In the past few years, private equity firms have been some of the most active participants in M&A activity in the insurance sector. For private equity firms, investing in this decidedly staid industry is quite a change from the halcyon days of the early 2000s, when they were known for a high-risk, high-reward strategy of using huge amounts of debt to acquire companies, streamline management, eliminate unprofitable operations and cash out through an initial public offering. Now private equity firms, once known as home-run hitters, more and more are seeking singles and doubles. In the past three years, private equity firms such as Apollo Global Management, Ares Private Equity Group, Blackstone Group and Carlyle Group, and diversified financial services firms like BlackRock and Guggenheim Partners, have all spent billions of dollars to purchase insurance companies or existing blocks of insurance business. In addition, Washington–based Carlyle Group just announced its second $1 billion fund focused on financial institutions and insurance companies.
Much speculation has arisen about why private equity firms are interested in investing in the life and annuity insurance sector, particularly in fixed annuities, which tend to have a much lower rate of return than what private equity investors typically demand. The singles-and-doubles strategy may offer insight. The acquisition of life and annuity insurance companies with predictable lines of business offers these firms an opportunity to add billions in assets under management and collect fees for putting their investment expertise to use. Thus the returns tend to be predictable and steady.
Contributing to the increased private equity interest in insurance companies is the fact that some insurers have been very willing to unload their annuity businesses, as interest rates have remained low for more than five years and profit margins have been squeezed. The reduced profit margins, in turn, have required annuity and life insurers to inject more capital into their businesses or risk being downgraded. The need for capital fits well with private equity firms, whose investors, seeking higher yields, have supplied them with enormous amounts of cash for investments. Although there hasn’t been a stampede to the exits by the management of insurance companies, data from 2012, the latest available year, indicates that the average price for life and health insurers, as measured by price-to-book value, has been decreasing.
Another point private equity firms have in their collective mind is that although interest rates may be quite low today, they are expected to climb in the not-too-distant future. As new capital comes in, it will be invested at better returns if interest rates rise as expected. This, together with the fact that some of the annuity products, particularly fixed annuities, might start to take off as baby boomers increasingly retire and shift their investments to lifelong-income-producing products, could result in greater-than-average investment returns for insurers.
One hurdle private equity firms must overcome when investing in insurance companies is that, unlike other industries, insurance is heavily regulated at the state level. When an insurer’s ownership changes hands, the state where the insurer is domiciled must approve the change in ownership. Individual states, led by New York, have been voicing concerns over the sale of insurers to private equity firms. To address these concerns, the New York Department of Financial Services (DFS) recently proposed amendments to its regulations that would require insurance company acquirers to file additional information and perhaps establish keepwell trusts, in the event more capital is ever needed. The National Association of Insurance Commissioners is studying whether there should be new regulations on private equity firms’ acquiring insurers, which states can choose to enact in whole or in part.
Regulators’ concerns are focused on the fact that private equity firms may only be investing to make a quick profit. In other words, some state regulators are of the view that the private equity business model, with its perceived short-term focus on profit, is at odds with the insurance business model, which, as many regulators claim, requires a long-term focus. This short-term-profit focus, according to insurance regulators such as Benjamin Lawsky, superintendent of the New York DFS, could lead private equity firm owners to take greater risks in their investment strategies, placing annuity owners at increased risk of losing their investments if such insurers become insolvent.
This oft-cited criticism that private equity firms intend to purchase more-exotic investments for insurers’ investment portfolios appears to be belied by the actual changes to a couple of the largest insurers purchased by these firms. According to Charlottesville, Virginia–based financial data firm SNL Financial, which collects and disseminates information on M&A activity, the changes made to the portfolios of insurers purchased by Guggenheim Capital and Apollo’s Athene Holding were in line with those of the life insurance industry as a whole. For example, West Des Moines, Iowa–based EquiTrust Life Insurance Co., which Guggenheim purchased at the end of 2011, reduced its holdings of bonds and increased its allocation of invested assets in mortgage loans as of March 31. This was also true of the life insurance industry in general. Regardless of whatever type of entity owns an insurer, it will have to invest the premiums collected from its insureds in accordance with applicable insurance laws.
Based on the available data, slim though it may be, and the protections provided by the investment laws governing insurers, insurance regulators should welcome the fresh capital, investment expertise and competition private equity firms can bring to the industry. If their past investment performance is any indication, these firms’ entry into the insurance business may confirm that a run batted in is just as valuable coming from a single or a double.
Robert Shapiro is an attorney in the Washington, D.C., office of Carlton Fields Jorden Burt, where he handles corporate, securities and insurance regulatory and transactional law matters in the firm’s insurance practice. Scott Shine is an associate at the firm’s Washington office, counseling a variety of clients, including life insurance companies and private equity firms, on transactional, regulatory and compliance matters.
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