Private Equity (“PE”) firms and other alternative asset managers, have become increasingly involved in the Pension Risk Transfer (“PRT”) market in recent years. Several insurers are at least partially owned by or have strong relationships with PE firms. Such PE related insurers now account for a substantial proportion of pension risk transfer business transacted. In the US insurance industry more widely, the National Association of Insurance Commissioners (“NAIC”) identified 117 PE owned insurance companies at year end 2020, investing a total of $487bn, or 6.5% of the total industry1.
The participation of insurers with these relationships has, in many cases, lowered transaction prices and has increased the insurance market’s capacity to absorb pension liabilities. However, concern has been raised about the impact on the security of participant benefits, most notably in March 2022, by the U.S. Senate Committee on Banking, Housing, and Urban Affairs who requested a formal briefing on this issue (“Brown Presses Admin to Study How Private Equity Companies Are Endangering Workers’ Retirements”2). The NAIC responded to this request in May 2022 in which they defended the robustness of the regulatory regime3, and in August 2022 adopted a plan to address a list of considerations “applicable (But Not Exclusive) to Private Equity owned insurers”.
In this article, we examine the involvement of PE firms in the industry, address some of the risks cited by observers, including the use of reinsurance to Bermuda. We discuss what these considerations mean for plan fiduciaries when purchasing annuities from an insurance company. We believe that some of the concerns expressed by market participants and observers recently may be too extreme. However, it is important to understand and closely monitor the strategies the PE backed insurers are using, particularly regarding their investment portfolio.
What is Private Equity and how has the industry evolved?
The traditional core business of PE firms has been “leveraged buyouts”, where the firm raises capital from investors which is then deployed alongside debt to ‘buy-out’ target firms. These are then managed for a period, typically 5-10 years, before being sold for (hopefully) a higher price.
PE has grown significantly over the past 30 years. The four largest publicly traded PE firms are Apollo Global Management, Blackstone Group, Carlyle Group, and Kohlberg Kravis Roberts & Co (“KKR”). These larger PE firms have evolved their businesses beyond the traditional leveraged buyout fund. Although buyouts still provide most earnings, they are no longer as dominant a component of their businesses. These firms now regard themselves as “one-stop capital providers” involved in private debt, real assets, infrastructure and securitized assets alongside buy-outs. The growth of these non-traditional areas has been partly facilitated by the retrenchment of investment banks in these financing activities following the global financial crisis of 2008/2009. An example of this trend is the recently agreed sale of most of Credit Suisse’s securitized products business to an Apollo Global Management-led group.
Thus, the larger PE firms blur the lines between engaging in traditional private equity buyout activity and being an asset manager, albeit one focused more heavily on private assets. The involvement of PE firms in the PRT market varies, but it is important to note that insurers in the PRT market have not been the target of traditional leveraged buyout funds where the intention is to own the insurer for a relatively short period. Rather, the common theme is the use of the insurer’s investment portfolio over a longer time horizon to invest a portion of insurer assets in forms of private debt or securitized assets where the PE firm believe they have a competitive advantage. Given this dynamic, and the involvement of alternative asset managers in the insurance industry who are not traditionally regarded as private equity firms, the term “PE” in this article is effectively referring to both PE firms and alternative asset managers collectively.
Defining the involvement in PRT
There is a range of engagement models, and the PE firm does not necessarily have a majority ownership of the insurance company. It is important to note that all firms transacting Pension Risk Transfer must be legally established as insurance companies and are regulated as such. It is not the case that an asset manager or PE firm can write annuities directly.
Although there may be certain trends associated with the involvement of PE firms, ownership in and of itself is much less of a material risk factor than how an insurer is investing and managing capital. A traditional insurer is also capable of investing in riskier assets or complex strategies and all the major insurance companies have asset management subsidiaries that invest in private assets.
Who are the PRT insurers with links to PE firms?
|Annuity Provider Name||PE Firm||Ownership Comments||Investment Relationship
with PE Firm
|Insurer Ownership and
(parent company is Apollo Global Management)
|Apollo Asset Management, Inc.||Athene and Apollo Asset Management are both subsidiaries of Apollo Global Management||All insurer assets managed by Apollo Asset Management, or its subsidiaries||Insurer and PE firm are part of same group, so there is a relatively high degree of interaction and influence between the two sides of the business.|
|Corebridge (formerly AIG Life and Retirement)||Blackstone Inc||Blackstone owns 10% of Corebridge Financial which is publically traded (AIG own a majority stake)||Outsourcing arrangement with Blackstone to manage private assets||Blackstone own a minority stake. Little observed direct management influence.|
|Fidelity & Guarantee (“F&G”)||Blackstone Inc||Fidelity National Financial, Inc. (“FNF”) took private ownership in 2020 and later spun off F&G in Dec 2022, which remains 85% owned by FNF.||Outsourcing arrangement with Blackstone to manage most assets||No material direct PE ownership.
CEO of F&G joined from Blackstone in 2019 but little observed direct management influence.
Outside of the insurers above that are currently active in the PRT market, there are a number of insurers who provide other types of annuity products that have notable PE links. Allstate has completed the sale of its life and annuity businesses to Blackstone. In May 2022, Brookfield Asset Management Reinsurance Partners Ltd. bought out American National Group. KKR own a majority stake in Global Atlantic.
What concerns have been raised regarding the involvement of PE firms?
The PE backed insurer may invest in riskier assets. i.e., lower average credit quality, more complex, lower liquidity.
- This is often true, although some ‘traditional’ insurers have riskier portfolios than those that have PE involvement.
- For context, when testifying in September 2022, Kathleen A. Birrane, on behalf of the NAIC, stated that “state regulators are particularly mindful of investment strategies by some PE controlled insurers that may be more aggressive than traditional insurance asset managers.”4
- Particularly in the cases of F&G and Athene, these companies use more securitized assets, which include private structured securities, than most other insurers in the PRT market. The insurers generally hold assets of high credit quality currently, but complexity and reduced transparency mean there may be a higher likelihood of credit quality decline compared to traditional bonds with the same rating. Asset manager skill is required.
- Insurers with PE backing will argue they are utilizing expertise in private asset markets and structured assets to deliver higher risk-adjusted returns than more traditional investors.
The PE backed insurer uses more complex capital management tools such as intra-group reinsurance
- This varies by insurer. Not all insurers with PE relationships reinsure PRT, and many ’traditional’ insurers do.
- Reinsurance to Bermuda is discussed further below.
The PE firm could somehow extract capital from the insurer impacting solvency
- Not true materially.
- The insurance companies that write group annuity contracts are highly regulated companies. Extracting capital out of the company is not straightforward and requires regulatory approval.
- However, Athene has historically been criticized for relatively high asset management fees that are paid to Apollo5. This concern has subsided somewhat as the fees have been reduced and following the merger of Apollo and Athene.
Policyholders experience a materially lower level of service
- Policyholder experience varies between insurers, but we have not observed materially inferior service at the PE related firms.
- Athene and F&G outsource PRT administration services to Alight, a large provider of pension and annuity administration services used by many large companies and insurers, as does one other non-PE backed mutual insurer.
‘Mod-co’ reinsurance to Bermuda
Several insurers offering annuities employ a strategy where business is reinsured to Bermuda. Athene has been the most prolific reinsurer of US PRT in recent years, although this strategy is not the sole domain of private equity backed insurers. Some traditional insurers such as MassMutual also use this tool, although not necessarily for PRT.
Modified coinsurance, abbreviated as ‘mod-co’, is a form of reinsurance. In this case, assets and reserves associated with a contract remain on the US insurer’s balance sheet, and assets remain under its control. However, the risks associated with both the assets and liability of the contract are transferred to the reinsurer such that US regulations permit little capital to be held in the US underwriting entity of this reinsured business. If losses emerge on the reinsured assets or liabilities, the reinsurer must reimburse the US insurer to maintain a certain level of capital coverage. The assets covering reserves are maintained and reported in the US, which provides some comfort as it means that there is the same transparency of holdings and restrictions on allowable assets that there would be without the reinsurance arrangement (aside from the investment of the capital itself).
So why go through this trouble? First, from the US insurer’s perspective, the mod-co arrangement reduces capital requirements. However, the capital is instead held offshore, and if capital standards in Bermuda were identical to the US and the insurer chose to maintain a similar coverage level in the Bermuda reinsurer, then it could be argued this arrangement has little impact on policyholder security.
However, it would be naïve to conclude there is no potential for “regulatory arbitrage” in this arrangement, as there are differences in accounting standards and capital rules between the US and Bermuda which have the potential to lower the overall amount of assets required to back an annuity liability compared to those if the mod-co arrangement were not in place. To determine whether this arrangement is riskier for policyholders, we need to ‘look-through’ and consider the US entity and its reinsurer together to evaluate the overall ability to pay claims.
Bermuda vs. US regulations
Bermuda is attractive as an insurance company domicile because it is recognized as ‘equivalent’ by both US and EU regulators. Equivalence doesn’t mean that the capital requirements are identical, but that the overall regime is strong enough in the view of regulators that reinsuring entities can ‘recognize’ the reinsurer and obtain capital reduction benefits.
Comparing capital requirements in Bermuda to the US in detail is beyond the scope of this article. However, some key points are:
- The actual capital requirement in Bermuda for credit risk on assets is higher than under US Statutory rules and is closer to European standards (known as Solvency II) which contemplate a more severe (1-in-200 year) event than US standards.
- However, the overall amount of assets an insurer must hold to support an annuity liability could be lower for a given asset because the reserves that the asset backs are allowed to be discounted at the yield on the assets less a haircut. This can make assets with a relatively higher yield for a given rating more attractive to hold in Bermuda, specifically structured securities such as Collateralized Loan Obligations (“CLOs”). As an aside, European rules apply what are generally regarded as punitive additional capital charges on structured securities, limiting their use in Europe.
- Over time, the higher yields on such assets would emerge as profit in the US. However, they would not in Bermuda, as this additional profit has effectively been booked up front in the form of a lower reserve to start.
- The Bermudian treatment should be relatively more responsive to downgrades than the US treatment, as this reserve benefit impact is lost as a bond gets downgraded.
Although the overall amount of assets required (reserves plus capital) at a minimum can be lower, this does not mean that Bermuda is a less sophisticated or a lighter regime overall in our view. The lower overall level of minimum capital in the US means that insurers must practically operate to higher capital coverage ratios to be regarded as sufficiently safe.
The crucial matter from the policyholder perspective, when evaluating the riskiness of such mod-co arrangements, is the actual amount of reserves and capital being held at the reinsurer, allowing for the ‘actual’ risk of the asset portfolio. We would want to compare the capital held in Bermuda on a like-for-like basis to the US. To this end, Athene discloses a US Risked Based Capital metric for their Bermuda-based reinsurance subsidiaries (if the US statutory accounting principals were hypothetically applied to them) of 410% at year-end 20216. This is higher than the ratio for its principal US PRT underwriting entity, Athene Annuity and Life Company, of 363% at year-end 2021.
Finally, we note that there may be legitimate business reasons to reinsure to Bermuda that are not about reducing capital. For example, there may be an economy of scale in reinsuring business from both the US and Europe to what has become a center of expertise for reinsurance. The capital required for expansion and the profits that emerge from that capital will lie in the Bermuda entity, which may be subject to a lower tax rate than the US. Although, the tax situation and any benefits of reinsurance are complex and will vary from insurer to insurer. The adoption of a minimum global tax rate from 2023 may erode any tax jurisdiction benefits further, if one exists.
Insurers with PE relationships have been competitive in the US PRT market. If an insurer is quoting a significantly lower price than others, it is critical to understand the drivers for that lower price and whether those drivers add material risk. Given the current strategy of PE backed insurers, this usually boils down to whether the investment portfolio, particularly the use of structured assets, is sound and whether the capital held is adequate.
However, it is too simplistic to penalize an insurer solely because of a PE relationship or ownership. Fiduciaries are encouraged by Department of Labor Bulletin 95-1 to select the “safest annuity available” and to “conduct an objective, thorough, and analytical search“. That search should consider the underlying facts and circumstances regarding the investment portfolio, capital, reserves, and other drivers of risk. These considerations are unique to each insurer, and insurers without PE relationships are capable of engaging in riskier activities.
In addition, as we described in our article from earlier in 2022 (Annuity purchases and guaranteed separate accounts, January 20227), the structure of the group annuity contract and the presence of the State Guaranty system can also substantially alter participant losses in the event of an insurer failure and need to be considered on a deal-by-deal basis. Sponsors undertaking an annuity transaction should also remember that the security of participant benefits is likely to remain higher in an insurance company, with associated guarantees, than it is in most corporate sponsored pension plans.
As we head into a potentially recessionary economic environment, it is critical that plan fiduciaries undertake thorough due diligence on insurance companies ahead of a PRT transaction. The involvement of PE backed insurers in the market, and some of the strategies that have been associated with them, requires vigilance, but it does not necessarily result in reduced security for policyholders.
 Private Equity-Owned U.S. Insurer Investments as of Year-End 2020 – NAIC, Capital Markets Special Report (https://content.naic.org/sites/default/files/capital-markets-special-report-private-equity-owned-2020.pdf)
 Central Laborers’ Pension Fund v. Athene Asset Management LLC et al, Supreme Court of the State of New York
 “Bermuda RBC”, Athene Holding Ltd. 10-K (https://irathene.q4cdn.com/886888837/files/doc_financials/2020/ar/ATH-10K-2021_Final.pdf)