How would you LBO an insurance company??
How would you LBO an insurance company?
Alternatively, what are some strategies PE investors use when buying insurance co's?
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This is an interesting question and thanks for raising because I think there are a lot of misconceptions among my PE clients given how outside the box some of these regulated businesses are, which leads them to pass over interesting investment opportunities.
Short answer is you can't, at least not in the traditional sense. Insurance companies are highly sensitive to ratings which will tank if you start pushing 20-25% debt / cap so it's tough to reduce the size of the equity check with leverage. There are some things you can do around structuring a transaction whether in type of security (e.g. add a pref that looks and feels like it should get equity credit), deal structuring with some third party coinvest, or via reinsurance to juice returns. This is why you saw Apollo coming in and crushing the life insurance space with Athene pretty early on as these guys are in my mind the absolute smartest in the room when it comes to structuring deals to squeeze blood from a stone.
The private equity firms that invest in these companies generally fall into one of two camps:
(1) de novo high growth platforms focused on some kind of niche (see: Genstar / Palomar); we are seeing a lot of these particularly in the specialty end of the market because these are way less crowded / more defensible with respect to rate cycle. H&F and Carlyle just backed a play in Bermuda and Matt Ebbel's shop just launched a new vehicle in this space as well led by former Validus execs. Bunch of others in market that aren't public. These are really just opportunistic plays and you see PE flood into the space every few years when there is a huge catastrophe and capital levels get totally depleted. In insurance we usually talk about the reinsurance classes of 2001 (9/11), 2005 (Katrina) and now 2020 (COVID). Happy to delve into rate dynamics a bit further if unclear.
(2) pretty stable cash machines / asset-gathering platforms that sometimes offer diversification / non-correlation benefit (particularly on the P&C side of things). At the life insurance end of things you don't get the diversification benefit, but for PE firms with significant credit expertise there's the ability to snap up a ton of assets and manage the asset portfolio in the opcos much more aggressively (but not too much more, as there is a ratings constraint on the asset side as well). The insurance co benefits from a yield enhancement in the portfolio (assuming the asset manager is actually good at security selection / portfolio management) and the asset manager benefits from a nice fat recurring fee stream on the portfolio that continues to grow as the insurance company reinvests premiums and AUM grows.
Thank you! This is such a comprehensive response and extremely helpful! A few questions (if too many, feel free to disregard some):
In the second paragraph, I'm not sure I understand the different transaction structures you mentioned: "pref that looks and feels like it should get equity credit" - how exactly does that work? "third party coinvest" - would coinvest errode the potential returns, as they share in the upside? "via reinsurance" - how would that work?
Are you familiar with how exactly Apollo structured Athene and how they are realizing their investment? Is that really considered PE even? How is it consistent with their mandate? Arent't there some regulatory hurdles? How does one even come up with such a structure (in your opinion)?
In paragraph 3, do you mind elaborating on the "rate dynamics" as you suggested? I'm not sure I understand that process. Wouldn't PE firms want to avoid insurance when there's a disaster that results in cash outflow? Also, are you saying that COVID will result in a spike of PE activity in the insurance space? What would be the dynamics there?
In paragraph 4, this is similar to what Apollo did right? Do these firms have an intention to "exit" from the investment ever? Is the investment associated with a particular fund within the PE firm, and which LPs benefit from it and how?
Also, out of curiosity, what is your background? You seem extremely knowledgeable on the space!
EDIT: Just read your oldest comment where you describe your switch from law to IB.
I'd defer to our ratings guys on stuff like this but in general - **pref that gets equity credit **would be something like a PIK perpetual. By contrast some paper that is a straight 11% cash coupon and has some conversion / redemption feature on a date certain would be more like a debt-like instrument. A **third party coinvest **is exactly that, it's just a way for you to reduce the size of your equity check. It shouldn't really impact the returns, it just means you have to share the upside with others. In a **reinsurance deal **you are basically offloading a portion of the book that is underperforming, or is in a business that you don't really want to manage anymore / is at odds with your go forward business plan, etc. On the subject of Athene, this is basically their bread and butter. They basically into agreements with other insurance companies to 'stand in the shoes of' the insurance company and therefore allow the insurance company to release some capital they otherwise held against the reinsured block. Another company that specializes in life reinsurance is RGA but they are more on the mortality risk end. The whole idea here is similar to acquiring a business in PE and then divesting non-core segments. There's usually an arbitrage play - for example if I think the ceding commission I have to pay to my reinsurer is less than the hit I would take if I held onto the business. You can juice returns with reinsurance by having one party that specializes in a particular liability type (e.g. variable annuities) come in and take those liabilities, and then you the PE firm take the platform and just focus on writing new business.
Like I said, this is more of a strategic investment for them. It's held on balance sheet. Athene owns some of Apollo and vice versa so the share register is really messy. I can't really think of a reason why this wouldn't consider this private equity - Apollo basically has a stranglehold on the company and they call all the shots. It doesn't fit the typical buyout strategy and is more of a long-hold investment but you could say the same of KKR's investment in USI, which is an insurance broker held on KKR's balance sheet. It's a different approach to generating returns but suggesting that this isn't private equity because there's not a ton of leverage being put on is a pretty narrow-minded view of what private equity 'is'. There are definitely regulatory implications to acquiring an insurance company - ins cos have to be licensed on a state by state basis and usually the state regulator in the primary jurisdiction will need to sign off on an acquisition vis a vis Form A filing.
Insurers make money either based on underwriting (premium rate) or based on investments (yield). When you have a significant capital event that forces insurers to pay out on policies like 9/11 or COVID, insurance companies usually have to either use available cash on hand or liquidate their investment portfolio to pay out on policies. This means less capital they can put up to back the liabilities written in the form of new business. The result is an opening for cash-flush players like PE firms who have a ton of dry powder to come in. The idea is - there was just an event that hit industries pretty hard. On the demand side a lot of people are going to be demanding risk protection (it's like the reverse of a moral hazard situation where people become extra cautious) and on the supply side you have carriers that are extra cautious and don't want to be aggressive about taking risk because they don't have the capital to back the liability. Markets where demand is high and supply is short = price increase i.e. premium rates go up, insurers likely to make more on the underwriting side. This is called a hardening market. Up until about a year ago we'd been in the midst of a 'soft market' driven by a glut of capital in the sector, but with insurers now getting hit pretty hard, rates are hardening again. The sector is cyclical but not necessarily correlated to the economic cycle.
Yes exactly. It's a long-hold investment. It's not usually held within a fund and firms can differ in terms of where the investment ultimately gets placed and who the team responsible for managing the investment is. At Apollo the team who works on Athene also works on other investments both within FIG and across other industries, but Apollo has recently sought to build out their FIG / insurance expertise so this may change in the near term.
I work in FIG, just wanted to say that these are some of the best / most informative posts I have seen on the site regarding insurance. Great write up.
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