Private equity firms see insurance company deals as an innovative way to increase return and assets under management, but at what cost? With competition for traditional PE deals increasing and putting pressure on returns, PE firms are evolving to be diversified alternative asset managers with holdings in a variety of asset classes. From 2015-19, for example, the five largest US alternative investment players on average drove annual net new money (NNM) flows at between 5% and 15% of AUM, while traditional active asset managers saw negative flows.
In the hunt for NNM, insurance companies have become one of the more interesting targets since many insurance products (such as annuities, life insurance and long-term care insurance) represent stable long-dated liabilities that need to be backed by pools of long-duration assets. This dynamic is heating up now because of two major drivers. First, these sophisticated asset managers can generate higher risk-adjusted returns on assets, helping insurers generate additional spread and higher return on equity. Second, they increase assets under management (AUM), generate additional fee income and provide a source of permanent capital through access to the insurance company’s balance sheet.
While these deals look relatively simple on paper, they can get quite complicated in practice. If an entire insurance company or a block of insurance assets (through an assumed reinsurance contract) is on your radar, here are six lessons we’ve learned based on our experience supporting insurance and alternative investment clients on recent deals:
We’ve seen firms come to regret how they structured the deal when they decide to change strategy after the deal is done. Things to consider up front: Do you want to manage the assets or buy the insurance company and manage the assets and the liabilities? If you do buy the insurance company, do you want to outsource liabilities management or actively manage the insurance risks in-house? Who will retain the operational responsibilities that come with servicing premiums and claims from retail policyholders and managing distributors?
If you take the path of full-blown acquisition of an insurer, make sure you know what you’re getting into. Concepts like mortality, morbidity risk and longevity risk, core themes in insurance risk management, may not be part of your firm’s core competency and could distract from your asset management mission. Similarly, the capabilities required to manage and service hundreds of thousands of retail policyholders and distributors (typically, third-party broker-dealer affiliated financial advisors) are very different from those required for originating credit or managing a portfolio of assets. Thinking through the endgame and the extent of your ambitions as you acquire insurance assets will drive everything that follows.
We’ve also seen firms wish they could change how they set up their legal and location structure after the fact. For example, you may find yourself in a situation where setting up the structure in another legal jurisdiction would have been more beneficial for the fund in terms of taxes or the cost of ongoing operations.
For asset managers who decide to acquire and operate the underlying company, failure to develop a plan to accelerate and track value creation opportunities can lead to overpaying for an acquisition. Don’t simply use the target firms’ projections.
We’ve seen firms miss important considerations in terms of the market environment, the target’s competitive positioning, the legacy asset portfolio mix, anticipated post redeployment portfolio composition and other operational considerations. For deal structures in which the bidder is also taking on servicing and administration responsibilities, we’ve also seen companies fail to think through streamlining operating costs using process reengineering, automation and offshoring, retiring legacy technology platforms, and more. Another potential misstep lies in neglecting to drill down into the unit costs to understand how the expense base might change under different scenarios. For example, how might the target’s revenue forecast and expense base be changed by shutting down a particular capital intensive or unprofitable business unit or product line? How could outsourcing technology and/or business processes contribute to cost reduction?
Your platform (the holding company you build to manage the insurance entity or block of assets) should match the goals of your firm and have the capabilities to achieve those goals. Imagine a fund that builds its platform with a focus on basic fixed income asset management. Without a clear understanding that you may later want to move into specific asset classes (such as middle-market loans, infrastructure, real estate) or other less liquid investments, you might regret everything you put in place (including controls, processes, people and technology). Not only might it be hard to modify or to access the investment talent you seek, you may be forced to reconsider your office footprint and location strategy. Another potential eye-opener: Depending on where you are domiciled, your regulator may require you to disclose the entire ownership structure of an investment. That may mean that your investors’ identities and their personal investments become part of the record.
The bread and butter of private equity is to find undervalued or under-appreciated businesses, buy them and execute changes to capital structure, management and operations to unlock or create value. Since capital is typically sourced from limited partners such as sophisticated institutions or ultra high net worth (UHNW) individuals, the regulatory overlay is relatively light. With insurance, the regulatory overlay is far more rigorous and complex. US insurance carriers must contend with any number of state regulators. This could be new territory for alternative asset managers and it could come with surprises when they realize that growth is tied to capital constraints.
For example, we’ve seen instances in which firms learned that their dollar amount of dividends are capped by statutory restrictions specific to their state of domicile. The quantity and type of new products that an insurance company may launch can also become a factor, along with the types of investments your platform might be allowed to make with the insurance company’s assets. Rating agency expectations and requirements to maintain a certain rating threshold (such as risk-based capital requirements) may also come into play. And keep in mind that state regulators generally require that a significant portion of an insurance company’s portfolio be invested in investment grade or better. We’ve seen firms stumble when taking an aggressive approach by acquiring higher yield investments without realizing that their actions may require higher risk-based capital (RBC) charges.
The legal structure of your platform can (and often does) trip up firms in their day-to-day operations after the deal closes. We’ve seen alternative asset managers wait too long to sort through the tax structure of an investment deal, many times not even addressing it until after the deal closes. These mistakes can be devastating. It’s possible, for example, for the deal team to get almost everything right but fail to dot a single i. Imagine checking a deal with regulators and moving forward with a deal only to find that the investment has put you in a position in which you need to submit more disclosures with your chosen domicile. Even worse, you could be subject to unexpected state or local taxes.
Depending on your planned level of involvement in running the day-to-day business of the underlying insurance company, you may discover the need for added insurance industry expertise on your team. This can be key as you look to innovate and create value within the constraints of the complicated regulated ecosystem that insurers operate.
Indeed, we’ve seen teams with sophisticated asset management knowledge inadvertently leave value on the table because they didn’t have access to the right level of insurance industry know-how. We’ve also seen teams unable to compete for deals and others that are missing sophisticated risk management capabilities specific to insurance.