Insurers will stake their claim in private credit

Metlife

24/12/2024 06:00

(The author is a Reuters Breakingviews columnist.  The opinions
expressed are his own.)
    By Jonathan Guilford
       NEW YORK, Dec 24 (Reuters Breakingviews) - Picture this:
a U.S. insurance industry grown fat after a period of explosive
growth began extending private loans, buying up debt churned out
by wheeling and dealing financiers. That was the year 1905. It
might also describe, in more measured form, the situation more
than a century later. This time, expect traditional insurers to
turn the tables and buy up private credit managers.
    Life insurance is fundamentally simple. Take the $385
billion market for U.S. annuities. A customer buys a policy from
MetLife  MET.N  or Prudential Financial  PRU.N , handing over
money in return for promised income down the line. The insurer
then plows the customer’s premium payments into assets that
offer a return. If done well, that return exceeds the cost of
future payouts. The insurer pockets this “spread.”
    For traditional insurers, that seemingly simple proposition
has proved far from straightforward. Rock-bottom interest rates
dragged the U.S. industry’s net spread – the yield on investment
portfolios above the rates guaranteed to policyholders – from
1.8% in 2007 to a nadir of 0.6% in 2020, according to the
National Association of Insurance Commissioners. That, in turn,
pressured the rates insurers offered to their customers, making
policies less appealing: total U.S. individual annuity premiums
in 2020 were lower than in 2008, S&P Global reckons. High fixed
payouts on old policies were a further drag on the industry.
    This created an opening for new entrants. Alternative asset
managers like Apollo  APO.N , Blackstone  BX.N  and KKR  KKR.N 
were expanding into real estate, infrastructure, direct lending
and structured credit. These investments offered attractive
long-term yields that neatly matched insurers’ liabilities in
both duration and return while also being hard to replicate.
Now-boss of Apollo Marc Rowan in 2009 helped establish the
insurer Athene, which scooped up liabilities from other players
and plowed the premiums into a novel mix of assets.
    Apollo merged with Athene in 2022, while KKR took full
control of rival Global Atlantic two years later. Private
equity-backed insurers now hold 25% of U.S. individual annuity
liabilities, according to Swiss Re. Athene is the nation’s
leading peddler, collecting $36 billion in premiums in 2023.
Investors have rejoiced. Jefferies analysts calculate that, as a
part of Rowan’s empire, Athene’s implied valuation stands at
about 12 times earnings, roughly double the multiple investors
ascribe to $15 billion life insurer Equitable  EQH.N .
    This situation threatens to be self-reinforcing. Athene’s
net investment spread of about 2% soundly beats the industry’s
sub-1% average, allowing the Apollo unit to offer juicier
policies to customers. To avoid getting left behind, insurers
are paying to let Apollo manage their investments. Rowan’s
company has booked $100 billion in business with third-party
insurers.
    To regain competitiveness, traditional insurers need three
things: to free up their balance sheets so they can write more
business; to gather capital to support expansion; and to gain
new asset management capabilities.
    There’s an increasingly popular way to address the first two
points. Insurers are setting up vehicles known as “sidecars”,
which use capital from co-investors to reinsure some of the
parent company’s liabilities, freeing up balance sheet capacity.
Prudential Financial, for instance, in 2023 set up its own take
on this approach by establishing independent vehicle Prismic in
partnership with private equity firm Warburg Pincus.
    If the insurer then also manages those assets, it can
effectively convert spread income into earnings from fees, which
public investors prize more highly. Prudential has an in-house
investment unit, PGIM, which juggles $1 trillion in assets.
Bolstered by efforts like Prismic, it’s trying to build out its
abilities with a view to selling services to other insurers,
too. Boss Charles Lowrey has said the company is looking for
acquisitions.
    Insurers’ M&A efforts have so far been piecemeal. Some –
like $63 billion Aflac, which purchased a stake in private
credit firm Tree Line Capital Partners in May – buy minority
positions to seal partnerships and gain access to deal flow.
Others – like Prudential, which acquired Deerpath Capital in
2023 – are locking up smaller managers. Guardian Life had a
passive minority stake in HPS Investment Partners, a big private
lender which in December sold itself to giant asset manager
BlackRock  BLK.N  for around $12 billion. Canada’s Sun Life
acquired a majority stake in Crescent Capital in 2021, when the
fixed income investor had around $29 billion under management.
    It is time to be bolder. To flip the tables, an insurer
would have to take a substantial stake in one of the bigger
alternative asset managers. That would be tricky from a
valuation perspective: Carlyle  CG.O , which is valued at 12
times expected earnings according to Visible Alpha, has the
lowest rating of the large listed private investment firms. Yet
it still trades at a premium to big insurers like Prudential or
MetLife.
    Nevertheless, as insurance and private credit become more
intertwined, insurers can either stand by as alternative asset
managers eat their lunch or compete head-on. Expect some big
insurers to reassert control in 2025.
    Follow @JMAGuilford on X

    This is a Reuters Breakingviews prediction for 2025. To read
more of our predictions, click here.

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Graphic: U.S. life insurers are battling lower yields    https://reut.rs/3AT6BIe
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 (Editing by Peter Thal Larsen and Oliver Taslic)
 ((For previous columns by the author, Reuters customers can
click on  GUILFORD/  
Jonathan.Guilford@thomsonreuters.com))