Private Equity Boosts Returns on Insurance Pools

With traditional bond investments failing to provide adequate returns, insurance companies have turned to private equity (PE) firms to help boost their bottom line using a different approach. By accessing alternative investments, PE firms are achieving higher yields than fixed income with better risk management.

Historically, insurers have accumulated assets (i.e., the premiums paid by policyholders) and invested them in high-quality bonds to pay off liabilities such as insurance policies or annuities. More recently, the opposite tack—generating liabilities such as life insurance policies and annuities in order to invest in potentially higher-performing assets—has become widespread.

Why PE Investments in Insurance Are Booming

There are several reasons for this shift. Near-zero interest rates made it much tougher for bonds to meet insurers’ long-term liabilities over much of the past decade, compelling them to look elsewhere for better returns.

Two other critical developments happened over roughly the same period. First, PE firms began to capitalize on the opportunities offered by the insurance industry, opening up a new world of possibilities for their investments. Second, the use of alternative investments to achieve above-average returns grew exponentially.

The market for insurance investments is huge: According to the National Association of Insurance Commissioners (NAIC), U.S. insurance general accounts held $8.5 trillion in cash and investments at the end of 2023. Life insurance accounted for the biggest piece by far ($5.5 trillion, or 64.4% of the total), followed by property and casualty (31.3%), health (4.2%), and title (0.1%).

The Private Equity Connection

PE firms have followed a variety of strategies in their pursuit of insurance-based businesses. Some have started or acquired annuity providers and managed their assets, while others have taken strategic equity stakes in life insurers and managed large chunks of their assets. Banks such as Fifth Third have significantly contributed to these trends by providing PE deal financing, cash management, and leverage support.

Several factors are driving PE interest in insurance pools, says Joshua Landau, Senior Vice President and Group Head of Financial Institutions and International Corporate Banking, within Fifth Third’s Corporate & Investment Banking division. He notes that while banks had been top lenders to insurers, restrictions on the amount of capital that banks must hold tightened after the financial crisis. PE firms stepped into the resulting vacuum.

"PE also has more flexibility in structuring and managing insurance investments," Landau says. "Finally, insurance premiums are a continuous source of long-term capital that PE firms can deploy at low cost across their various businesses, particularly credit investing."

An important milestone in PE’s involvement with insurance came in 2009 when PE firm Apollo co-founded an insurance company, Athene. Apollo’s need for capital to invest fit perfectly with the generation of policy premiums for which Athene was designed. Athene decided to exclusively focus on issuing annuities—continuous long-term capital from which Apollo could earn management fees. Apollo acquired full control of Athene in 2021, and Athene has become the third-largest issuer of U.S. annuities.

PE’s involvement with insurance has since skyrocketed. The general accounts of PE-owned U.S. insurers held $605.7 billion at year-end 2023, or 7.1% of the $8.5 trillion industry total.

A Mutually Beneficial Relationship

Both sides of the PE-insurance connection stand to reap benefits. The benefits for insurance providers include:

• Higher returns. Some of the largest insurers have significant investment capabilities that include trading floors rivaling those of the top Wall Street firms. Most in-house investment teams, though, concentrate on conservative securities such as U.S. Treasury bonds and top-rated corporate debt, both as required by regulations and as a matter of fiduciary prudence.
  
  PE firms and other external managers, on the other hand, have fewer restrictions and much more experience with higher-returning alternative instruments such as private credit and asset securitizations.
• Management expertise. PE investment teams are skilled and experienced in managing alternative investments and investment risk, areas where insurance companies have not always allocated resources.
• Broader opportunity set. In addition to buying and selling companies, many PE firms issue and manage instruments such as private credit, collateralized loan obligations and other asset securitizations, private placements, and debt for their portfolio companies. This is a much broader universe of investment opportunities than most insurers have on their own.
• PE track record. The largest PE firms have been around for decades and have built successful track records of investing in companies and managing specialized assets. This kind of success attracts capital and is a big draw for insurers seeking better returns.
• Less regulation. The PE industry is less regulated than insurance, notably when it comes to maintaining capital to offset liabilities. Insurers can gain considerable flexibility by having PE firms manage their investments.

The Many Positives for PE Firms

It’s not only the insurance companies that stand to benefit. PE firms also gain by their involvement in insurance:

• Permanent capital. PE firms typically raise capital in the form of pooled funds that must be returned to investors on a fixed schedule. Annuities and life insurance policies, by contrast, are designed to pay out years into the future and generate a steady stream of premiums that must be invested for the long term.
  
  "This ‘permanent capital’ not only saves PE firms the time and expense required for fundraising, but it also gives them important liquidity and financial flexibility," says Christine Reyling, Managing Director and Senior Vice President at Fifth Third Bank.

• More assets mean more income. Managing insurance accounts increases PE firms’ fee-based income and can help attract assets from other insurance businesses.
• Ready buyers. Insurers are ready buyers of PE firms’ wide range of available investments, which tend to offer above-average returns.
• Stronger investing capabilities. Because premium flows are ongoing, predictable, unaffected by market fluctuations, and often at large scale, they enable PE firms to rapidly build and develop their investing capabilities.
• Diversification.Adding insurance businesses helps PE firms diversify beyond PE and provide a broader scope of financial services.

Why Alternative Investments Are Attractive

Alternative investments are financial assets that don’t fit into the conventional categories of publicly traded stocks, straight bonds, and cash. Within the alternative's universe, insurers find private credit and asset securitizations most appealing.

Private credit comprises privately negotiated loans and debt financing issued to small- and medium-size companies by non-bank lenders. These loans are especially attractive to lenders because they typically offer higher-than-usual yields, attractive pricing, and strong investor protections.

Research firm PitchBook values the private credit market at $1.5 trillion. PE firms and dedicated alternatives managers have raised six of the top seven private credit funds, according to Private Debt Investor.

There are multiple reasons why private credit is a great fit for insurance portfolios. For starters, it provides high credit quality, stable income streams, superior yields, portfolio diversification, lower volatility, and favorable regulatory treatment. It also offers lender-friendly structures that can reduce downside risk and customization that can match up with liabilities more closely than straight bonds.

In addition, private credit instruments tend to be floating rate, meaning they provide built-in hedging against rising interest rates. Their relative illiquidity also helps portfolios soften the declines of traditional fixed income when rates rise and enables lenders to charge meaningful illiquidity premiums. Finally, the variety of private credit sub-asset classes allows insurers to meet their duration, asset seniority, and credit quality needs, and find their preferred collateral types.

Hungry for Securitizations

Asset securitizations are a subset of private credit. They pool assets such as mortgages, loans, and lease payments, and transform the pools into securities. The most common securitizations are asset-backed securities (ABS), collateralized loan obligations (CLOS), commercial mortgage-backed securities (CMBS), and residential mortgage-backed securities (RMBS).

Securitizations’ appeal to insurance portfolios is similar to that of private credit: steady income payments, above-average yields, diversification, advantageous regulatory treatment, and strong credit quality.

NAIC data indicates that ABS and other structured securities account for the second-largest share of insurance fixed-income holdings (i.e., $625.2 billion, or 12.1% of total bond investments, at the end of 2023).

Not surprisingly, PE-owned insurers invest more heavily in securitizations than the industry as a whole. At year-end 2023, ABS and other structured securities accounted for 29% of PE-owned insurers’ bond investments—more than double the overall insurance industry’s 12.1% allocation.

A Bright Future

Recent survey results signal a bright future for private credit and, by extension, insurance investing by PE firms.

Mercer and Oliver Wyman’s 2024 Global Insurance Investment Survey points to insurers raising their investments in private markets. Some 60% of respondents said that they hadn’t yet reached their target private markets allocation, and 53% expected to raise their private markets exposure in the next 12 months. In addition, 47% were using, or planned to use, a third-party manager for private markets.

As the integration of PE firms in the insurance industry evolves, Fifth Third Bank is helping PE firms obtain financing for mergers and acquisitions and loans for leverage in making deals. The bank has over 50 years of experience in the insurance industry, notably in cash management, and its teams maintain strong relationships with both C-suite executives at insurance companies as well as PE firms.

"The market dynamics are changing, and banks are playing an increasing role in this evolution by providing financing at the PE firm level," Landau says. "PE firms understand that we can offer a revolving credit facility, as well as cash management services to make insurance firms more efficient and leverage to support the deals PE firms are making."

For more insights into the benefits for PE firms and insurance companies, please contact Fifth Third’s Financial Institutions Group.