Permanent capital—investment funds that do not have to be returned to investors on a timetable, or at all—is, according to some, the “holy grail” of private investing.1 Permanent capital owes its exalted status to the time and effort that managers can save on fundraising, and the flexibility it provides to invest at times, like a crisis, when other forms of capital can become scarce.
Permanent capital can take many forms, including long-dated and open-ended fund vehicles. The balance sheet of a life and annuities company is one form of permanent capital that has drawn much attention. In 2021, private investors announced deals to acquire or reinsure more than $200 billion of liabilities in the United States. Such investors now own over $900 billion of life and annuity assets in Western Europe and North America. Assuming the pending deals close successfully, private investors will own 12 percent of life and annuity assets in the United States, totaling $620 billion, and represent more than a third of US net written premiums of indexed annuities. All five of the largest private equity (PE) firms by assets have holdings in life insurance, representing 15 to 50 percent of their total assets under management. By our count, 15 alternative asset managers have entered the market, or stated their intent to do so. Insurance carriers are also benefiting from all the attention: many of the largest insurers have sold legacy books to private buyers, typically to improve their return on equity and to free up capital for reinvestment or return to shareholders. For some public carriers, these transactions have generated near-instantaneous expansion of their price–earnings multiple.
The trend is not new: private investing in insurance dates back more than 50 years to Berkshire Hathaway’s acquisition of National Indemnity in 1967. As that example shows, many forms of insurance beyond life and annuities can serve as permanent capital, including specialty and property and casualty (P&C). In this article, however, we’ll focus on the reasons why many PE firms have concluded that life insurance and annuities represent a once-in-a-generation opportunity. We’ll also look at the requirements for PE firms on the sidelines that want to enter the market, discuss some overlooked ways that PE owners can create value, and highlight some implications for life insurers as they consider either selling a portion of their book of business or emulating and competing with this potent new industry force.
Why PE investments in life insurance are growing
The core attraction is straightforward. The balance sheets of life and annuities companies are well stocked with assets (to match the liabilities of future payouts and indemnities), but until payout, these assets need to be invested to generate returns. And in many cases, the cost of servicing the liabilities is significantly lower than the potential investment return. The spread represents an attractive margin.
The most common way for general partners (GPs) to capture the spread is to set up an insurer that they control through an equity investment (sometimes in conjunction with other investors, such as sovereign-wealth funds) and then acquire or reinsure books from other insurers. To ensure they earn the required returns on acquired books, these GPs typically influence the strategic asset allocation (SAA) and apply their investment management capabilities to earn alpha on some of the asset classes. The benefits to the GP in this case are threefold:
First, in our experience, executing the value-creation playbook can generate internal rates of return (IRRs) of 10 to 14 percent. Investment returns have substantially lifted return on equity (ROE) in recent years. GPs achieve stronger investment returns largely by rotating the asset allocation into classes that are higher risk and higher return (while still meeting regulatory and rating agency guidelines) and achieving higher alpha within these asset classes. Consider what US PE-backed insurers have accomplished: one analysis found that they generated 62 basis points (bps) higher investment yield than the industry average.2 Within three years of acquisition, 80 percent of these insurers had increased their allocation to asset-backed securities (primarily collateralized loan obligations), and over half of their investments were in private loans (compared with 37 percent for the industry). Many PE firms have privileged, at-scale capabilities to originate higher risk-return assets and deliver excess returns. What’s more, the approximately ten times asset-to-equity ratio typical of insurers amplifies the impact of strong investment performance.
A few other factors also contribute to healthy IRRs. For one, disciplined owners are often able to operate the business more efficiently and effectively, as we discuss below. In addition, for some books like variable annuities, public valuations appear to be lower than private valuations. As such, public investors may be wary of the volatility and opaque risk profile, raising the issue of whether such books are better suited to private ownership.
- Second, investing these assets provides a stable base for GPs to rapidly build their alternative credit capabilities. Credit investing is a strategic growth area for many firms at a time when PE markets are becoming more competitive. Acquiring a life book immediately provides long-term assets for the firm’s credit arm to invest. It’s a much faster way to reach scale and significantly less onerous than raising several credit funds. Depending on the structure of the vehicle, this can provide a significant source of fee-related earnings, which are more resilient to market fluctuations and more stable than carried interest. In particular, PE-backed insurers typically use structured credit products as core assets in their life insurance books. Origination of these asset classes is reaching record levels. For example, collateralized loan obligations, a core asset class for PE-backed insurers, are now a $760 billion market.
Finally, life insurance offers the potential for scale. Traditional life liabilities in Europe total €4.5 trillion; in the United States, life and annuity insurers carry $4.5 trillion of assets on the general account, with an additional $1.5 trillion in separate variable-annuity liabilities, and there are $3 trillion of private-sector defined-benefit liabilities. Even after many large PE acquisitions, a huge supply continues to be available, allowing PE firms that build insurance capabilities to scale and take full advantage of this opportunity.
Another model that some GPs follow is a partnership or outsourced chief-investment-officer (OCIO) model, in which they work with incumbent insurers to manage a portion of their assets for the long term and take only a limited equity stake, or none at all. In this case they still receive the benefits of scaling their credit capabilities, as a high-performing OCIO operation can attract other insurers looking to outsource investment management. This also provides a steady source of fee-related earnings, which can drive higher valuations for the GP. And as a strategy, this too has potential to be scaled, as other insurers seek higher allocations to these high-yielding asset classes.
Sellers are willing
Put it all together, and it’s clear why life insurance is attractive to PE buyers. Further fueling the market is insurers’ willingness to sell: some see an opportunity to shift strategy and move into more attractive businesses; others think they can deliver greater value by exiting these books and returning the capital to shareholders. One example of the strategic shift is the move by many insurers to a capital-light, fee-based business model (such as investment management and recordkeeping) in structurally advantaged value pools in their domestic markets (for example, in defined-contribution pensions in which assets are growing at 6 to 8 percent annually across Europe and the United States). Similar to GPs with strong fee income in their revenue mix, insurers with a high proportion of fee earnings will typically trade at higher valuations (often nine to 12 times P/E ratio, or 1.1 to 1.7 times book value) than those in capital-intensive businesses (usually five to eight times, or less than 1.1 times book value). Selling a life back book can provide the needed capital to pivot quickly into a new business, and investors are supportive of such moves. For example, one broad-based US player divested its closed block of variable annuities to reduce the volatility of earnings and refocus on capital-light businesses. Investors responded well: over the subsequent three years TSR outperformed the life index by ten percentage points. The carrier’s price-to-book (PB) ratio rose from 1.2 to 1.6 times, at a time when the broader industry’s PB ratio fell from 1.3 to 1.0 times.
Even as the capital-light model has gained favor, the traditional business has become less attractive. Many insurers’ earnings on in-force blocks have come under pressure, as guarantee rates to policyholders are still as high as 150 to 400 bps in some markets, while yields on bonds have declined by 150 to 300 bps since 2010–11. Naturally, this has strained capital as insurers have had to adjust their reserves to reflect future earnings expectations. An average insurer reinvests about 12 percent of its assets annually, so this profitability challenge becomes increasingly acute every year. PE buyers are subject to the same pressures, of course, but with their different approaches to investment and operations, they are better able to overcome the costs of the capital requirements.
In addition, operational and IT issues have continued to challenge profitability and require significant investment and management attention to address. For example, migrating legacy policy-administration systems and investing in automation can be attractive in the medium term but require careful management to prevent technical or servicing issues.
In short, opportunity abounds. But how to take advantage? The playbook varies for PE firms considering an acquisition, those that have owned a life book for some time, and insurers.
Market entrants: How to begin
As so many PE firms have acquired insurance assets, would-be entrants and firms looking to scale their nascent operation may find the market more complicated than it once was.
As always, the approach starts with strategy. PE firms must first get clear on their strategy for insurance investments, choosing from a spectrum that ranges from a one-off opportunistic play to be sold in several years to the foundation for a future platform—and a source of permanent capital. The choice of strategy has material implications down the line, on whether or not to insource IT and operational capabilities; talent strategy; target geographies (where market dynamics and regulatory factors are also important); and target books of business (in annuities, life, or pension risk transfer). Defining the approach up front will save costs later. Further, if the deal is large and part of a platform strategy, the investment could change the DNA of the firm, shifting the focus from PE to private credit, while also posing future regulatory hurdles.
Those firms that are thinking of a platform play, and a long-lasting and growing source of permanent capital, will need three capabilities: proprietary access to potential deals, value-creation skills to make the most of the deals they close, and strong risk-management capabilities given the nature of insurance.
The most common path for new entrants is to acquire or reinsure a closed block. As competition increases, some GPs are exploring alternatives, such as scaling organically or through a series of smaller transactions. However, these approaches are proving challenging given the need to reach scale to attain attractive economics. A third approach seen in two recent examples is a partnership model. New entrants could consider partnering with insurers in addition to making outright acquisitions. If the two parties share in the upside (and the risks) and share the capabilities (for example, the insurer brings some of the technical capabilities while the GP supplies investment skills), PE firms might be able to secure the benefits of permanent capital while avoiding the complexity of operating a life insurer.
There are a few risks that PE firms should be aware of and take action to mitigate, starting with the asset side of the balance sheet, including illiquidity and credit risk. Rotating the portfolio into higher-risk credit assets has advantages but also creates risk that is important to manage, particularly as the portfolio has typically been invested in more liquid, stable assets. Managing the credit risk of the underlying assets, maintaining sufficient liquidity as needed for policyholders, and managing the mark-to-market volatility on the credit portfolio during a credit downturn to maintain regulatory and rating stability are all critical. This risk has been latent, given the relatively benign credit environment in the past decade, but a future emergence could put stress on balance sheets.
A second concern is regulatory uncertainty. Although regulators are getting used to the idea of PE ownership of life carriers,3 approval can take time. As PE firms enter a highly regulated industry for the first time (and encounter all the risks of shifting regulation), they will need skills to engage well with the regulator (and ratings agencies, critical stakeholders in reinsurance), to build their trust, and, ultimately, to persuade them that the firm is a responsible owner.
Public opinion can be another obstacle. In two recent Western European deals, concerns about the impact of a PE owner meant that late-stage negotiations did not succeed.4 Finally, firms should consider limited partners’ (LPs) reactions to a life acquisition. The potential for sponsor-owned insurers to invest in other assets and funds raised by the same sponsor may change the GP/LP dynamic. Such governance challenges are subtle and may only emerge over time.
Current owners: The value-creation playbook
Once they’ve acquired a book, firms can turn their attention to driving value. Building on our guidelines for closed-book value creation, owners have six levers that can collectively improve ROE by up to four to seven percentage points (exhibit):
- Investment performance: optimization of the SAA and delivery of alpha within the SAA
- Capital efficiency: optimization of balance-sheet exposures—for example, active management of duration gaps
- Operations/IT improvement: reduction of operational costs through simplification and modernization
- Technical excellence: improvement of profitability through price adjustments, such as reduced surplus sharing
- Commercial uplift: cross-selling and upselling higher-margin products
- Franchise growth: acquiring new blocks or new distribution channels
Most PE firms view the first lever, investment performance, as the main way to create value for the insurer, as well as for themselves. This lever will grow in importance if yields and spreads continue to decline. Leading firms typically have deep skills in core investment-management areas, such as strategic asset allocation, asset/liability management, risk management, and reporting, as well as access to leading investment teams that have delivered alpha.
Capital efficiency is also well-trod ground, and for private insurers it presents a greater opportunity given their different treatment under generally accepted accounting principles, (GAAP), enabling them to apply a longer-term lens and reduce the cost of hedging. However, most firms have yet to explore the other levers—operations and IT improvement, technical excellence, commercial uplift, and franchise growth—at scale. Across all these levers, advanced analytics can enable innovative, value-creating approaches.
Cost cutting is a paradox for private acquirers of insurance books. On one hand, the opportunity is tempting: insurers have generally not cut costs as fast as other industries, and the books in question are often high-cost operations. On the other hand, acquirers sometimes underestimate the complexity that drives these costs, given the complicated nature of multiple legacy systems and nuances across policy vintages—to say nothing of new costs for postmerger integration. New entrants have a particular advantage here, as they can adopt a digital-first approach to data and technology, unencumbered by legacy-system issues. Our preliminary analysis suggests that as PE firms achieve scale in insurance, typically defined as at least $10 billion of assets, costs can be wrestled lower. In our study of a small sample of US and European closed-book acquirers, US firms, which have typically reached scale, enjoy costs 20 to 40 percent lower than general life insurers in most major operating-cost categories. But European acquirers are burdened with costs 30 to 60 percent higher, in part due to the more complex books they have acquired.
Many of the techniques to address operating and IT costs are well understood: process streamlining, changes to operating location, and efforts to reduce overhead costs are levers most insurers have pulled to some degree. Many have also attempted to capture scale benefits. To get to the next level, insurers can take a comprehensive look at these levers to understand their interdependencies. For example, unlocking scale benefits requires action to reduce complexity of the book, by offloading legacy products, say, or decommissioning legacy IT systems. For a GP, this can reduce dividends in the short term but offer an attractive return given the longer-dated nature of these investments.
New AI techniques, including machine learning, can also help insurers capture more of these opportunities than was previously possible. For example, applying these methods to system migration and data extraction allows insurers to bring down part of the costs before executing an outsourcing contract and therefore retain more value.
Conducting a thorough review of contractual terms and finding opportunities to adjust where appropriate (for example, through reduced surplus sharing) can be a material driver of value. New AI skills and modernized IT systems can also bolster the ability of insurers to apply technical and commercial levers. For example, AI can enhance an insurer’s understanding of customer blocks and enable it to develop a segmented approach with targeted interventions.
AI offers additional benefits, such as avoiding lapsing through a better understanding of customers and identifying opportunities to cross-sell or upsell. For example, one insurer applied AI modeling along with a refreshed strategy for sales force optimization. Agents in this program delivered between 40 and 250 percent more cross-sell revenue than a control group that did not use analytics.
Identifying attractive new blocks and ensuring an operating model that can successfully scale without raising costs significantly or damaging policyholder service is a critical lever. Advanced analytics can unlock new opportunities here as well: applying machine learning to model policyholder behavior in a target book, for example, can be 20 to 50 percent more accurate than traditional actuarial methodology. Combining actuarial and AI techniques can unlock significant value as the franchise grows. For new entrants, identifying innovative ways to grow the franchise can be particularly attractive. They might, for example, expand into structured settlements, flow reinsurance, or coinsurance (particularly for those without manufacturing capabilities). There are at least three prominent examples of players that began with a closed-book focus but now derive significant value from organic growth which represents 25 to 50 percent of their flows and assets.
Insurers: Fight or flight?
Several leading insurers already exercise the same value-creation playbook that PE firms are using. In many cases, these insurers are better positioned on the operational, technical, and commercial levers. For example, by running operations and IT transformations or using analytics-powered methods to release capital or improve in-force earnings, they are creating value despite the challenging interest-rate environment.
Insurers are also taking a fresh look at investment levers and, in some cases, studying the moves made by GPs for potential insights. Many insurers are building investment skills, reviewing the strategic-asset allocation, and finding new ways to secure access to, and generate alpha from, higher-yielding, capital-efficient asset classes, provided they can effectively manage the risk. In more challenging asset classes, some insurers are exploring partnership models. For example, at least two insurers have recently partnered with alternative managers; in these deals, the insurer brings operations expertise, and the alternative manager can capture the upside from managing the credit investments and delivering best-in-class capabilities for investment performance. The arrangement lets the insurer capture a share of the upside without having to build or buy all of the needed specialist capabilities, and can create a structure with which to raise external capital.
For insurers who cannot see a path to building leading capabilities or have more attractive investment opportunities, sale or reinsurance of part or all of a capital-intensive book could free up significant capital. To gain the best price, they must understand the PE value-creation playbook sketched above and strike a fair deal.
One final possibility for insurers facing a challenging value-creation path: a few insurers could pool their challenged assets and build sufficient scale to offer a compelling proposition to another insurer, either as a purchase or a joint venture.
The window is firmly open on this once-in-a-generation opportunity—momentum is building, and more investment is sure to come. But as competition increases and credit spreads remain low, firms will need to evolve their value-creation playbook and deploy a broader set of levers to capture the full potential from this opportunity.