The Money Factor

U.S. Insurers’ Private Equity Holdings Continue to Climb

Continued low interest rates, strong but cash-strapped businesses create opportunities

New market research from AM Best. Read the complete report here

OLDWICK, N.J., June 29, 2020—U.S. insurance companies for a fourth-straight year increased their private equity holdings—by nearly 10% in 2019 to $81.3 billion—as this asset class remains attractive to insurers looking to diversify their investment portfolios or increase returns in the low interest rate environment, according to a new AM Best special report.

The Best’s Special Report, titled, “Private Equity Holdings Continue to Climb,” notes that companies that made private equity investments and were looking for an exit such as an IPO or sale, may need to defer doing so amid the COVID-19 pandemic environment, as they may not be able to get their desired price. Nevertheless, the lower interest rate environment and an abundance of cash-strapped businesses with sound economic models create opportunities for private equity capital.

As insurers have pulled back from hedge fund investments, many have shifted allocations to private equity to maintain exposure to alternative assets and achieve better returns, compared with the public markets. U.S. life/annuity (L/A) insurers have driven the majority of the growth in private equity holdings. The L/A segment accounts for three-quarters of the insurance industry’s private equity book adjusted/carrying value (BACV). However, they have the smallest allocation to invested assets on average—1.5% compared with 2.3% for property/casualty insurers and 7.1% for health insurers, although the health allocation is not meaningful due to a small population and one outsized exposure.

More Conservative Investment; Less Risk Tolerance

The small allocations as a percentage of invested assets point to generally more conservative investment strategies and lower levels of risk tolerance. Insurers are also wary of the effects on capital models, as investing in limited partnerships or other common equity vehicles face 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. Most insurers prefer experienced money managers with a solid track record.

The insurance industry as a whole has the greatest exposure to leveraged buyout funds, at approximately 60% of overall holdings. Venture capital accounts for another 25%, and mezzanine financing composes the remainder. Additionally, the insurance industry has more than $46 billion in commitments for additional investment, more than $36 billion of which are by L/A insurers.

AM Best reviews company investment guidelines to gauge whether current investment allocations are within the risk tolerance parameters set by a company. Investment management capabilities, performance and the resulting impact on capital also are evaluated, and companies rated by AM Best should be able to explain the risks they take with their alternative asset investment portfolio, particularly as many companies have commitments for additional private equity investments.

Excerpts from the report: Private Equity Holdings Continue To Climb

Capital Raised Increases Even as Deals Decrease

As insurers have pulled back from hedge fund investments, many have shifted allocations to private equity to maintain exposure to alternative assets and achieve better returns, compared with the public markets...

Despite a 27% YoY drop in deal closings in the first quarter of 2020, the total amount of capital raised grew almost 12%, according to Preqin. Venture capital deals bore the brunt of the decline in closed deals, but leveraged buyouts—where the insurance industry is most exposed—also dropped 12%. A key issue for fund managers is how to value portfolio companies and potential targets at a time when revenue for many businesses is declining owing to the economic fallout of COVID-19.

The spread of COVID-19 has accelerated the digital transformation of a number of industries. With significant numbers of people sheltering in place, demand for digitally accessible healthcare products and services is on the rise. Regulatory barriers that have long impeded the provision of digital healthcare services such as virtual medical appointments have been eased by governments.

These factors have contributed to venture capital deals soaring. In the first quarter of 2020, the total value of global venture-backed healthcare deals jumped 76%, to hit $8.2 billion, from the first quarter of 2019—a 25% increase in aggregate deal value from the fourth quarter of 2019 and the highest quarterly total on record, according to Preqin.

The technology sector as a whole will likely see further private equity interest, as companies continue to seek ways to improve operations with a larger and increasingly remote workforce, paving the way for tech companies to step in with creative solutions and investors to finance.

Market Players Are Concentrated,Exposure Is Manageable

Despite the continued growth in this asset class, only 25% or less of insurers in each segment invest in private equity, with the most widespread use by L/A insurers. More than twice as many insurers (119) increased their private equity holdings as those that decreased (57), with the top five accounting for roughly one third of the increase and ten for more than half. The 20 biggest holders—largely L/A insurers—account for nearly three quarters of private equity holdings in the insurance industry.

Despite accounting for a larger portion of the industry’s holdings, allocations average less than 4% of invested assets. Similarly, the average exposure to capital and surplus for the top 20 holders is 25%, which is somewhat elevated by a handful of companies while most companies have more manageable levels of exposure. However, given the valuation of private equity is difficult to quantify precisely, the ratio to capital can act as more of a guide pointing to 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.

To view a video discussion with Jason Hopper, associate director, industry research and analytics, AM Best, please go here.

 

 

 

AM Best is a global credit rating agency, news publisher and data analytics provider specializing in the insurance industry. Headquartered in the United States, the company does business in over 100 countries with regional offices in New York, London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City. For more information, visit www.ambest.com.