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Private Equity Firms Play Ball with the Insurance Industry

In the past few years, private equity firms have been some of the most active participants in M&A activity in the insurance sector. For private equity firms, investing in this decidedly staid industry is quite a change from the halcyon days of the early 2000s, when they were known for a high-risk, high-reward strategy of using huge amounts of debt to acquire companies, streamline management, eliminate unprofitable operations and cash out through an initial public offering. Now private equity firms, once known as home-run hitters, more and more are seeking singles and doubles. In the past three years, private equity firms such as Apollo Global Management, Ares Private Equity Group, Blackstone Group and Carlyle Group, and diversified financial services firms like BlackRock and Guggenheim Partners, have all spent billions of dollars to purchase insurance companies or existing blocks of insurance business. In addition, Washington–based Carlyle Group just announced its second $1 billion fund focused on financial institutions and insurance companies.

Much speculation has arisen about why private equity firms are interested in investing in the life and annuity insurance sector, particularly in fixed annuities, which tend to have a much lower rate of return than what private equity investors typically demand. The singles-and-doubles strategy may offer insight. The acquisition of life and annuity insurance companies with predictable lines of business offers these firms an opportunity to add billions in assets under management and collect fees for putting their investment expertise to use. Thus the returns tend to be predictable and steady.

Contributing to the increased private equity interest in insurance companies is the fact that some insurers have been very willing to unload their annuity businesses, as interest rates have remained low for more than five years and profit margins have been squeezed. The reduced profit margins, in turn, have required annuity and life insurers to inject more capital into their businesses or risk being downgraded. The need for capital fits well with private equity firms, whose investors, seeking higher yields, have supplied them with enormous amounts of cash for investments. Although there hasn’t been a stampede to the exits by the management of insurance companies, data from 2012, the latest available year, indicates that the average price for life and health insurers, as measured by price-to-book value, has been decreasing.

Another point private equity firms have in their collective mind is that although interest rates may be quite low today, they are expected to climb in the not-too-distant future. As new capital comes in, it will be invested at better returns if interest rates rise as expected. This, together with the fact that some of the annuity products, particularly fixed annuities, might start to take off as baby boomers increasingly retire and shift their investments to lifelong-income-producing products, could result in greater-than-average investment returns for insurers.

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