‘Predictable And Steady’ Make Insurers Attractive To Private Equity
May 11, 2015 by Arthur D. Postal, arthur.postal@innfeedback.com
WASHINGTON – Private equity firms interested in buying life insurance companies are not looking to hit home runs, but singles and doubles.
That’s according to the authors of a paper appearing in Institutional Investor’s blog, “Unconventional Wisdom.”
The private equity industry is showing an interest in buying life insurance companies. That interest reflects private equity’s desire for investments that are “predictable and steady,” not a desire to use the life insurance companies for quick and highly profitable turnarounds, according to Robert Shapiro and Scott Shine of Carlton Fields Jorden Burt.
“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,” Shapiro and Shine wrote.
Many industry regulators are concerned about whether to require private equity firms that buy insurance companies to provide additional financial information and perhaps establish so-called “keepwall trusts” that would provide additional financial backing for the insurance company investment if a problem would occur.
The paper notes that the National Association of Insurance Commissioners is examining whether there should be new model laws to allow states where the acquired firms are domiciled to impose additional standards, either through the whole model law or parts of it.
Shapiro and Shine said there has been “much speculation” 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 acquisition of life and annuity insurance companies with predictable lines of business offer these firms an opportunity to add billions of assets under management and collect fees for putting their investment expertise to use. “Thus, the returns tend to be predictable and steady,” the paper said.
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. Among the reasons for this are that interest rates have remained low for more than five years and profit margins have been squeezed, the paper said.
The reduced profit margins, in turn, have required annuity and life insurers to inject more capital into their business or risk being downgraded, according to Shapiro and Shine.
Recent examples include Allstate’s decision to divest itself of Lincoln Benefit Life, which included Allstate’s entire deferred fixed annuity and long-term care insurance businesses. In addition, Genworth recently announced it is seeking buyers for its life and annuity unit in order as a means of shoring up its troubled long-term care LTC unit. AIG also said it is working to “derisk” its business, especially its life insurance business, by offering fewer guarantees.
The Federal Reserve, as stated in congressional testimony last week, is also examining the books of insurance companies which operate savings and loan holding companies to examine the level of risk on their books. Such firms as John Hancock and MetLife are also reducing the risks in their life and annuity portfolios.
Shapiro and Shine said in their paper that the need for capital “fits well with private equity firms, whose investors, seeking higher yields, have supplied them with enormous 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,” Shapiro and Shine said.
Another reason why life insurance companies are attractive to private equity is that although interest rates may be quite low today, “they are expected to climb in the not-to-distant future,” Shapiro and Shine wrote. As new capital comes in, it will be invested at better returns if interest rates rise as expected, they said.
“Thus, 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,” the paper said.
