NAIC Body Issues Guidance on Affiliated Investment Management for Insurers

Insurers that outsource investment management to affiliates should consider new guidance from insurance regulators on such arrangements. On March 19, 2024, following its March 16 session at the National Association of Insurance Commissioners’ (NAIC) spring National Meeting, the NAIC’s Risk-Focused Surveillance (E) Working Group (RFSWG) issued draft changes to the NAIC’s Financial Analysis Handbook (FAH) and Financial Condition Examiners Handbook (FCEH) regarding investment management agreements, including those with investment managers under common control with an insurer. The public comment period for this proposal, which is available on the RFSWG’s homepage here, runs until April 30, 2024.

The FAH and FCEH are key resources that provide structure and uniformity to state regulatory review of insurers’ financial matters. Changes by the NAIC to the FAH and FCEH can provide insight into the priorities and initiatives of the NAIC at a given time on current developments in insurance regulation. These particular changes exposed by the RFSWG are important because they show regulators’ heightened focus on relationships between insurers and their affiliates. This is especially salient insofar as the NAIC is placing additional scrutiny these days on ownership of insurers by private funds, particularly private equity firms. The proposed changes to the FAH and FCEH indicate areas where the NAIC perceives opportunities for abuse of holding company structures to the detriment of policyholders.

The principal changes to the FCEH included in the guidance add to existing FCEH provisions on investment management agreements (whether or not affiliated). These changes include:

• “Detailed” investment guidelines should be attached to any such agreement.
• Preexisting language in the FCEH suggested that conflicts of interest between an insurer and an investment manager may or may not exist (“To the extent that any conflicts of interest may be known...”). This language has been stricken (and certain conforming changes have been made), indicating that the potential for conflicts of interest presumptively exists in every such instance.
• In the section on fiduciary responsibility, the guidance indicates that it is “advisable” that the investment adviser be registered with the U.S. Securities and Exchange Commission. If an investment adviser asserts that it is exempt from registration requirements, the team of regulatory staff examining the insurer should “consider verifying that the advisor continues to meet the exemption criteria.”
• In the discussion of fees, language is added to the effect that investment management fees should reflect market conditions. In addition, “special attention should be paid [by regulatory staff] if there are any performance or incentive fees over and above a base management fee.”
• The use of subadvisers should be considered, including the ability of the insurance company to terminate a subadviser.
• The exam team should ask whether there are “adequate provisions for [investment manager] reporting to the insurer on a regular basis.”
• Are there “appropriate termination provisions, both with and without cause?”

The guidance also proposes that the entire section on investment management agreements in the FCEH be adapted and incorporated into two FAH sections on “affiliated” investment management agreements.