Private Equity

Last Updated: 6/28/2023
Private equity (PE) has an increasing presence in the insurance industry. The relationship between PE and the insurance industry has emerged in two directions. First, U.S. insurance companies—particularly life insurers—invest in PE to increase the return on their balance sheet portfolios. This activity accelerated during the extended period of low interest rates following the 2008 financial crisis and up until late 2021. Second, PE firms are increasingly investing in insurance companies and, in many cases, taking full ownership of the companies.

What Is Private Equity?

PE is capital put at risk to invest in businesses, business ventures, funds (such as loan funds), or other assets that are not listed on open, public exchanges (hence, “private”).[1] PE firms are investment management companies, and the investments of these firms usually (but not always) take the form of a PE fund. Most PE funds are limited partnerships. A general partner (GP) manages the fund’s investments, and limited partners (LPs) are investors in the fund. LPs typically are sophisticated institutional investors or high-wealthy individuals.[2]^,[3]

While PE funds, as they are known today, have existed since the 1980s, their growth has been exceedingly rapid, especially since the 2000s. In 1980, there were 24 PE funds; in 2015, there were roughly 6,600 PE funds; and by 2022, the number of PE funds had soared to more than 19,000.[4] Perhaps more astounding is the growth in total assets under management (AUM). (Refer to Figure 1) In 2000, PE firms in the aggregate held $579 billion in AUM. By 2022, that figure had surged to about $7.8 trillion.

Figure 1: Assets Under Management by Private Equity Firms

Data source: Preqin

Primary PE investment strategies include venture, growth, and buyout. Venture capital finances early-stage business undertakings; growth capital is used to purchase and/or finance businesses (usually young businesses) requiring further development; and buyout capital is used to purchase established businesses.[5]^,[6] The largest component of PE fund investments is buyout. (Refer to Figure 2) In a buyout, the PE fund takes a controlling interest in an operating company or business and engages actively in the management and direction of the company in order to increase its value.

Figure 2: Composition of Aggregate PE Investment Strategies (2023)

Data source: Preqin

Note: “Early Stage” includes seed and start-up.

PE funds carry several risks and are often characterized as “alternative investments."[7] PE funds face significant liquidity risk. Because they are not traded on open, public exchanges, they are not readily exchangeable for cash. Also, investors are subject to irrevocable commitments to the fund for a specified period. Traditionally, these commitments have not been tradable, but that is changing as the PE industry evolves.

PE fund investors also are subject to “blind risk.” This type of risk happens when investors’ commitments fund unknown, future investments. As with any equity investment, whether public or private, PE funds are also susceptible to market risk (or price volatility) and, therefore, the possibility of a realized loss of original capital (upon the fund’s termination). And as with any fund, whether public (e.g., a mutual fund) or private, there is selection risk or the risk that the GP does not make good investment choices. Finally, more unique to PE funds, and private funds in general, is that risk can be magnified, possibly several times over, by leverage. A leveraged investment uses borrowed capital to finance investment in an asset.

PE firms, if not exempt, are subject to regulation by the U.S. U.S. Securities and Exchange Commission (SEC) and possibly other authorities, such as the Financial Industry Regulatory Authority (FINRA) and the Commodity Futures Trading Commission (CFTC), but they are regulated differently from public investments.[8] In particular, PE investors do not benefit from some of the protections offered to public market investors.

PE-Owned Insurers

Since the financial crisis of 2008, PE firms have become some of the most active participants in insurance sector merger and acquisition (M&A) activity.[9] PE firms’ involvement in insurance dates back to the purchase of discounted blocks of business from legacy U.S. carriers in 2008–2009.[10] PE’s entrance into the insurance sector is largely due to the long-lasting low interest rate environment that proceeded the financial crisis, lasting until late 2021. This low interest rate environment incentivized insurers to sell or reinsure blocks of business to improve profitability and to optimize capital management.[11] PE firms offer insurers opportunities to achieve higher investment returns (albeit at higher risk) and gain access to capital and asset sources through PE capital markets networks.

PE firms’ activity in the insurance sector is not limited to buying blocks of business. PE firms also purchase insurance firms outright. PE firms are most interested life and annuities insurance firms because of the predictable and steady returns from these companies.[12] In addition to adding diversifying assets to their portfolios, PE firms generate fee income from investment management fees. Life insurance companies accounted for about 95% of PE-owned insurers’ cash and invested assets at year-end 2021.[13] However, property/casualty (P/C) insurers also are attractive to PE firms because of renewals and minimal capital expenditures.[14]

PE ownership of insurance companies is expanding rapidly. In 2021, there were 132 PE-owned insurers by year end, compared with 117 at year-end 2020 and 89 at year-end 2019.[15] In 2019, PE-owned insurers held $345.5 billion in book/adjusted carrying value (BACV) of cash and total assets or about 2% of total cash and invested assets for the U.S. insurance industry.[16] At year-end 2021, total cash and invested assets for these insurers was $450 billion, a decline of 3% from year-end 2020. But the holdings of PE-owned insurance companies accounted for about 8% of total U.S. insurance industry cash and invested assets. (Refer to Table 1)

Similar to the overall U.S. insurance industry, bonds were the largest asset type for PE-owned insurers at 69% of their total cash and invested assets at year-end 2021 (in BACV), but that was down from 74% at year-end 2020. U.S. PE-owned life insurer asset allocation (year-end 2021) is roughly comparable to the asset allocation for the U.S. life insurance industry as a whole (year-end 2022). (Refer to Table 1)

Table 1. PE-Owned Insurer Investments (as of year-end 2021) vs. Total U.S. Insurance Company Investments (as of year-end 2022) ($B, BACV): Life Insurance

Data sources: Jennifer Johnson and Jean-Baptiste Carelus, 2022, “Private Equity (PE)-Owned U.S. Insurers’ Investments Decrease as of Year-End 2021; Number of PE-Owned U.S. Insurers Increases”; Michele Wong, 2023, “Growth in U.S. Insurance Industry’s Cash and Invested Assets Declines to 1.3% at Year-End 2022.”

Note: Assets may not sum to totals due to rounding.

What is not apparent from Table 1 is the composition of assets within these categories. For example, among bonds, PE-owned insurers tend to have higher concentrations of asset-backed securities (ABS) and other structured securities (28%) than the overall U.S. insurance industry (11%). As noted above, PE firms and funds typically hold riskier investments than their counterparts in hopes of generating a higher return. This trend is evidenced by an increase in Schedule BA, or long-term, investments held by PE-owned U.S. insurers over the past few years in terms of BACV.[17] Importantly, whether or not insurers are owned by PE firms, investment activity must abide by applicable state insurance laws.

Private Equity Investments by Insurers

While PE firm investments in insurers have increased in recent years, so have insurance company investments in PE funds. In the historically low interest rate environment following the 2008 financial crisis until late 2021, U.S. insurance companies increasingly acquired investments reported on Schedule BA. As suggested above, PE investments are regarded as considerably more risky and more illiquid than other assets. But for institutional investors that can bear such risk and illiquidity, the high expected returns are a major attraction.

Insurer investments in PE funds have grown swiftly in recent years. Since 2017, PE investments reported on Schedule BA have increased at a compound annual rate of 23.6%, rising 34% to $173 billion at year-end 2021, compared with 15% growth over all Schedule BA assets. (Refer to Figure 3) Life insurance companies account for the largest PE exposure. PE investments were the largest category of Schedule BA assets at year-end 2021 at 33% of total Schedule BA assets.

Figure 3. Aggregate Private Equity Investments Reported on Schedule BA

Source: NAIC Capital Markets Bureau, various reports

Insurers invest in PE for the same reasons as other institutional investors—to obtain higher returns, increase diversification, and access additional or emerging asset classes. The long-term nature of insurers’ liabilities, especially compared to those of banks and broker/dealers, lends itself ideally to longer-dated or illiquid investments, such as PE. These investments fit well in an overall framework of asset-liability management that balances risk and return. However, due to inherent risks in these investments, PE funds also carry the highest risk-based capital (RBC) factor for investments.

Status of Private Equity

Various committees, task forces, and working groups, as well as other state insurance regulators and NAIC staff, closely monitor the PE investments of insurers to ensure they meet regulatory requirements and earn a reasonable return without undue risk. The NAIC also monitors PE investments to ensure the primary objective of these investments is  adequate capital to pay claims and maintain other fiduciary responsibilities to policyholders. Most NAIC activity around PE, however, is focused on PE ownership of insurance firms.

One of the Macroprudential (E) Working Group‘s 2023 charges is to “[m]onitor domestic and global activities including those frequently associated with private equity (PE) ownership that may affect the U.S. Insurance Industry.” (Refer to “2023 Adopted Charges” at left on the Macroprudential (E) Working Group landing page)

In 2013, Form A reviews guidance was added to the NAIC Financial Analysis Handbook for when a PE owner is involved, although these considerations are not limited to PE acquisitions.[18] The guidance provides examples of stipulations, both limited time and continuing, that regulators can use when approving the acquisition to address solvency concerns, as well as for use in ongoing solvency monitoring.

The NAIC has maintained a list of 13 primary regulatory considerations applicable to PE-owned insurers. However, these considerations are not exclusive to PE-owned insurers. A simplified summary of these considerations follows (in no particular order):

• Holding company structures.
• Ownership and control.
• Investment management agreements.
• Owners of insurers with short-term focus and/or unwilling to support a troubled insurer.
• Operational, governance, and market conduct practices.
• Definition of private equity.
• Identifying related part-originated investments (including structured securities).
• Identifying underlying affiliated/related party reinvestments and/or collateral in structured securities.
• Asset manager affiliates and disclaimers of affiliation.
• Privately structured securities.
• Reliance on rating agencies.
• Pension transfer business supported by complex investments.
• Offshore/complex reinsurance.

A plan has been developed for these 13 primary considerations by the Financial Stability (E) Task Force and Macroprudential (E) Working Group. Substantial progress has been made in addressing these considerations, and the remainder are ongoing (status document).

The Center for Insurance Policy and Research (CIPR) continues to research PE and its impact on the insurance industry. These projects include a better understanding of PE investment strategies, particularly as they apply to infrastructure investment.

[18] Form A is one of six forms intended to be guides in the preparation of statements required by certain sections of the Insurance Holding Company System Model Regulation (#450).