By Linda Koco
Variable annuity companies might become the apple of private equity eyes in 2013. That’s according to a new report from Deloitte, which says the appetite for insurance mergers and acquisitions among private equity firms appears to be on the rise, “especially in the variable annuity space.”
The report does not name the carriers that might be likely candidates for purchase, nor does it project the number of such deals that might occur in 2013. But it does make a case for why private equity firms might be giving the variable annuity industry a once over.
This news should be a heads up to variable annuity advisors, many of whom watched in disbelief last year as many carriers intentionally downsized or reined in their businesses in reaction to the double whammy of prolonged low interest rates and high volatility. Hartford Financial left variable annuity sales altogether.
If what Deloitte is seeing proves out, advisors will have some new questions about the business to untangle—in particular, if some carriers want out of the variable annuity business, why does private equity want in?
Appetite to buy
The insurance industry is in “the early innings of a general rebound,” say Deloitte researchers in a report on expected insurance merger and acquisition activity in 2013.
Private equity interest in this area is only one of the trends spotlighted in the report. Others include economic and regulatory uncertainty, deal complexity, tax reform and more.
The discussion on private equity activity in this area involves not only the annuity and life-health sides of the insurance business but also the property-casualty, multiline managed care, title, mortgage guarantee and finance guarantee sectors.
In the insurance business, volume, pricing power and economic activity “are moving in the right direction,” the researchers say of the industry’s appeal to private equity.
An environment like that can offer a “good entry point” for deals among investors looking to buy an insurance company or selected assets at a low price, they note.
These buyers would be firms wanting to “aggressively manage” their new acquisitions, “clean up the business” and then “quickly sell it to reap appropriate rewards.”
The traditional market for insurance underwriting “is risk and balance
sheet intensive and therefore it can be hard for private equity firms to leverage their investment,” the researchers state.
Even so, there has been a “recent uptick” in private equity mergers and acquisitions in the insurance industry and they expect that will continue in 2013.
One reason for this expectation has to do with available cash. Many private equity firms today are “sitting on ready cash,” and they are looking for investment options in a low-return market where good deals can be hard to find, the researchers say.
Current discount-to-book values may make a stock deal challenging, but it is “relatively easy” for these firms to offer cash for “solid companies that are trading inexpensively and need to do deal,” they explain.
Another reason is that many life insurers are, as the report puts it, “trying to sell off their volatile variable annuity business.” By comparison, private equity firms (presumably, the ones that are interested in buying such carriers) “may be able to sit on the block until interest rates recover without worrying about short term profit-and-loss volatility.”
It is unlikely that many annuity advisors have given much consideration to that last point, at least not in public venues.
Instead, many have voiced concern that private equity takeovers of existing carriers could trigger market retrenchments as the new owners pare back operations, products and advisor support in order to boost higher return on investment.
Some advisors are also concerned about the owners’ commitment to, and willingness to stay in, the insurance business for the long term. They continue to state that clients buy annuities for the long term. So, advisors generally prefer to deal with carriers that appear to be highly likely to stay in the business for the long term.
Any notion that a private equity firm might be readying a carrier for a quick sale therefore sends shivers down the backs of many advisors.
This concern may impact some advisors’ product recommendations and even influence their decisions about whether to contract with privately held carriers. Much will depend on how the private equity firms address these issues with advisors and the larger insurance community.
Assuming the Deloitte assessment is correct—that private equity owners may be able to to “sit” on a block (book of business) while interest rates recover “without worrying about the short-term profit-and-loss volatility”—and assuming that advisors start factoring that possibility into their assessment of future prospects, the “sitting” attribute may be viewed as only a short-term factor.
After all, there is no telling whether the new owners will, in fact, decide to hold on to their insurance acquisitions long enough for interest rates to recover.
Even if they do, some may just wait out the low-interest era and then shake the carrier loose. That possibility may prompt some industry professionals to guess that this could happen in, say, just three or four years from now—an ownership period that is very common to private equity firms that flip their holdings frequently. Rates could always go up sooner or later, but in the absence of solid indicators about what might happen, short-term thinking tends to prevail.
Then again, it is also possible that certain private equity firms will do the exact opposite. That is, they might instead see benefit in owning insurance carriers for the long term. And, if they have indicated long-term intentions to regulatory authorities while in the midst of doing their deals, the firms might also feel compelled—by ethics and/or by law—to keep those long-term promises.
The uncertainty factor
Right now, there are a lot of uncertainties—for instance, about whether Deloitte’s assessments will pan out, and, if so, whether often-expressed advisor concerns about private equity players will hold water. That makes this a time of wait-and-see. It pumps some edginess into the air.
But the firms definitely have a nose under the tent. Several noses, in fact. Private equity firms made more than 100 acquisitions in the insurance industry in in the 24-month period ending Dec. 31, 2012, according to a Deloitte analysis of FactSet Merger data, 2012.
In general, overall activity in insurance industry mergers-and-acquisitions may see an uptick in 2013, the researchers say, noting that there has been a “flurry of activity by insurance companies” to rebuild internal mergers and acquisitions capabilities.
This is in contrast to 2012, when the number of insurance industry mergers and acquisitions tracked by SNL Financial decreased by about 20 percent from 2011, they point out.
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