State Insurer Investment Statutes – Designation as “Admitted Assets” versus “Nonadmitted Assets”
Each state has adopted a set of laws that limit the types of investments a domestic insurer may make.[9] These laws also limit the amount of assets a domestic insurer may invest in any category of permitted investment and in any one person or entity. As explained above, the specific investment categories and maximum limits will vary from state to state. The purpose of these limitations is to ensure that insurance companies diversify their assets and investments and maintain a balance of liquidity, risk and investment earning potential, thereby aiming to avoid insolvency while allowing insurers to be competitive with other types of businesses.[10]
To the extent an insurer’s assets and investments satisfy the limitations and requirements codified in its domiciliary state’s investment laws, those assets will be considered “admitted assets”, which are assets that are allowed to be included on the insurer’s statutory financial statements and are accordingly included in evaluating the insurer’s reserves and compliance with risk-based capital (“RBC”) requirements.[11] However, even to the extent that an insurer’s investments qualify as “admitted assets”, depending on the nature of such investment, it may be given an RBC factor that may result in such asset not counting dollar-for-dollar towards the insurer’s capital and reserve requirements. Conversely, to the extent that an insurer has made an investment either in a category or type of investment that is prohibited under its domiciliary state’s insurance laws or in an amount that exceeds authorized limits, those assets would be considered “nonadmitted assets.” An insurer’s nonadmitted assets are not included in evaluating the insurer’s reserves or calculating the insurer’s RBC.[12] As a result, insurance companies should regularly monitor their investments to ensure compliance with any applicable limits and should evaluate any proposed investment to evaluate whether the assets held in such investment will qualify as an admitted asset, be assessed an RBC factor, or may otherwise be subject to prior review and approval by its domiciliary insurance regulator.
State Insurer Investment Statutes – Limitations on Hypothecation of Assets
In addition to adopting limitations on types and amount of investments insurers can make, a number of states have also codified statutes and regulations subjecting certain types of investments to prior review and approval by the state insurance department. One such requirement involves prior approval of “hypothecation”, or pledging, of an insurer’s assets in connection with an investment.[13] There are currently five states that expressly limit an insurer’s right to hypothecate its assets. By way of example, Connecticut’s hypothecation statute prohibits domestic insurers from pledging, hypothecating or otherwise encumbering their assets “to secure the debt, guaranty or obligations of any other person without the prior written consent of the Insurance Commissioner.”[14] Connecticut also prohibits domestic insurers from hypothecating their assets to secure their own debts or obligations if the total amount of all amounts hypothecated “exceeds the lesser of five percent of admitted assets or twenty-five percent of [policyholder] surplus” as of the immediate prior December 31 without the prior written consent of the Insurance Commissioner.[15] In light of this limitation, a proposed investment by a Connecticut-domiciled insurer that otherwise complies with Connecticut’s insurer investment laws, such as an investment in a venture capital fund, would be subject to prior review and approval if the investment contemplates future capital commitments by the insurer. Similarly, such an investment by a non-insurer affiliate, which may not otherwise be subject to Connecticut’s insurer investment laws, would also be subject to prior review and approval if the insurer’s assets would be hypothecated to meet the non-insurer affiliate’s ongoing capital commitment requirements for that investment.
Investments by Non-Insurer Affiliates of an Insurance Holding Company System
As noted above, insurance holding company systems are subject to various ongoing monitoring and reporting requirements which may impact investment strategy, diversification and oversight of both insurer and non-insurer affiliates, many of which are also Accreditation Standards.[16] Potential investments by non-insurer affiliates should be evaluated in light of the holding company system regulatory framework and applicable reporting requirements, as well as state insurer investment laws, to ensure such investment does not run afoul of any of the applicable requirements or limitations, and does not otherwise subject the insurance holding company system to heightened scrutiny or negative treatment with respect to such investment. The factors that may be important in evaluating potential investments include:
- Investments by a Wholly-Owned Subsidiary
An insurer is able to include the assets of a wholly-owned subsidiary on its own financials.[17] As a result, the investments of a wholly-owned subsidiary would need to comply with applicable insurer investment laws, including any hypothecation statutes, to be considered “admitted assets” of the insurer. Any investment of a wholly-owned subsidiary’s assets in a prohibited investment or in an amount that exceeds statutory maximums would render such assets “nonadmitted assets” for purposes of the insurer’s financial statements.[18]
- Non-Insurer Affiliate Investments – Assets Relied Upon to Satisfy Insurer’s Capital or Reserve Requirements
Similarly, to the extent that the assets of an insurer’s parent or other non-insurer affiliate are pledged or will be relied upon to satisfy an insurer’s ongoing capital or reserve requirements, the parent or non-insurer affiliate’s assets should be invested in compliance with the insurer’s domiciliary state’s insurer investment laws to be considered “admitted assets” of the insurer. To the extent that the insurer investment laws of the insurer’s domiciliary jurisdiction limit hypothecation of assets, the insurer should consult its domiciliary regulator to confirm whether the hypothecation laws apply to investments of non-insurer affiliates.
- Non-Insurer Affiliate Investments – Assets Not Needed to Satisfy Insurer’s Capital or Reserve Requirements
Conversely, to the extent that a parent or non-insurer affiliate’s assets are not needed to satisfy the insurer’s capital or reserve requirements, the investment of that affiliate’s assets would generally not be subject to the insurer’s domiciliary state’s insurer investment limitations. Nor would such investments generally be subject to regulatory approval. Therefore, an insurer’s parent and non-insurer affiliates would have greater flexibility in the types of investments they may make and the amount of assets that can be invested in any single person or entity. Notwithstanding such greater flexibility, the insurance holding company system should still evaluate any potential investment light of ongoing reporting requirements.
- Potential Reporting Requirements Related to Parent and Non-Insurer Affiliate Investments
While the assets and investments of an insurer’s parent and non-insurer affiliates may not have to comply with the insurer’s domiciliary insurer investment laws, the insurer and the insurance holding company system may nevertheless want to consider evaluating potential investments in light of the various NAIC model regulatory reporting requirements that apply to the insurer and any ultimate controlling parties, including, but not necessarily limited to:
- Disclosure of potential enterprise risk involving an investment through the annual Form F Enterprise Risk Report, such as where the affiliate may be subject to a large capital call
- Form D Prior Notice of a Transaction, where the investment contemplates certain types of intercompany agreements between the insurer and a parent or non-insurer affiliate
- Schedule Y Information Concerning Activities of Insurer Members of a Holding Company Group, which requires disclosure of companies whose stock is owned by the insurer or an affiliate
- Corporate management and oversight of affiliate investments, which may require or include discussion of riskier investments or investments that involve hypothecation of a material amount of an affiliate’s assets under the Corporate Governance Annual Disclosure at the parent/ultimate controlling party level
Conclusion
Because insurers are required to maintain sufficient capital and assets to fulfill their obligations to policyholders and claimants, insurers are subject to a comprehensive and complex system of financial reporting and oversight. The NAIC has adopted a number of Accreditation Standards addressing financial reporting, capitalization, reserving and solvency, but each state is authorized to regulate insurer investment limitations and impose requirements as it deems appropriate and necessary, as long as such investment laws require diversification and liquidity. As a result, state law may vary greatly with respect to the types of investments an insurer may make as well as the amount of assets that can be invested in any category of investment or any single person or entity.
An insurer’s assets, as well as the assets of a wholly-owned subsidiary or an affiliate or parent that are relied upon by the insurer to meet its capital or reserve requirements, must comply with the insurer’s domiciliary insurer investment laws in order to be considered “admitted assets”. Moreover, to the extent the insurer or an affiliate’s, including a non-insurer affiliate’s, assets may be hypothecated in connection with a proposed investment, such investment may be subject to prior review and approval by the insurer’s domiciliary regulator. However, to the extent a parent or non-insurer affiliate has assets that are not relied upon to satisfy the insurer’s capital or reserve requirements, that affiliate’s investments would generally not otherwise be subject to regulation or oversight by the insurer’s domiciliary regulator. Notwithstanding that such investments may not need to comply with the domiciliary state’s insurer investment laws, the insurer and insurance holding company system should still evaluate any potential investment, including any investment that may require hypothecation of the insurer’s or any non-insurer affiliate’s assets, in light of the NAIC Accreditation Standard oversight and reporting requirements and state insurer investment laws.