Private equity – the Janus investor
Private equity can be a good funding option for (re)insurance businesses looking to expand, but management and investors’ aims need to be closely aligned for the partnership to work
The years following the global financial crisis brought a wave of interest in private equity (PE) investments from institutional investors as they sought out longer-term sources of returns that were relatively uncorrelated with public markets.
The swell in global allocations has driven assets under management to record highs, with $4.5tn invested in the sector as of 31 December 2019, according to data provider Preqin.
However, PE managers have struggled to put this money to work. More than $1.4tn is currently waiting to be deployed. Fortunately for PE investors, this build-up of cash has coincided with a growing need for investment from insurance and reinsurance companies.
As Christiane Schmidt, a strategy and market intelligence specialist at BNP Paribas Securities Services, explained in an article published by the company in April 2019, ultra-low interest rates have eroded investment returns, while new legislation has made allocating to riskier assets more expensive.
“Growing liability burdens, especially in markets where life insurance rates are contractually guaranteed, are further pushing insurers to wind down all or part of their non-core businesses and reposition their strategies,” Schmidt added.
The changes have also required greater investment in operations and IT as the regulatory bar has risen and client expectations have increased.
So is PE and (re)insurance a match made in heaven?
Finding a partner
PE is not a homogenous asset class. Different funds could look to back early-stage companies, take firms out of public markets or carve out teams from larger entities, or invest to turn around a company’s performance.
Like Janus, the Roman god of transitions, PE is sometimes – and perhaps mistakenly – viewed as having a split personality – either positive or negative – but like Janus, the truth is a little more nuanced.
“PE investment can take many forms and can be deployed into a multitude of scenarios,” explains Simon Fitzsimmons, director at Mazars’ mergers and acquisitions (M&A) advisory business. “As such, deciphering whether it is a good or bad option is difficult to answer directly as it really depends on the situation of the business and their objectives from a transaction.”
PE is a good option for a “good-quality management team driving a growing business in an expanding market”, he says. Investors want to buy businesses with M&A prospects on top of a “strong organic growth story”.
“In this scenario they can align with a management team to deliver good returns to themselves, their investors and management,” Fitzsimmons adds.
Several established (re)insurers and start-ups have turned to the PE sector in recent months for access to funding.
US PE firm Stone Point recently increased its stake in Lloyd’s business Atrium Underwriting from 36% to 80% via a share swap deal with Enstar, which has an 11% stake in Atrium. Stone Point is a particularly influential name in the insurance sector, holding 20 insurance-related companies in its portfolios.
Digital start-up Ki gained $500mn in backing from private capital giant Blackstone in September to fund its efforts to disrupt the Lloyd’s market.
The long game
A close relationship with a single majority owner can prove beneficial if an insurer needs access to capital quickly to respond to changing market conditions, said Sanjiva Perera, managing principal at consultancy group Capco.
PE can also offer a long-term perspective that may be difficult for listed companies with the pressure of quarterly earnings reports. PE funds typically look to invest assets over 10-15 years, giving investee companies “breathing space to focus on the longer-term outlook”, Perera says.
However, (re)insurers with corporate strategies stretching beyond these time horizons should be aware of the potential for a mismatch. Perera highlights that public markets could be better suited to companies that require a much longer-term investment backing.
The Organisation for Economic Co-operation and Development (OECD) has been promoting a “patient capital” approach to public equity investment since the launch of its Long-term Investment Project in 2012. This was followed by the Focusing Capital on the Long Term group, launched in 2016 as a non-profit organisation by the Canada Pension Plan, McKinsey, BlackRock, Dow and Tata Sons.
Both initiatives are designed to encourage shareholders to take a longer-term view of their equity allocations – which can in turn suit management teams with similar time horizons in mind.
PE backing – particularly from finance or insurance specialists – can support insurers interested in consolidating or pursuing an aggressive acquisition strategy, explains Perera. It can also provide management with access to a new network of contacts, either through other portfolio companies or strategic partners, potentially providing access to new technology, services, talent or customers.
In 2018, AIG entered into a strategic partnership with PE firm Carlyle, whereby Carlyle acquired 19.9% of AIG’s reinsurance subsidiary DSA Re. As part of the transaction, Carlyle agreed a strategic asset management deal with AIG and DSA Re, with the two companies allocating $6bn to Carlyle strategies. This gave Carlyle new investment assets from clients with which they were strategically aligned.
The AIG-Carlyle relationship bore fruit in 2019, when it partnered with T&D Holdings to buy a 76.6% stake in Fortitude Re from AIG. In a press release announcing the deal, Carlyle said the transaction was part of a plan to spin out Fortitude as an independent company.
Carlyle further increased its interests in the (re)insurance space through the acquisition of a majority stake in US broker Hilb Group last year, and in August this year when it partnered with Korean Re to develop solutions for Korean carriers.
To PE or not to PE?
PE is not always the right path, however. Insurers and reinsurers should be wary of firms with no prior experience of financial services or insurance, says Capco’s Perera. They may not be willing or able to support strategic objectives, or they might struggle to understand some of the more complex areas of the market.
Companies eyeing a PE backer should also consider carefully whether cheaper sources of capital are available. Private backers will often want a large chunk of equity, if not full control, and will likely expect at least a seat on the board, meaning insurers should be comfortable with the amount of power they are expected to relinquish.
According to Perera, it is also important to consider whether the greater scale of public market investment would be a more appropriate capital raising method.
PE backing also requires a clear alignment of interests, incentives and approaches between the PE investor and the investee company management. As Mazars’ Fitzsimmons explains, if these are not aligned or there are question marks around the company’s growth plan or market dynamics, these could challenge the business case for any deal.
“Covid-19 has brought this into the spotlight, with some good-quality insurance businesses being hit extremely hard by the restrictions that the pandemic has placed upon us,” Fitzsimmons says, highlighting the travel and motor insurance sectors in particular.
“This reiterates the need for a business to demonstrate its robustness through periods of disruption and change, which is something PE will place great value on, as it will help to protect downside risk on their investments.”
The challenges of 2020 have demonstrated that corporate leadership in all sectors requires flexibility, a long-term plan and access to capital to help ride out difficult periods.
While PE partnerships can provide this support, (re)insurance leaders should consider carefully whether their strategies and time horizons are truly aligned to ensure that any investment is made to benefit all parties.