using alternative compensating program contains administrative, technical and controls reviewed and approved by its CISO. physical safeguards designed to protect either To the extent a Covered Entity is using such “personal information” or “personal information alternative controls, the feasibility of encryption and restricted information.” and effectiveness of the controls must be reviewed at least annually. “Personal information” is defined elsewhere in the Ohio Code as “an individual’s name, OHIO ADOPTS CYBERSECURITY SAFE consisting of the individual’s first name or first initial and last name, in combination with and HARBOR linked to any one or more of the following: social security number; driver’s license or On August 3, 2018, Ohio enacted the state ID number; account or credit/debit Cybersecurity Safe Harbor Act (the “Act”), number (in combination with a password).” intended to use the promise of relief from “Restricted information” is defined by the Act legal liability to incentivize companies to adopt as any information that can be used, alone appropriate cyber protections. Specifically, the or in combination with other information, to

110 Global Insurance Industry Year in Review distinguish or trace the individual’s identity or The Act requires companies to have “reasonably that is linked or linkable to an individual and conform[ed]” to one of the industry-recognized “the breach of which is likely to result in a frameworks in order to rely on the affirmative material risk of identity theft or other fraud to defense. Those frameworks available for non- person or property.” The definitions of both regulated companies include: personal and restricted information exclude information that is encrypted, redacted or • NIST Cybersecurity Framework; otherwise rendered unreadable. • NIST Special Publications 800-171 or The Act further specifies that a company Special Publications 800-53 and 800-53a; asserting the affirmative defense must establish that it implemented a written cyber program • Federal Risk and Authorization Management designed to: Program (“FedRAMP”)’s Security Assessment Framework; 1. “protect the security and confidentiality of the information,” • Center for Internet Security Critical Security Controls; and 2. “protect against any anticipated threats or hazards to the security or integrity of the • ISO/IEC 27000 family of information security information,” and standards.

3. “protect against unauthorized access to and Companies regulated by sector-specific laws acquisition of the information that is likely may rely on the affirmative defense if they to result in a material risk of identity theft or can demonstrate that their plan conforms to other fraud to the individual to whom the one of the applicable security requirements, information relates.” identified in the Act as the Health Insurance Portability and Accountability Act (“HIPAA”), The Act provides that the scale and scope of a Health Information Technology for Economic company’s program should be shaped by (1) the and Clinical Health Act (“HITECH”), Title V company’s size and complexity, (2) the nature of the GLBA, and the Federal Information and scope of their activities, (3) the sensitivity of Security Modernization Act (“FISMA”). To avail their information, (4) the cost and availability of themselves of the Act’s protections, companies tools to improve security and (5) the resources accepting credit cards must comply with the available. Developing a written information Payment Card Industry Data Security Standard security program of this type may be familiar in addition to one of the generally applicable to insurance entities, since having a security frameworks listed above. plan in place is required by certain regulations (see, e.g., the Gramm-Leach-Bliley Act (GLBA) Simply having drafted a written security implementing regulations) and included as a program would not be sufficient to establish the recommendation in existing best practices (see, affirmative defense. Companies must also have e.g., the Federal Trade Commission and the maintained and complied with their programs, National Institute of Standards and Technology although the Act provides no further information (NIST) Framework).

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on how a company would demonstrate that As stated in the Strategy, that outline is they have satisfactorily done this, nor does the structured around four pillars: Act specify how a company would show that its plan “reasonably conforms” with one of the 1. Defend the homeland by protecting identified frameworks. networks, systems, functions, and data

As indicated above, defendant companies 2. Promote American prosperity by nurturing would not be able to rely on the Act to avoid a secure, thriving digital economy and the early stages of litigation, but rather would fostering strong domestic innovation have to make a substantial showing in order to benefit from the safe harbor that it provides. 3. Preserve peace and security by Moreover, it remains to be seen whether data strengthening the United States’ ability – in breach plaintiffs will bring their suits outside concert with allies and partners – to deter Ohio or under legal theories other than the tort and, if necessary, punish those who use claims covered by the statute. As a result, the cyber tools for malicious purposes Act may well have limited immediate impact for companies as they continue to refine their cyber 4. Expand American influence abroad risk management programs or as they defend to extend the key tenets of an open, against data breach litigation. Nonetheless, interoperable, reliable and secure Internet the Act may prove to be a significant milestone in ongoing policy debates over cybersecurity According to the Strategy, the US government regulation and litigation, particularly if this will seek to achieve the goals in these pillars model is followed by other states or draws during “a new era of strategic competition” in interest of federal policymakers. which the threat of “peacetime cyber attacks” and “cyber attacks…short of war” is growing. THE UNITED STATES RELEASES A As a roadmap to achieving these goals, each of the Strategy’s four pillars includes numerous NATIONAL CYBER STRATEGY “priority actions” that the Administration intends to take or support. On September 20, 2018, the Trump Administration released a comprehensive The Strategy’s first and most detailed pillar National Cyber Strategy (“Strategy”). The addresses how to manage cybersecurity risks Administration’s stated objective in issuing the to “increase the security and resilience of the Strategy is to outline “how the United States Nation’s information and information systems.” will ensure the American people continue to It focuses on three topics: reap the benefits of a secure cyberspace that reflects our principles, protects our security, and 1. Securing Federal Networks and Information, promotes our prosperity.” 2. Securing Critical Infrastructure, and

3. Combating Cybercrime and Improving Incident Reporting.

112 Global Insurance Industry Year in Review Many of the priority actions under these topics and the development of cyberspace as an open apply principally to the federal government. engine of economic growth, innovation, and For example, the Strategy calls for further efficiency.” It focuses on three topics: centralizing cybersecurity management responsibilities for federal civilian agencies 1. Fostering a Vibrant and Resilient Digital under the US Department of Homeland Security Economy, (“DHS”) and improving the federal supply chain to enhance accountability for cybersecurity risks. 2. Fostering and Protecting United States Ingenuity, and Notably, many of the priority actions described in this pillar have the potential to impact private 3. Developing a Superior Cybersecurity sector entities as well, especially those in Workforce. critical infrastructure industries. For example, the Strategy provides that the government The priority actions highlighted to advance will engage with industry to improve risk these goals could align with certain private management for “critical infrastructure at the sector imperatives and concerns. For example, greatest risk,” a phrase associated with prior the Strategy calls on the government to executive orders, including Executive Order “promote best practices and develop strategies 13800, which directed the Secretary of DHS, in to overcome market barriers to the adoption of coordination with several other departments secure technologies.” (The Strategy does not, and agencies, to identify legal authorities however, recommend regulatory enforcement and capabilities that could be employed to or rulemaking to improve cybersecurity.) The support the cybersecurity efforts of high-risk Strategy also states that the government will critical infrastructure entities. The Strategy explore the use and potential risks of emerging also prioritizes “risk-reduction activities across technologies such as artificial intelligence and seven key areas: national security, energy and quantum computing and work with the private power, banking and finance, health and safety, sector and civil society “to ensure secure communications, information technology, and practices are adopted from the outset.” transportation.” The Strategy also identifies “full-lifecycle The Strategy describes prospective initiatives cybersecurity” as a priority and indicates for several specific industries as well, including that the government will “promote regular transportation and maritime cybersecurity, and testing and exercising of the cybersecurity information and communications technology and resilience of products and systems during providers. In addition to critical infrastructure development.” In particular, the Strategy efforts, the Strategy also identifies priority highlights coordinated vulnerability disclosure actions with respect to cybercrime and as one tool to improve cybersecurity resiliency. cybersecurity incidents that could impact private This has been an area of significant public and entities across economic sectors. private sector activity in recent years, as the role of vulnerability management in protecting The second pillar of the Strategy identifies networks and systems has increased with high- priority actions designed to preserve “United profile cyber attacks exploiting vulnerabilities in States influence in the technological ecosystem common technology platforms.

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The Strategy’s third – and perhaps most discussed by the media – pillar identifies priority actions designed to identify, counter, disrupt, degrade, and deter behavior in cyberspace that is destabilizing and contrary to national interests, “while preserving United States overmatch in and through cyberspace.” The Strategy also calls for the imposition of “swift and transparent consequences” for malicious cyber activities, and heralds a new international Cyber Deterrence Initiative that would seek to build a coalition of like-minded states to collectively impose such consequences and thus augment their deterring effect.

The Strategy’s final pillar identifies actions to “[p]reserve the long-term openness, interoperability, security, and reliability of the Internet, which supports and is reinforced by United States interests.” This section is devoted to explicating the American position on “Internet freedom” and its inextricable connection to national security and the advancement of American values.

The Administration’s Strategy identifies a wide array of actions that are intended to improve the nation’s cybersecurity posture. Although it remains to be seen how the Strategy’s specific objectives will be implemented, the Administration is already taking some initial steps to advance certain goals. It will be important to follow developments closely to track how this high-level strategy will be implemented in practice.

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Tax

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OVERVIEW THE BEAT

The major tax developments in the US insurance Some analysts have described the BEAT as a industry in 2018 all dealt with the issuance minimum tax on transactions between a US of Treasury guidance regarding the so-called taxpayer and a related foreign person. In broad “Tax Cut and Jobs Act” enacted in December terms, the BEAT requires US taxpayers subject 2017 (the “TCJA”). The TCJA made significant to the BEAT12 to recalculate their taxable income changes to life insurance company taxation, without the benefit of “base erosion payments” including in the calculation of reserves, in the to determine the taxpayer’s “modified taxable calculation of OAC, and in tax reporting on life income.” The taxpayer then multiplies his settlement transactions. The Act also made “modified taxable income” by the BEAT significant changes affecting non-life insurance tax rate.13 If that product is higher than the companies, including the modification of the taxpayer’s regular tax liability, then the taxpayer method for discounting reserves. The TCJA must pay a BEAT tax equal to the excess of that included changes in the general tax rules product over the regular tax amount. No BEAT regarding international transactions and cross- is due if the taxpayer’s regular tax exceeds the border ownership structures. We have found product of the taxpayer’s “modified taxable considerable interest among our insurance income” and the BEAT tax rate. industry clients in how those changes affect the US taxation of international insurance Many commentators have observed that, at transactions. We have seen considerable least in the insurance industry, the BEAT acts interest in how the “Base Erosion Anti- similarly to Congressman Neal’s oft-repeated Avoidance Tax” (“BEAT”) and the new rules proposals to limit tax benefits that US insurance regarding “Global Intangibles Low-Taxed company subsidiaries of foreign groups arguably Income Included in Gross Income of United may have obtained pre-TCJA on reinsurance States Shareholders” (“GILTI”) apply to the US premiums paid to related foreign reinsurers insurance industry, and how the modification of in low tax countries. There can be no doubt the exception to the Passive Foreign Investment that the offshore insurance industry was a Company (“PFIC”) rules for insurance target of the BEAT. The proposal, as originally companies will be implemented. We will passed by the Senate, defined a “base erosion briefly summarize 2018 developments in payment” as any tax deductible amount paid these three areas. to a related foreign party. At that time, some interested parties argued that reinsurance payments by non-life insurance companies

12 The BEAT applies to US taxpayers that are members of an aggregate group with annual average gross receipts of over $500 million over a three-year period and a “base erosion percentage” (broadly, the ratio of base erosion payments to total deductions) of more than 3% (or 2% in the case of banks and registered securities dealers).

13 The BEAT tax rate in 2018 is 5% (6% for banks and registered securities dealers), in 2019-2024 is 10% (11% for banks and registered securities dealers) and in 2025 and after is 12.5% (13.5% for banks and registered securities dealers).

118 Global Insurance Industry Year in Review were not “base erosion payments” because not “deductions” subject to section 59A(d)(1)) reinsurance payments are an amount subtracted should be treated as base erosion payments. from “premiums earned” under section 832(b) The Treasury also asked for comments on (5) in determining “gross income” for a non- whether life insurance companies should life insurance company, and therefore were not exclude claims payments in a similar manner, “deductions” covered by the original definition even though life companies are not subject of “base erosion payment.” That theory was to section 832(b)(3), and there is no analog to short-lived. In the final bill, Congress added section 832(b)(3) in section 803 which defines section 59A(d)(3) to the definition of “base “life insurance gross income.” erosion payments.” Section 59A(d)(3) provides that the term “base erosion payment” shall We understand that some industry participants also include “any reinsurance payments which prefer excluding claims payments from are taken into account under section 803(a)(1) deductions, and thus from treatment as “base (B) or 832(b)(4)” if they are paid to a related erosion payments.” We also understand foreign party. So regardless of whether an that other participants prefer keeping claims insurance payment to a related foreign party is a payments as “deductions” so that the “deduction” from gross income or “subtraction” denominator of their “base erosion percentage” from gross receipts in determining gross fraction (i.e. all “deductions”) is higher, with income, such a reinsurance payment is a “base the result that their base erosion percentage erosion payment.” is lower, and that the company will fall below the 3% base erosion percentage threshold and The proposed regulations interpreting the not be subject to the BEAT. Other participants BEAT issued in December gave some guidance argue that related party claims payments for insurance companies. The proposed should be excluded from the numerator of regulations provide amounts paid as premiums the base erosion percentage fraction but all on a reinsurance contract are not netted against claims payments should be included in the ceding commissions or claims payments, even denominator We shall see. if the contract is settled on a net basis [Prop. Treas. Reg. §59A-3(b)(2)(ii)]. The proposed GILTI regulations do not address the treatment of payments to foreign insurance companies The GILTI rules seem designed to attack a tax electing to be taxed as domestic companies planning strategy that has not been widely used under section 953(d). But the Treasury stated in in the insurance industry, but the GILTI rules the preamble to the proposed regulations that may nevertheless apply to insurance companies. such payments are not base erosion payments The language used in section 951A suggests because the section 953(d) insurance company that Congress’s goal in enacting GILTI was to is treated as a domestic person for purposes of currently tax some of the intangible income that the Code. a few high tech companies (Apple? FaceBook? Big Pharma?) have previously been able to build The Treasury asked for comments on whether up offshore, free of any tax. But the operations claims payments made by non-life companies of section 951A could easily catch US insurance which may be treated as reductions in gross companies with foreign subsidiaries. income under section 832(b)(3) (and therefore

Mayer Brown 119 6 Tax

Section 951A requires a United States Although many insurance industry participants shareholder of a controlled foreign corporation argued that CFC income which is excluded (“CFC”) to include in gross income that from subpart F income by means of the active shareholder’s “global intangible low-taxed insurance exception could also be treated as income.” GILTI is defined as the shareholder’s excluded from foreign base company income “net CFC tested income” for the year over (and thus excluded from net CFC tested income the “net deemed tangible income tax return.” and GILTI) by reason of the high tax kickout, The main element of “net CFC tested income” the Treasury disagreed. Treasury interpreted is the gross income of a CFC determined the phrase “by reason of” the high tax kickout without regard to subpart F income of the CFC. in the statute excluding insurance income “Net deemed tangible income return” is the from foreign company base income to mean excess of 10% of the “qualified business asset “solely by reason of”. (Prop. Reg. §1.957A-2(c) investment” (“QBAI”) (i.e., the adjusted basis of (iii).) So because an item of CFC insurance depreciable tangible property used in the trade income might be both excluded from subpart or business) over the interest expense taken into F income by operation of the section 953(e) account in determining the shareholder’s net active insurance income and excluded from CFC tested income. foreign base company income by means of the section 954(b)(4) high tax kickout, that income Domestic corporations that are US shareholders not subpart F income, and therefore is treated of CFC’s operating insurance companies are “net CFC tested income.” Some have observed likely to find themselves caught in GILTI’s web. that it seems odd that insurance income which Insurance company CFC’s are likely to have Congress had previously deemed eligible for nearly all of their income be “net CFC tested two favorable rules to exclude that income from income” because most insurance company subpart F is now required to be taxed under the CFC’s are designed to qualify for the section unfavorable GILTI regime. 953(e) and 954(i) active insurance exemptions from Subpart F income. Because the insurance Not only is GILTI subject to current taxation in company CFC’s income qualifies for these the hands of a 10% US corporate shareholder, exemptions, that income is not subpart F GILTI is disadvantageous in other ways. One income. And because the income is not subpart of the more unfavorable aspects of the GILTI F income, the income is not eligible for the tax regime is that the deemed paid foreign tax exclusion from “tested income” for subpart credit is limited so that only 80% of the foreign F income. There is a similar exception from tax paid by the CFC with respect to GILTI is “tested income” for income that is excluded allowed to offset the US tax on GILTI income. from foreign company base income or insurance Another unfavorable aspect is that a separate income by the “high tax kickout” rule of section FTC basket is created for GILTI inclusions. 954(d)(3). Also, the typical insurance company CFC will have a relatively small amount of depreciable tangible property, so the offset of 10% of QBAI to reduce “net” CFC tested income has little effect for insurance companies.

120 Global Insurance Industry Year in Review SECTION 1297 PFIC EXCEPTION FOR INSURANCE COMPANIES

The PFIC regime generally applies to widely owned foreign corporations with significant amounts of passive income or assets which produce passive income. Insurance companies generally hold assets that produce passive income. Under prior law, a corporation “predominantly” engaged in the insurance business could treat its income from the “active conduct of an insurance business” as non- passive income for purposes of determining its PFIC status.

The TCJA changed this rule. The exception for insurance company income now only applies if the insurance company’s “insurance liabilities” constitute more than 25% of the insurance company’s assets, or at least 10% of the insurance company’s assets if the dip below 25% “is due solely to runoff related or rating-related circumstances” as determined under regulation to be issued.

Section 1297(f)(3) defines “applicable insurance liabilities” to mean loss and loss adjustment expenses and reserves (but not deficiency, contingency or unearned premium reserves). Regulations will presumably answer most of the many unanswered questions regarding the definition of terms related to the determination of insurance liabilities.

Some observers of this area have asked whether any new start-up insurance company could ever meet the 25%, or even the 10%, “applicable insurance liabilities” test. Will new Section 1297(f)(3) prevent the establishment of new foreign corporations in the offshore insurance world?

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