Analysis: Chasing yield, U.S. private equity firms nudge up risk on insurers
01/06/2021 11:00
By Alwyn Scott
NEW YORK, June 1 (Reuters) - Private equity firms have spent
nearly $40 billion buying U.S. insurance companies in recent
years, promising to earn higher returns on the mountains of
money that insurers set aside to pay policyholders years or
decades from now.
The firms are moving some of the money out of traditional
low-yield investments such as government bonds into riskier,
harder-to-sell assets such as private loans and equity.
The shift has caught the eye of regulators and raised
concerns about a cash crunch if asset managers had to liquidate
large portfolios in a hurry to meet insurance claims.
PE-insurance marriages can be joyous: Asset managers have
skills and access to investments that insurers lack, and
insurers provide cheap funding. PE firms also earn significant
fees, even though their investments do not always capture
outsized returns. urn:newsml:reuters.com:*:nL1N2KA38H
But PE firms are nudging up risk on a large pool of money.
They now own 7.4% of all U.S. life and annuity assets, or $376
billion, double the tally in 2015, credit agency AM Best said.
Pending deals could add $250 billion this year, pushing PE
ownership to 12%.
The higher-yielding investments do not necessarily increase
the risk of default but tend to lose more money if they do
default, compared with plain-vanilla portfolios, said a senior
structured finance expert who works closely with state insurance
regulators.
LIQUIDITY, STRUCTURING RISK
Strategies vary widely. Carlyle Group Inc CG.O said it has
put the approximately $5 billion of insurance money it manages
into buyout funds, credit and alternative investments. The money
is part of Fortitude Group's FRTD.PK $43.7 billion portfolio.
Carlyle bought a majority stake in Fortitude from American
International Group Inc AIG.N last year.
Apollo Global Management Inc APO.N runs all $186 billion
in assets of annuity provider Athene Holding Ltd ATH.N , a
portfolio that accounts for 40% of Apollo's total managed assets
and 30% of the firm's fee-related revenue.
Apollo says buying the 65% of Athene it doesn't already own
will make both companies the most "aligned" with policyholders
in the industry. The purchase also shows Apollo's commitment to
safe investments, since Apollo's shareholders are exposed to any
additional risk. None of Athene's money is in Apollo's flagship
private equity funds.
"Insurance companies are ideally situated to take a certain
amount of liquidity and structuring risk," Apollo Chief
Executive Officer Marc Rowan told Reuters. "Excess return (is
earned) through accepting less liquid securities rather than
taking on credit risk."
Recent deals that Athene calls "high-grade alpha" provide a
window into Apollo's strategy of seeking 100 to 200 basis points
above similarly rated public securities on about 15% of the
portfolio.
Athene loaned $2 billion to bankrupt rental-car company
Hertz Global Holdings Inc HTZGQ.PK in November, and $1.4
billion to the Abu Dhabi National Oil Company (ADNOC), secured
by office and apartment buildings in September.
Athene's Hertz loan is 85% investment grade and 15%
speculative, or junk, grade. The loan earns an interest rate of
3.75%, according to loan documents reviewed by Reuters and two
people familiar with the matter.
Fees that Athene earned for structuring the loan boost
Athene's yield above 4.75%, these people said. That compares
with 3.2% for investment-grade and 4.8% for speculative debt
when the loan was made, according to a bond index and Federal
Reserve data. Hertz plans to exit bankruptcy in a deal that
includes Apollo. urn:newsml:reuters.com:*:nL4N2MZ44W
The Middle Eastern real estate provides a revenue stream for
24 years, after which ownership reverts to ADNOC, which kept a
51% stake. Reuters could not determine the return, but brokers
said occupancy has been falling from relatively high levels.
ADNOC declined to comment.
REGULATORS WATCHING
The build up of difficult-to-sell investments has drawn
attention from U.S. regulators and raised concerns that insurers
may lack cash to pay a surge of claims in a crisis. The Federal
Reserve recently flagged this as a concern. urn:newsml:reuters.com:*:nL1N2HY19M
"What the Fed is concerned about is that these risky assets
may not be liquid enough, or they may go down in value
sufficiently to endanger policyholders," said Joshua Ronen, an
accounting professor at New York University whose research
focuses on capital markets and financial statements.
The Fed declined to comment.
Insurers still appear well-capitalized despite the past
year's economic upheaval. While the pandemic hit industry
profits, it did not weaken capital, analysts said.
Athene's credit rating, for example, was upgraded this month
to "A+" with a positive outlook by S&P Global Ratings. About 7%
of Athene's investments are rated speculative, compared with 6%
for all insurers, according to S&P Global Ratings.
Still, concern about risk has affected some deals. When
Allstate Corp ALL.N went to sell its life and annuity business
recently, it looked for firms not aggressively redeploying
assets to riskier investments, Chief Executive Officer Tom
Wilson told Reuters.
In January, Allstate agreed to sell 80% to Blackstone Group
Inc BX.N and the rest to Wilton Re, an insurer owned by the
Canada Pension Plan Investment Board. Both sales are expected to
close this year.
"There are some people out there who take these assets, they
assume the insurance regulators won't pay that much attention to
them. And they swing for the fences. We chose not to even talk
to people like that," Wilson said. "We want our customers to be
paid, even though they're not our customers anymore."
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GRAPHIC: Private equity ownership of life and annuity insurance
assets https://graphics.reuters.com/PRIVATEEQUITY-INSURANCE/RISKS/oakpebgyyvr/
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(Reporting by Alwyn Scott in New York
Additional reporting by Saeed Azhar and Hadeel Al Sayegh in
Dubai and Kate Duguid and Karen Brettell in New York
Editing by Lauren Tara LaCapra and Cynthia Osterman)
((alwyn.scott@thomsonreuters.com; +13322191977; Reuters
Messaging: alwyn.scott.thomsonreuters.com@reuters.net))