This latest Opinion piece is by Brian Slattery, senior vice president and head of Northern Europe, Clearwater Analytics. It looks at the latest trends in private equity
Private equity sharks have circled the US insurance market for decades, but it seems more and more firms are now sinking their teeth into the space. According to a recent analysis by McKinsey & Company, the share of US life-insurer assets held by private-capital-owned platforms has surged to almost 9% from less than 1% a decade ago.
Indeed, all five of the largest private equity firms possess meaningful holdings in insurance, representing 15-50% of their total assets under management. These private market investors typically seek to generate attractive returns on acquired books by influencing the strategic asset allocation of the insurer, while applying their own tried and tested investment management strategies to deliver alpha across its various asset classes.
This trend is not limited to the US. Buyout titans including the likes of Blackstone and KKR are increasingly looking across the pond to Europe and even further afield to the Asia Pacific region in search of fertile hunting ground for acquisitions in the insurance industry. While elevated takeover activity offers a host of potential benefits to both buyout firms and insurers, there are also major challenges that must be addressed when integrations of this type are executed – particularly when it comes to data infrastructure.
Permanent capital potential
From a private equity investor’s perspective, there are several reasons why insurers look increasingly attractive in the current market context. Access to capital – which refers to investment funds not required to be returned to investors in the near to medium-term – is perhaps insurers’ most attractive characteristic at present.
Access to this pool of ‘sticky’ capital reduces the need for private equity houses to spend considerable resource raising funds – a process that becomes more difficult and time-consuming amid heightened economic uncertainty, such as that witnessed over the last couple of years, when forms of capital like debt financing tend to dry up.
The ability to invest insurers’ assets also provides private equity firms with the potential to quickly ramp up their alternative credit capabilities. Alternative credit, which encompasses non-traditional credit instruments like private debt, is a growing focus for many private investors, owing largely to its diversification potential and ability to generate attractive risk-adjusted returns. Indeed, with private markets growing increasingly competitive following a period of underwhelming public market returns and lower bond yields, holding alternative credit has seldom looked so compelling.
The market is also primed with a good number of willing sellers, with many small and medium-sized insurers well aware of the potential advantages of an acquisition. After all, for insurers, a takeover presents the opportunity to enact a meaningful shift in strategy, perhaps towards the increasingly popular capital-light, fee-based business model.
The devil’s in the data
Nevertheless, acquiring insurers is by no means a risk-free strategy for private equity investors. An important consideration for those sizing up insurance firms is the magnitude of the operational burden they may inherit. Many insurers unfortunately still rely on dated legacy systems when it comes to their investment, risk, accounting and reporting processes. These systems are simply not fit for the scale, which can create significant teething problems when private equity firms look to integrate their investment management processes with an insurer’s existing digital infrastructure.
If the information underpinning an insurer’s investment portfolio, for instance, is managed manually via spreadsheets, a private equity firm will have to invest significant capital to modernise its operational infrastructure, to ensure it can cope with much greater data volumes as it scales. In addition, given a takeover of this type will likely result in an insurer investing in a broader range of asset types, the challenge of ensuring its investment data infrastructure is up to scratch becomes doubly important. After all, this can have a major impact on the speed at which an integration can be completed – which in turn has a material impact on the value of a deal.
Then there is the challenge of ensuring private market investors successfully meet the insurance industry’s fast-evolving regulatory reporting obligations. With private equity’s involvement in the space continuing to grow, an increasing number of policymakers are calling for further action to safeguard the already heavily regulated industry. The private-capital-owned insurers with outdated reporting processes will struggle to cope should additional regulatory requirements be imposed.
The most attractive takeover prospects will subsequently be those insurers already in possession of comprehensive, transparent and centralised data management systems, as well as a clear understanding of their current risk exposures. Ideally, their data infrastructure will be cloud-based, helping ensure greater interoperability with external systems. For private equity players looking to capitalise on the vast potential on offer in the insurance industry, it seems the devil is in the data.