October 19, 2023

Private Equity Moves Into Insurance: Rewards Are Strong, but So Is Risk

The tiff over Brookfield’s new acquisition underscores the pros and cons.

Reported by Larry Light

Private equity firms’ buying or partnering with insurers is a growing trend. For both sides, there’s a financial gain, but the pairings also add risk, according to a study by Moody’s Investors Service.

The potential problem for PE-owned insurers is that the parent company might unload riskier assets into the carriers’ portfolios, Moody’s warned, thus saddling the insurance subsidiaries with investments that feature “lower liquidity and transparency than corporate bonds, and some have not been tested in a prolonged economic downturn.” That contention is the focus of a recent squabble between a labor union and Brookfield Asset Management over its new insurance holding.

In addition to Brookfield, major private equity players controlling insurers are Apollo Global Management Inc. and KKR & Co., Moody’s said. Blackstone Inc. takes minority stakes in insurance companies. This year, Brookfield took over American Equity Investment Life for $3.6 billion and Blackstone bought a 10% piece of Resolution Life for $3 billion.

For PE firms, the plus side of insurance subsidiaries is that they throw off predictable income and generally maintain conservative portfolios. For publicly traded PE outfits, that aspect of insurers is pleasing Wall Street, Moody’s observed. Insurance linkups allow private equity firms “to shift away from episodic performance fees and toward recurring” earnings from policyholder premiums, the study said.

Steady Income Stream

The key virtue of this arrangement, Moody’s wrote, is that PE owners secure a solid foundation of capital: “Unlike funds raised from investors, perpetual capital does not need to be returned and provides a steady stream of recurring management fee revenue.”

Fixed-income assets, in which insurers specialize, are particularly appealing to PE companies, Moody’s wrote: “In the low interest rate environment that lasted until 2022, credit products that produced excess returns became increasingly attractive, and became a larger component of alternative asset managers’ product offerings.”

Even now, amid higher rates, the broad asset class remains enticing to PE firms, as banks have “reduced their appetite for lending,” the study pointed out.

For insurance clients, not to mention private equity investors, another advantage is that PE-managed investments tend to perform better, per a McKinsey & Co. analysis—to the tune of 62 basis points higher than the insurance industry average for returns.

One reason may be how the new PE owners shift allocations, McKinsey found, toward higher yielding assets: Within three years of acquiring insurers, 80% of the PE-owned carriers had boosted their allotment of asset-backed securities (mainly collateralized loan obligations), and more than half of their investments were in private loans, compared with 37% for the insurance industry.

The Brookfield Fight

These assets, prominently ABS and private credit, often carry higher risk than the standard insurance preference for bonds. Moody’s warned that the alternative investments that PE purveyors prefer are “not easily converted into cash, especially during periods of stress.” What’s more, Moody’s admonished, they often “have less transparency to outside investors.”

In that vein, consider the recent critique by a hospitality workers’ union of Brookfield’s dealings with American National Insurance Co., headquartered in Galveston, Texas, which Brookfield had acquired for $5.1 billion in May 2022. The labor group, called UNITE HERE, produced a study charging that Toronto-based Brookfield, an alternative asset manager with interests in PE and real estate, sold ABS to American National, which has a strong annuity focus and a pension-risk transfer business.

The ABS are hard to evaluate and, as such, are potential weakness for American National, the union contended. It added that Brookfield’s actions “undermine the architecture of state-based insurance solvency regulation.”

Last spring, the union sent a letter to hundreds of pension funds and actuaries detailing its accusations against Brookfield’s interactions with its insurance affiliate. “In our view, pension obligations should not be used as a cheap funding source for private equity asset managers chasing the illiquidity premium or offloading illiquid assets their own affiliates have originated,” the letter stated.

At the time, American National responded, in an email to CIO, by countering the union’s assertions. “Like all insurance companies, American National and the group annuity product used for pension risk transfers are highly regulated and we maintain high levels of liquidity,” American National’s senior vice president, Scott Campbell, wrote.

This week, a Brookfield spokesperson added, in a statement, that UNITE HERE has an ulterior motive: “to coerce us into agreeing to the union’s demands relating to our hotel business.” The union is trying to organize several of Brookfield’s hotels. The spokesperson labeled the union’s allegations “irresponsible and factually inaccurate.” He called on UNITE HERE to shut down “its irrelevant sideshow” and to negotiate “with us in good faith.”

Brookfield Reinsurance, the unit that oversees American National, issued a statement saying its 2022 acquisition was “well-capitalized and conservatively managed.” The insurance division added that its “mission and approach are completely aligned with all stakeholders committed to policyholder protection.”

In response, the union remarked that the American National deal should have strong regulatory scrutiny and that pension sponsors should be wary of “Brookfield’s unique and untested investment strategy.” Charles Decker, UNITE HERE’s research coordinator, who wrote the paper on the Brookfield-American National union, said the PE firm “didn’t actually identify any inaccuracies in our report and has no track record as a manager of long-term pension obligations.”

Although no major regulatory actions have occurred yet, the U.S. Department of Labor is reviewing a key regulation, Interpretive Bulletin 95-1, which governs fiduciary standards for selecting an insurer for a pension annuitization via pension risk transfers.

In a written statement on the DOL review earlier this year, Apollo-owned Athene Holdings, a major PRT provider, stated that “there is simply no compelling need to overhaul IB 95-1.”

That, Athene declared, is because the legitimate concerns about PRTs are already addressed by IB 95-1, plus no PRT payment has been missed owing to a solvency issue since the reg was issued. Furthermore, it went on, as corporate bonds have become more correlated to one another, a need exists to diversify into alternative investments.

Still, Moody’s wrote, regulatory change likely is coming. When it does, the dynamics of the PE foray into insurance could well shift.