New investments in 2021 were concentrated in a few large organizationA special report from AM Best looks closely at the positive new investment for the life/annuity sector. Access the full report here.
OLDWICK, N.J., May 24, 2022—U.S. insurance companies’ private equity investments grew in 2021 by 25.8% to $117.4 billion, from $93.3 billion in 2020 —the biggest year-over-year increase in recent years, according to a new AM Best report. In its Best’s Special Report, titled, “Strong Performance, New Investments Drive Private Equity Growth,” AM Best states that life/annuity insurers, which account for three-quarters of the insurance industry’s private equity book adjusted/carrying value, are driving the new investments, realizing widespread book value gains.
Of the $24.1 billion in year-over-year growth, $12.9 billion was from growth in book value from 2020 (net of disposals) and $11.2 billion from new investments. The overall annual increase follows strong growth of 14.8% in 2020 and 10.0% in 2019. “New investments in 2021 were concentrated in a few large organizations, with 10 insurers by book value accounting for roughly 60% of acquisitions for the year,” said Jason Hopper, associate director, industry analytics and research. “Furthermore, nearly a third of insurers had new investments totaling less than $5 million, signaling a more-cautious approach by most of the insurers that do not have significant scale or in-house expertise with this asset class.”
Private equity investments span all stages of a company’s life cycle, each with its own unique sets of risks. The insurance industry as a whole has the greatest exposure to leveraged buyout funds, comprising roughly 58% of its private equity investments, although allocations vary by segment. Venture capital accounts for another 29%, and mezzanine financing, the remainder. All three allocations grew, driven largely by life/annuity insurers, though mezzanine funds grew by double digits for all three insurance segments. “Insurers are still seeking higher returns and opportunities to diversify their portfolios, and the performance of private equity investments has been strong with a low correlation to the public markets,” said Michael Lynch, associate analyst, AM Best.
Insurers use private equity to diversify investments and potentially achieve higher yields compared with other asset classes, but the small allocations as a percentage of invested assets point to more-conservative investment strategies and lower levels of risk tolerance. Of all of the major types of investors, insurers have the smallest average allocations to private equity as a percentage of total assets.
Excerpts From The AM Best Special Report:
- Private equity investments held by insurers grew by $24.1 billion (25.8%) in 2021, with $11.2 billion in acquisitions and nearly $13 billion in appreciation before disposals—the biggest year-over-year increase in recent history.
- Ten insurers accounted for about 60% of new private equity investments made in 2021.
- Life/annuity companies continue to account for the vast majority of holdings in private equity, with about 74% of all industry book adjusted/carrying value (BA/CV) holdings.
After the initial uncertainty surrounding the pandemic in 2020, private equity grew substantially in 2021, having grown exponentially in the last few years. In 2020, private equity grew by about $12 billion from the prior year. In 2021, it nearly doubled, to $24 billion. The need for yield continues to make alternative investments such as private equity an attractive option for insurers looking to diversify their investment portfolios or ramp up allocations, to increase returns in an environment characterized not just by low interest rates, but also equity and spread volatility.
Market Players Are Concentrated, Exposure Is Manageable
Despite the continued growth of this asset class, investments in private equity are concentrated in a few large insurers. Almost five times more insurers expanded their private equity holdings (158) than decreased (33), with the top five insurers accounting for roughly 40% of the rise in private equity value. The 15 biggest holders—largely L/A insurers—account for over 60% of private equity holdings. Still, L/A insurers’ allocations average less than 4% of invested assets.
Similarly, the average exposure to capital and surplus of the top 15 holders is 27.3%, which is somewhat skewed by a handful of companies; most companies have smaller exposures. However, given the difficulty of precisely quantifying the valuation of private equity, the ratio of these holdings to capital can be a better guide to determining a potential range of exposure.
Insurers use private equity to diversify investments and potentially achieve higher yields compared to other asset classes, but the small allocations as a percentage of invested assets point to generally more conservative investment strategies and lower levels of risk tolerance. Of all of the major types of investors, insurers have the smallest average allocations to private equity as a percentage of total assets, according to Preqin.
Insurers are also wary of the effects on capital models, as investments in limited partnerships or other common equity vehicles are subject to higher capital charges than rated debt or preferred equity. Private equity sponsors have started developing products and structures to help ease the capital strain on these investments. Some products address risk-based capital (RBC) charges by implementing a feeder or parallel vehicle that issues rated debt (as well as some equity) to insurers, with the debt portion of the investment incurring substantially lower RBC charges than limited partnerships, particularly when the underlying investments are credit products rather than equity holdings. The debt issuer may be a dedicated feeder for a particular fund or part of a collateralized fund obligation structure that invests in a variety of products.
Co-investment accounts that allow an insurer to hold debt instruments directly—in lieu of limited partnerships—is another solution to address RBC concerns. Many insurers invest in numerous private equity managers to establish a broad network and for further diversification in the asset class. However, insurers also know that, for alternative assets, manager selection has a material impact on performance over time. Insurers can also pick the best co-investment opportunities from managers with low or no fee load co-investments that provide the most attractive returns relative to risk tolerance.