Following a frenzied 2021, the private equity (PE) market saw a 15 percent decrease in deal count in 2022.1 The North American insurance industry also felt the slowdown, seeing a similar reduction in deals from 2021 to 2022, according to McKinsey analysis of data from Pitchbook. Despite these shifts, the insurance sector remains an appealing investment avenue for PE firms seeking stable returns in a challenging macroeconomic environment.
In August 2021, when we last published our perspective on this space, the world was beginning to emerge from the COVID-19 pandemic, and several broad themes were top of mind, including continued broker consolidation, a move toward nonadmitted markets, and divestitures amid a low-interest environment.2 Today, the circumstances warrant a strategic shift in approach. An increase in inflation, the cost of capital, the trajectory of interest rates, and the escalated valuation of some assets necessitate a more discerning approach toward the selection of acquisitions. In this capital environment, multiple arbitrage on roll-ups will be more costly, and deal theses will be more complex as they take additional factors into account to achieve the same returns.
The prevailing market conditions have ushered in a considerably more formidable environment than what has been witnessed in recent years. In this article, we dive into four trends—distribution aggregation and diversification, insurtech investment focus, life and annuities as a continued source of permanent capital, and alternative capital solutions—that will shape PE’s role in the insurance sector in the coming months and years. PE practitioners must navigate this terrain with a blend of prudence, adaptability, and innovation to achieve success in the landscape of insurance-focused investments.
Private equity in insurance today
Insurance is an increasingly significant portion of PE financial-services deals, accounting for approximately 60 percent of all PE deal volume among financial institutions groups (by number of transactions) in recent years, according to McKinsey analysis of Pitchbook data. A pronounced deceleration in the rate environment for many lines of business has become apparent, a trend projected to lead to further softening of various insurance lines in the short term.
From 2020 to 2022, approximately three-quarters of insurance PE deal volume was driven by insurance distributors. According to our analysis, approximately 10 percent of deals were balance-sheet plays, and 9 percent were services (for example, claims, underwriting, or distribution support for incumbents).
Four themes that will define PE in insurance
The changing landscape and macroeconomic uncertainty force industry players to navigate a terrain that demands not only growth but also strategic agility. With this in mind, four themes will dominate insurance investors’ focus in the short term.
Distribution aggregation and diversification
Distribution aggregation and diversification continues to represent one of the biggest drivers of PE activity within insurance. Distributors, such as brokers and managing general agents (MGAs), remain popular PE investments because of their minimal capital intensity, high free-cash-flow conversion, recurring revenue models, and historical resilience across economic cycles. However, the recent rise in interest rates and the ensuing higher debt costs have slowed broker consolidation, while MGAs are still in the early stages of what could be considered the “next” phase of broker roll-up. As a result, the appetite for M&A in the MGA space is on the rise, and the gap in valuation multiples between small and large players in this sector remains substantial.
Brokers. Broker consolidation will continue, albeit at a slower pace, emphasizing the growing importance of postdeal value creation and adjacent opportunities. In 2022, brokerage M&A activity declined 5 percent, after 16 percent annual growth from 2014 to 2021 (Exhibit 1).
As the inflow of new investments slows and the momentum of rate hikes eases, investors will face pressure to stimulate organic value creation with their current broker portfolio. PE-backed distributors are actively engaging in the integration of brokerages that previously functioned with considerable independence under federated models. These endeavors are centered around optimizing placement strategies, embracing vertical integration (for example, through the acquisition and launch of wholesalers and MGAs), harnessing technological capabilities, reducing cost, and exploring adjacent products (cross-selling), among other organic value-creation levers. This integration, when done properly, has the added benefits of securing succession planning, allowing for better governance and capture of synergies, and preparing the brokerage for a wider range of exit options.
Moreover, brokerages are poised to expand their scope by venturing into the employee benefit space, as well as by expanding their connections with professional employer organizations (PEOs), wealth management firms, and registered investment advisors (RIAs). These strides will be propelled through strategic acquisitions.
Managing general agents. With the landscape shifting toward more-specialized underwriting, insurance capacity is turning to MGAs for this expertise, as well as for unique distribution access. Forty percent of carriers have MGA relationships for specialty risks,3 with MGAs collectively underwriting more than $85 billion in annual premiums4—equivalent to around 10 percent of total property and casualty (P&C) premiums.
Partnering with MGAs empowers investors to tap into these specialized risk domains, capitalizing on the value created by navigating complex markets without the same balance sheet risk of carriers. Drawing on a strategy that has historically proved successful in the retail brokerage sphere, investors are extending their value-creation tactics to diversified, multiline MGAs, fueling a flurry of interest in MGA roll-ups in 2022.
Investors are increasingly aware of the opportunity to identify and acquire high-performing MGAs or secure underwriting talent with the expertise to launch them. This has led to heightened valuations and put the onus on investors to identify high performers with distinctive capabilities amid a growing number of MGA contenders for acquisition. MGA aggregators with the ability to appropriately source, evaluate, manage, and retain underwriting talent and performance are especially sought after. Investors further along the roll-up journey are also looking to leverage additional value-creation tactics—for example, the use of generative AI, improved integration to achieve scale benefits, and better reporting and results management.
Fronting carriers. Fronting carriers—insurance companies that issue policies but take on little to no risk (that is, less than 20 percent)—have gained traction as a capacity provider for the MGA market. From 2020 to 2022, the fronting market experienced steady growth, reaching about 15 percent of the MGA market in 2022. Fronting direct written premiums have nearly doubled since 2018, reaching $12 billion in 2022.5 PE firms can seize the opportunity to tap into this market to access fee-based income, benefiting from capacity providers seeking partnerships with MGAs or program administrators.
Fronting carriers command between 2 and 8 percent (with the majority around 5 percent) and bear less risk than traditional carriers, making the economics attractive for investors. However, as the model gains traction, its associated risks are surfacing. Fronting carriers have credit risk—not to mention balance sheet risk (for those that provide some portion of the capacity)—and issues related to capacity and credit can reveal cracks in the system. Despite these challenges, the consensus is that fronting carriers will remain integral to the value chain as MGAs grow and capital providers seek access to US risks and talent.
Independent marketing organizations. The consolidation of independent marketing organizations (IMOs) within the independent agent channel in recent years has catalyzed significant transformation within the life insurance and annuities distribution landscape. The independent agent channel is one of the largest channels for fixed-indexed annuities and indexed universal life insurance. These products offer consumers the dual benefit of principal protection coupled with potential for market gains. Since 2017, PE-backed IMOs conducted more than 150 transactions in pursuit of scale, capturing substantial market share in the channel. Notably, the uptick in interest rates amid market volatility led to a surge in indexed annuity sales between 2021 and 2022.
The pivotal role IMOs play in the distribution of fixed-indexed annuities underscores their enduring appeal to investors for a few reasons:
- IMOs serve as indispensable intermediaries in the sale of annuities, insurance, and Medicare Advantage products within the independent agent channel.
- They cultivate close relationships with both insurers and distributors, which grants them a distinct advantage in the insurance value chain.
To capitalize on the M&A opportunity in the IMO channel, firms can explore additional opportunities within the realm of smaller IMOs and brokerage general agencies (BGAs), in which the potential for further consolidation remains abundant.
Targeted insurtech investment, led by ecosystem players that support incumbents
From 2017 to 2021, insurtech investment boomed, reaching record highs in 2021. However, the high-profile declines of several insurtechs following their IPO have left investors wary. Investors’ hesitance has been compounded by inflationary pressures and restricted access to capital, which have slowed insurtech investment over the past year in geographies around the globe (Exhibit 2). For example, venture capital experienced a significant decline from a four-year CAGR of 12 percent in insurtech deals to a 21 percent decline in 2022.
Software insurtechs gain traction. Software players represent approximately 30 percent of US-based insurtechs today, and insurance players across the value chain will continue to rely on scalable software solutions that automate and enable critical insurance workflows. As a segment, software insurtechs are poised to gain traction, particularly as incumbent carriers and brokers seek “plug and play” solutions to capture efficiencies across the value chain.
Moreover, many software vendors and services have been bolstered by the potential use of generative AI, and insurance carriers want technology partners capable of integrating these capabilities into their existing offerings and enabling the development of new ones. The insurtech players that are early to market with positive-ROI offerings will take advantage of first-mover opportunities and lock in what are likely to be lucrative and “sticky” licensing contracts.
Insurtech collaborators enable ecosystems. Some insurtechs have thrived in the role of ecosystem participants, facilitating the activities of traditional insurance players and expanding the products and services available to their customers. A constellation of insurtech participants has taken shape, supporting established carriers and brokers across the entire value chain—spanning distribution, underwriting, claims, and service.
These entities often occupy specialized niches within the market landscape. For instance, a diverse array of data offerings, complemented by associated analytics and insights, cater to property risk assessment. Additionally, sophisticated pricing tools tailored to specific market segments have emerged. Leading insurtechs in this arena will continue to transition from the role of “disrupter” to that of “collaborator” as they look to partner with traditional carriers. Investors are seeking opportunities (and making investments) in technology players that provide value to traditional carriers and brokers, given the value these players without balance sheets offer compared to the profitability challenges insurtech disrupters face.
Embedded insurance finds numerous entry points. Both the demand for embedded-insurance solutions and the supply of solutions in this space are on the rise and will continue to grow.6 Insurtechs have been both beneficiaries and enablers of the embedded-insurance space. Incumbent carriers, brokers, and reinsurers are using their capital base to partner with noninsurers to launch embedded-insurance solutions, often at point of sale on adjacent products and services (for example, auto or travel).
For instance, some automotive OEMs have launched embedded-insurance solutions to offer insurance directly to their customers at point of sale and after purchase. Leveraging their proprietary telematics data for dynamic pricing, these OEMs use the balance sheets of carriers or fronting carriers to ensure coverage. We expect insurtechs to continue as both takers and providers of capacity in the embedded insurance space.
Capital arrangements take innovative forms. Capital arrangements between insurtechs and investors are evolving, and new funding structures that support insurtechs have emerged. For example, a digital-native insurer and an investor recently launched a virtual agency program. Under this arrangement, the investor agrees to finance a portion of customer acquisition cost (CAC) in exchange for a fixed, time-limited commission on the premiums generated from the insurance policies it helped finance. This frees up cash for the insurer to invest in growth, while the investor gains access to commission-based income without taking on risk from the insurer’s underwriting results. We expect investors to continue to explore new partnership models to learn about and access the insurance space.
Life and annuities as a continued source of permanent capital
A growing number of alternative-asset managers have identified life and annuities as a source of permanent capital: long-dated liabilities whose counterbalancing assets need to be invested, often providing attractive spread margins. We first published on the opportunity in early 2022, and since then, the investment opportunity has only found more suitors and become increasingly competitive.7
Alternative-asset managers continue to increase their presence among life insurers. According to S&P Global, PE-backed platforms now hold over $600 billion in US life and annuity assets, and their contribution to alternative-asset managers is significant.8 Despite this growth, however, the opportunity remains largely untapped, with an addressable market of nearly $4 trillion across in-force liabilities and new business inflow.
The scaled results of many alternative-asset managers have attracted new entrants and increased competition in the space. Investment focus will likely evolve in three specific ways. First, some investors are increasingly taking an expansive liability focus, shifting from the historic anchor of simple, spread-based liabilities (for example, fixed and fixed-indexed annuities) to increasingly complex liabilities (for example, secondary guarantee universal life). Second, some are taking an expansive value-creation approach, which was historically anchored on investment alpha (particularly within private asset classes) and is now evolving to increasingly operational and liability-focused levers. And third, the PE insurance landscape is now focused globally across the United States, Western Europe, and parts of developed Asia.
Continued momentum for alternative-capital solutions
Alternative capital continues to represent opportunities for investors and PE-backed insurers, albeit with certain limitations. Investors can tap growing insurance-linked securities (ILS) opportunities; however, they often experience mixed results. P&C insurance has been in a hard-market cycle since 2017, resulting in significant reinsurance capacity constraints for carriers. In 2023, reinsurance rates hardened 20 to 30 percent compared with the prior year, and this trend shows no indications of abating in the short term. Consequently, brokers and carriers are increasingly seeking external investors to provide capacity, leading to the rapid growth witnessed in ILS issuances and other forms of alternative insurance capital, such as industry loss warranties (ILWs) and sidecars.
In 2021, investors injected approximately $20 billion into the insurance market in the form of ILS, according to McKinsey analysis of data from Artemis. At the time of writing, 2023 issuances are on track to exceed this record (projected at between $20 billion and $25 billion, with an approximate 20 percent CAGR over the past five years). While most new issuances typically focus on property catastrophe (cat) bonds (60 to 70 percent of total) and mortgage bonds (20 to 30 percent), more recently, investors have demonstrated interest in cyber bonds—a trend pioneered by Beazley’s launch of the first cyber cat bond, structured by Gallagher Securities.
Drawn by the prospect of consistent returns and investments that are uncorrelated with broader financial markets, ILS investors have faced mixed performance since 2017, in part due to an uptick in extreme weather events. Since 2017, an average of 14 to 22 natural catastrophes per year have caused damages exceeding $1 billion each year, compared with fewer than five such catastrophes per year in the prior two decades.9 As a result, ILS returns ranged from –6 percent to 11 percent from 2017 to 2023 (Exhibit 3).
Within this volatile but hardening market, investor interest in ILS is expected to continue. Investors are drawn to issuers with distinctive underwriting expertise in property catastrophe and to those with proven track records of profitability offering bonds covering new perils. For example, cyber insurance has attracted attention due to its loss ratios hovering between 30 and 50 percent in the past five years, accompanied by sharp pricing hardening. A potential “soft market” cycle could result in a slowdown in ILS growth as insurers rely less on external investors, but it could also bring more stability in returns, attracting more investors to the space.
A forward-looking insurance investment strategy
To realize optimal returns in the short term, PE investors will need to develop precise insurance investment strategies and partner with their portfolio companies to drive both near-term and midterm value creation.
Today, some PE investors are working closely with their portfolio companies to maximize the value of their investments and explore a variety of growth and value-creation opportunities. This starts with identifying quick wins post-integration (where relevant), deploying a combination of organic and inorganic growth strategies that anticipate market cycles, and consistently keeping an exit focus in mind given the rapid shifts in the broader insurance market.
Find quick wins after acquisitions through integration
PE investors can take early actions to capture value from insurance acquisitions through effective post-deal integration (recognizing that different degrees of integration will be more appropriate for certain acquisitions). Robust 100-day plans—developed during the deal process—can ensure that the team takes a disciplined approach to realize strategic quick wins and to start to plan for longer-term bets (for example, technology migration). PE firms should also ensure their new portfolio companies have the right talent in place, making strategic senior hires with deep insurance expertise as needed.
Develop strategies for portfolio optimization and organic growth
Effective portfolio management requires precise, coordinated execution across targeted initiatives. Investors should review their portfolio mix (for example, products or customer segments) and identify leading and lagging areas. Decisions on where the company wants to grow, shrink, or enter should be made based on the organization’s capabilities and insurance market dynamics (for instance, economic cycle or competitive landscape). As the direction of the portfolio takes shape, investors should launch organic value-creation efforts, including leveraging generative AI and launching efficiency initiatives such as core technology refreshes. Commercial-oriented initiatives, including pricing, commission, and marketing and sales optimization, can generate incremental value and targeted growth.
Drive disciplined cost-reduction efforts
Several headwinds are creating profitability challenges for PE-backed insurance companies. Financial inflation has pushed up loss costs faster than premiums in some lines of business, while social inflation has elevated litigation costs, also cutting into profitability. In response, PE-backed firms should evaluate and quantify opportunities to reduce costs to protect margins. After sizing and prioritizing opportunities, PE-backed companies should follow detailed execution plans and ensure there is clear accountability regarding expected pace and impact to capture their targeted savings.
Create an effective M&A engine fit for the current economic environment
As the spread on multiple arbitrage decreases and roll-up strategies become more difficult to realize, vertical integration is becoming an increasingly attractive option for investors to reduce costs and increase EBITDA. There have been instances of retail brokerages acquiring both MGAs and specialty wholesalers that specialize in cybersecurity risk. Other distributors have expanded into adjacent areas (for example, wealth or professional employer organizations). PE firms can capitalize on these opportunities by creating a repeatable, data-driven M&A process for researching and selecting the best investment opportunities.
The trajectory of private equity in insurance is being redrawn by the convergence of rising capital costs, shifting rate dynamics, and the ripple effects of significant risk changes. This juncture raises the bar for investment decisions and underscores the need for heightened value creation, calling for a strategic finesse that goes beyond the simplicity of yesteryear’s acquisitions.