Working our stimulating jobs day by day, surrounded by amenable teammates, we feel contented and secure; all is well and in order.
Then, suddenly, the halls are full of strangers.
Who are they? New clients come to enrich us? Or investors ready to buy out the farm, or at least top up the tank with an infusion of capital?
We see that first group regularly; we tighten our ties, smile, look busy. But what about those buyers with the raptor eyes? That’s a matter of intent: will they stoke up the boilers and keep our train rolling, or are they planning to rationalize, downsize, make us redundant – chop us to bits?
Down the halls of insurance firms, that thrill of opportunity and its attendant anxiety are flowing freely today. It’s an industrywide happening: since 2014, private equity firms have been snatching up insurers like money-stuffed hotcakes. Observers – and regulators – are asking the question: why are PEs buying so hungrily?
Insurers have exactly what private equity firms need: first, lots of investible assets, readily at hand in case mass payouts to policyholders are needed; second, a dependable stream of income from premium payments and account charges. A steady source of investible capital is not usually so easily available to PEs, making insurers worthy targets for acquisition.
Purchasing a good-sized insurer can deepen a PE firm’s pockets by tens of billions. I read that KKR & Co. has fattened its books with $90 billion in assets by acquiring insurer Global Atlantic. You may say that a billion ain’t what it used to be, but bundle them in tens and you’ve got the power.
If you’re wondering why there are so many sellers, it’s because insurance companies are having a dickens of a time making their traditional model pump money in this low-rate environment. Interest rates – the 10Y Treasury yield today fell to just 1.32% – haven’t been this low since the 1930s, during the Great Depression.
Depressingly low rates and worrisome historical associations build little confidence, and some of the oldest names in the business are selling off, if not out.
Letting go of a portion or all of their insurance businesses frees capital for companies to use more productively. Just this year, Prudential Financial’s CEO said his firm wants to sell its “low-growth businesses” (that’s life insurance and annuities), which could place $5-10 billion in its hands – and they know how to use it. IB ladies and gentlemen don’t arise dripping from hot tubs for 1.35%. This I know for a fact, though I blush at sharing the details.
Pundits and observers are worried the PE industry’s penchant for relatively risky behavior could undermine the insurance industry’s stability. Right now, PE firms own 7.4% of total US life and annuity assets – that’s $376 billion worth. Deals underway could soon take this north of 12%, potentially topping up the total by $250 billion in 2021.
Critics seem chary to quantify their benchmark of instability – the point where PE ownership and their riskier practices could undermine the insurance system. I think the ‘wildness’ of PE firms is exaggerated, but their acceptable risk profile does exceed that of staid insurance. This raises some questions: does our industry need to become more productive? And would PE firms really cut self-harming deals? In a rational world, I’d answer a clear ‘yes-no’. In the realm of the humans, history suggests why some pundits are nervous.
KKR says that alienating customers by taking on excessive risk and charging too-high fees (standard procedure at PE firms, critics say) would hurt its own interests. Sustained growth can only be built on “strong, trusted” relations with clients, says the company. KKR provides easier access to higher-performance products than do traditional insurers; who could object?
My substantial gut tells me: this trend could be good for our industry. The insurance business recalls that enduring underperformer, Social Security: ever hamstrung by fears that riskier investment, undertaken to assuage chronic underfunding, would undermine a key pillar of societal stability. These fears are rational at root. Yet, while I agree the cowboys should be left to mind the cattle, seeking one or two hundred basis points more – the benchmark of one PE company actively buying insurers – hardly seems beyond the pale.
If you don’t agree with my assessment, raise your hand.
Ah, the Federal Reserve – ever ready to throw up its paw and a tie on the rails when I’m building up steam. The shift of insurance assets into private equity firms has rankled the regulator. PE firms favor better performing, yet harder-to-sell assets than do conventional insurance companies. This might land the insurers in powerful trouble if they were forced to liquidate fast to cover any mass life insurance claims, says the Fed.
Mass life policy payments were made during the World Wars, yet they failed to break the system. The coronavirus pandemic, which we worried could kill a tottering industry, was endured with that industry intact. Are critics overreacting?
The Fed’s role is to warn where trends might be leading, and the ‘unknown unknows’ bite the hardest. Yet here is our question: could the insurance industry handle – indeed, profit from – a bit more risk? Private equity firms are tolerant of risk (their corporate loans induce me to shiver), yet in acquiring insurers, they are hardly proposing, ‘Let’s dump it all into a resource-rich emerging market and light up the rocket’.
Their comments so far suggest prudence with an appetite for a few hundred extra basis points. The Fed, from its crow’s nest, sees little specific to criticize just yet, but is keeping its eyes peeled. Just so, I say, but let’s not kill the goose before we know how it’s laying.
So I’m sanguine today, yet still… My business partner Davíd says this reminds him of Chernobyl, the HBO miniseries. He’s from Ukraine; it hits close to home.
“Three roentgens of risk is OK, but what if it trends toward 12,000?” asks D. That’s likely what worries the Fed: at what point does the reaction run wild and blow off the containment facility’s roof?
It certainly can happen – we remember 2008. I’m not worried now and think events as they’re running could be positive for the insurance industry. But as the days tick by, rest assured I’ll be watching the dials most closely.