By Cyril Tuohy
Excess capital among annuity insurers, low organic growth and financing rates, louder activist shareholders and the narrowing of bid-ask spreads means it’s likely the market will see more private equity deals, an expert said.
Perhaps most important in greasing the deal trend, however, is the “additional clarity” offered by the New York Financial Services Superintendent Benjamin M. Lawsky, with regard to the amount of capital insurers must set aside to protect annuity contract holders.
Lawsky, one of the most influential insurance regulators in the country, is responsible for protecting the long-term interests of annuity contract holders. Private equity, with responsibilities to themselves and shareholders first, think annuity companies can be run more efficiently with no additional risk to annuitants.
“It’s his obligation to evaluate the risks associated with the transactions with an eye towards protecting policyholders and to ensure the capital required to meet contractual obligations is in the companies,” Boris Lukan, leader of the insurance mergers and acquisition practice for Deloitte Consulting in the U.S., said in an interview with InsuranceNewsNet.
In the most recent announcement, Fidelity & Guaranty Life of New York earlier this month agreed to stiffer policyholder protections in connection with the ban by the New York Department of Financial Services (DFS) of Harbinger Capital Management from exercising any control over Fidelity & Guaranty Life, or from doing business with any New York-licensed insurer for seven years.
Fidelity & Guaranty Life, in addition to agreeing to higher risk-based capital levels, agreed to establish a reserve of $18.5 million in a “Backstop Trust Account” to replenish the company’s capital should it dip below a 450 percent threshold, Lawsky said in a news release.
The ban on Harbinger and its chief executive officer Philip A. Falcone followed a settlement between the New York hedge fund and the Securities and Exchange Commission in which Harbinger was fined $10.5 million for an illegal loan in 1990 to pay for a tax liability.
Fidelity & Guaranty Life’s protections were modeled after similar agreements between the DFS and private equity funds Guggenheim Partners and Apollo Global Management. Guggenheim, based in New York and Chicago, bought the U.S. annuity business of Sun Life, Canada’s third-largest life insurer, for $1.35 billion. Apollo Global Management, based in Chicago, agreed to safeguards in connection with Athene Holding’s $1.55 billion purchase of the annuity operations of Aviva USA.
Private equity firms have specifically been attracted to fixed and indexed annuity writers. As of April, private equity-controlled insurers accounted for nearly 30 percent of the indexed annuity market, up from 7 percent in April 2012, and 15 percent of the total fixed annuity market, up from 4 percent in April 2012, Lawsky said.
“There can be exceptions, but generally private equity firms follow a model of aggressive risk-taking and high leverage, typically making high-risk investments,” Lawsky said in a statement. “If just a few of these investments work out, then the firm can be very successful — and the failed ventures are just viewed as a cost of doing business. This type of model isn’t necessarily a natural fit for the insurance business, where a failure can put policyholders at significant risk.”
The three-to-five year time horizon of a private equity firm is inappropriate for annuity companies that promise income for retirees for years or even decades, Lawsky said. He noted that insurers provide a juicy target for private equity firms compared to the more highly regulated banking sector from which private equity has generally steered clear.
Private equity shops are targeting insurance brokers as well, Lukan said. In August, San Francisco-based Hellman & Friedman announced it would buy Hub International, a huge global property/casualty and life and health benefits broker.
Chicago-based Madison Dearborn Partners’ recent investment in National Financial Partners, an independent advisor and distributor of life and benefits products, and in Nuveen Investments, an investment and benefits advisory company, also represents a private equity company taking stakes in big life insurance and financial services companies.
Low interest rates are “putting pressure on the bottom line” of annuity and life insurers who typically espouse conservative investment philosophies due to the financial guarantees for which they are on the hook. ”Private equity firms believe they can dramatically improve those investment returns without creating undue risks for policyholders,” Lukan said.
There were 60 private equity-driven insurance industry transactions in 2012, up from 55 in 2011 and 47 in 2010, Lukan added. Private equity making investments in insurers isn’t new, but the “aggregation of private equity firms is a relatively recent phenomenon,” he said.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].
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