Acquisitions and Other Holding Company Transactions

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Acquisitions and Other Holding Company
Transactions
Danny Saenz Financial Analysis and Examinations
Chief Financial Analysis and Examinations Financia
l Program
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Topics of Discussion

• Overview
• Standards for Review of a Holding Company
  Transaction
• Holding Company Regulatory References
• Types of Transactions
• Reasons for Delay in Approvals
• Current and Future Developments
• Questions

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Overview
The Holding Company section is part of the
Financial Analysis and Examinations Division
Each Texas domestic insurance or commercially
domiciled company including health maintenance
organizations (HMOs) is assigned to a Financial
Analyst and a Holding Company Analyst Effective
September 1, 2005, Senate Bill 1284 made HMOs
subject of the Holding Company Act
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Overview continued
A Financial Analyst is responsible for
reviewing the Annual and Quarterly Statements,
CPA Audits, MDAs, as well as assisting the
Holding Company Analyst regarding the financial
impact of proposed transactions A Holding
Company Analysts primary responsibility is the
review and analysis of various transactions to
ensure that each meets the requirements of the
Texas Insurance Code (TIC), the Texas
Administrative Code (TAC), and Statements of
Statutory Accounting Principles (SSAP)
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Standards for Review of a Holding Company
Transaction
Standards for transactions with affiliates found
in TIC 823.101 are

• Must be a material transaction
• Terms shall be fair and equitable
• Charges/fees for services shall be reasonable
• Accurate books and records must be maintained
• Expenses incurred and payments received shall be
  allocated on an equitable basis or in conformity
  with customary insurance accounting principles
• The Companys Policyholder Surplus shall be
  reasonable in relation to its outstanding
  liabilities and financial needs

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Holding Company Regulatory References
Texas Insurance Code

• 823.102 and 823.103 relating to Materiality
• A transaction that involves more than the lesser
  of ½ of 1 of assets or 5 of surplus as of the
  preceding year
• 823.107 relating to Dividends
• 823.253 relating to General Standards for
  Investments in Affiliates
• 803 relating to Location of Books and Records
  outside of Texas
• 805 relating to Transactions with Officers,
  Directors and Shareholders

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Holding Company Regulatory References continued
Texas Administrative Code

• 7.7 relating to Surplus Debentures
• 7.203 relating to Registration of Insurers
• 7.204 relating to Filings requiring
  Commissioners Approval
• 7.205 and 7.209 relating to Form A
• 7.210 relating to Form B
• 7.211 relating to Disclaimers
• 7.212 relating to Extraordinary Dividends

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Holding Company Regulatory References continued
Statements of Statutory Accounting Principles
(SSAP)

• SSAP 25, Thresholds for Affiliated Transactions
• SSAP 40, Investments in Property
• SSAP 41, Surplus Debenture Notes
• SSAP 88, Valuation Alternatives for
  Subsidiaries
• SSAPs 61, 62, 68, and 75, Goodwill

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Types of Transactions

• Acquisitions of control, Exemptions from change
  in control, and Disclaimers
• Transactions with Texas domiciled affiliates
  (or commercially domiciled companies doing 30
  or more business in Texas)
• Form B Registration Statements
• Transactions with Officers, Directors and
  Shareholders
• Dividends and Distributions
• Applications to move books and records outside
  the State of Texas
• Surplus Debentures

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Types of Transactions continued
Total number of transactions processed during
Fiscal Years (FY) 2004 -- 2006

• FY 2004 734
• FY 2005 760
• FY 2006 -- 808

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Types of Transactions continued
Acquisitions of control and Exemptions from
change in control and Disclaimers

• Acquisitions are commonly referred to as Form As
• Largest and most complex transactions received
• Can involve multi-state approval
• Work closely with NAIC to coordinate review
  among other states
• Working Group set up by NAIC, headed by lead
  state, to track progress of transaction, address
  any concerns, and review of the Form A
• In 2005, the acquisition of the Pacificare group
  of companies by United-Health Group Inc.,
  included review by
• California, Colorado, Indiana, Nevada, Oklahoma,
  Oregon, Wisconsin, Washington, and Texas
• Issues included market share, provider issues,
  and executive compensation

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Types of Transactions continued
Form As continued

• Total number of Form As reviewed by our Holding
  Company Analysts during Fiscal Years 2004 --
  2006
• FY 2004 -- 13
• FY 2005 -- 22
• FY 2006 --- 20
• Total purchase price for the above Form As --
  19 billion

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Types of Transactions continued
Form As continued

• Important Issue regarding the Form A review
• Projections may cause delay in the approval
  process
• Analysts may have to request actual
  projections, revised projections, more complete
  projections, justifications

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Types of Transactions continued
Form As continued

• Exemptions
• Reorganizations within the Holding Company, or
  increased ownership from present owners
• A Pre- and Post- Organization Chart should be
  submitted with this type of filing, together with
  a reason for the restructuring
• Disclaimers
• Increased ownerships by a shareholder, or over
  10 of investments by financial institutions
• Most do not exceed 15 and have filed 13G with
  the SEC

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Types of Transactions continued
Transactions with Texas Domiciled Entities or
Commercially Domiciled Insurers

• The most common type of holding company
  transaction is an affiliated agreement, which
  include
• Production of business
• Underwriting
• Management or administrative services
• Data processing
• Personal or professional
• Investment advisory or asset management
• Cost allocation or reimbursement
• Third party administrator
• Consolidated tax allocation

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Types of Transactions continued
Transactions with Texas Domiciled Entities or
Commercially Domiciled Insurers continued

• These types of contracts should contain, at a
  minimum, the following components
• Parties involved
• Types of duties and services
• Compensation
• Accounting and settlement periods
• Effective date
• Governing law, which includes Texas
• Termination provisions
• Other provisions can include hold-harmless,
  assignment, arbitration, and for consolidated tax
  agreements, the indemnification language required
  by TAC 7.204 (a) (2) (E)

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Types of Transactions continued
Transactions with Texas Domiciled Entities or
Commercially Domiciled Insurers continued

• Issues with Common Transactions
• The most common component that is missing is the
  accounting and settlement provision, which must
  be included in the contract
• The most important information needed is the
  justification that fees, relating to services
  provided, are fair and equitable

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Types of Transactions continued
Transactions with Texas Domiciled Entities or
Commercially Domiciled Insurers continued

• The total number of management/service
  agreements processed by our Holding Company
  Analysts during Fiscal Years 2004 2006
• FY 2004 46
• FY 2005 64
• FY 2006 -- 57

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Types of Transactions continued
Form B Registration Statements

• Statements are filed on an annual basis, and
  include
• Ownership identity and percent and
  organizational chart
• Transactions with affiliates that are ongoing,
  or have occurred during the year
• Biographical affidavits on officers and
  directors of the ultimate controlling
  person
• Pending litigation against the Company or its
  officers
• Financial statements of the ultimate controlling
  person
• Notarization
• These statements are completely restated every
  five years (years ending in a 5 or 0) and are
  considered confidential

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Types of Transactions continued
Transactions with Officers, Directors and
Shareholders
A domestic insurance company can enter into
various types of arrangements with its officers,
directors and shareholders, as long as they
obtain prior approval of the Commissioner Most
transactions fall under the same review as other
affiliated transactions, however, a transaction
with an officer, director or shareholder requires
approval by a Commissioners Order
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Types of Transactions continued
Dividends and Distributions

• A domestic insurance company can declare either
  an ordinary dividend or an extraordinary
  dividend, if the company has experienced earnings
  for the period of December 31st of the prior year
  to the present proposed payment date
• The Department must be given 10 days prior
  notice to the payment of an Ordinary dividend and
  30 days prior notice to the payment of an
  Extraordinary dividend
• Since the implementation of the Holding Company
  Act, the Department has seen an increase in
  Extraordinary dividends filed by HMOs
• Previously HMOs notified the Department if the
  dividend exceeded 10 of the PHS
• Now, the same dividend is considered
  Extraordinary, and requires Commissioner approval

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Types of Transactions continued
Dividends and Distributions continued

• All dividend requests should include the
  following
• HC Dividend form (found on our website) for
  Ordinary Dividends
• Form D (TAC 7.212) for Extraordinary Dividends
• Declaration date and payment date
• Amount of dividend
• Identity of shareholder
• Analysis of Surplus Form (excluding HMOs)

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Types of Transactions continued
Application to Move Books and Records Outside the
State of Texas

• A domestic insurer can move any portion or all
  of its books and records outside the State of
  Texas, if it receives prior approval by the
  Commissioner
• Unless the domestic company is maintain its own
  records, an affiliated agreement must be filed in
  connection with the application
• The accompanying agreement must contain the
  language specified in TAC 7.25
• The only non-affiliate that can maintain books
  and records of a domestic company is a TPA, and
  the records must be only active claim files and
  any closed files must be returned within 60 days
  of closing
• Any changes to addresses and locations previously
  approved need to be sent to the Department and
  usually result in amended filings

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Types of Transactions continued
Surplus Debentures

• Surplus debentures must include the surplus
  floor, which can either be a minimum of 500,000
  or the minimum surplus as stated in the agreement
• The Department is now requesting that no payments
  be made unless the surplus exceeds the greater of
  the minimum surplus floor or 250 of Authorized
  Control Level Risk Based Capital
• The Department also reserves the right to
  disapprove any payments based on the Companys
  financial condition

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Reasons for Delay in Approvals
There are various reasons why the approval
process may be delayed, including

• Companies with financial or management problems
• Coordination with other areas of the Department
  (Legal, Health, and WCN, Financial Management,
  Company Licensing, Actuarial, etc.)
• Incomplete filings
• Missing or incomplete projections
• Missing provisions in agreements such as
  settlement terms
• Justification that a transaction is fair and
  equitable

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Current and Future Developments

• TAC 7.7 was recently amended, as follows
• To acknowledge that a domestic insurer may
  purchase or hold as an admitted asset, a surplus
  debenture of a non-affiliate insurer that meets
  the requirements for rated and non-rated note
  under the NAICs SSAP 41
• Requires an affidavit containing affirmation
  that the debenture will be funded within 15 days
  of the Commissioners approval that written
  evidence of such funding will be provided to the
  Department and acknowledging the admitted asset
  provision listed above
• The Department is in the early stages of
  reviewing its regulations relating to the Holding
  Company Act with the objective of updating and
  re-codifying the requirements

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Questions