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Katja Butler Robert A. Chaplin
Key Points
Financial sponsors have become progressively more involved in the insurance sector over recent decades. Their involvement broadly falls into three categories:
The diversification of private capital into the insurance sector reflects several factors: the ever more competitive environment for private equity type deals, well-established playbooks for success in the sector and a desire to acquire new long-term money to manage.
There have been recent headwinds, such as the rising cost of debt finance, secondary effects of the recent banking crisis, and regulatory and legislative concern around private equity involvement in the sector. The general view, however, is that financial sponsors will continue to expand their share of the sector as they steadily recast themselves as diversified financial businesses.
The top five financial sponsors all now own or partially own a life and annuity business insurer or reinsurer. Many other sponsors do as well, or are seeking to find their way into the sector.
Why?
Financial sponsors are becoming diversified alternative asset managers. They are looking to maximize their assets under management (AUM). They are particularly interested in opportunities that provide long-term capital to manage; such capital is hard to move and can be invested in private credit strategies where they have strong origination capabilities.
Life and annuity insurers and reinsurers offer these characteristics. They can also provide the opportunity to spread income in various lines of business based on the difference between what is earned on investments and the return required to be paid on the underlying policies. Typically, on acquisition, the AUM will be transitioned from lower-yielding assets into private credit strategies that offer higher yields. This is subject to the constraints of insurance regulation.
The transition of asset portfolios has not been without controversy. For example:
Sponsors have worked hard to establish their regulatory credibility in light of these concerns. In turn, regulators worldwide have become increasingly comfortable with the regulation of sponsor-owned insurers and the techniques required to regulate them. This is demonstrated by the now widespread ownership of both life and nonlife insurers by private capital businesses.
Life and annuity insurers and reinsurers are balance sheet businesses that require considerable amounts of capital. They are typically valued by reference in some way to book value. In contrast, insurance brokerages are “capital light” and usually valued on a multiple of earnings before interest, tax, depreciation and amortization (EBITDA).
The ability to leverage investments in life and annuity businesses is meaningfully constrained by insurance regulation. In contrast, brokerage investments can be made with a considerable amount of debt, which historically could be at a six or seven times EBITDA level.
In many jurisdictions, brokerage business was and continues to be highly fragmented, offering a substantial opportunity for roll-ups, with all the cost and revenue synergies that can come from combining businesses.
Executing a roll-up to create a larger platform, with the support of leverage, is a well-established private equity playbook across sectors, but the insurance brokerage arguably has been the area where the approach has been most successful.
In many ways, the success of the roll-up strategy is demonstrated by a number of the larger consolidators, where the platforms have become so considerable and successful that they have become backed by multiple sponsors.
While the consolidators easily catch attention, we should not disregard single company strategies. These have typically been at their most successful where a sponsor has taken equity in an insurance intermediary that handles specialty lines. The sponsor has then helped the company improve its business and often exited after EBITDA has grown materially and at an expanded multiple.
No survey of the sector would be complete without reference to sponsor investment in Bermudian reinsurers. Reinsurers are the support of the insurance industry, allowing primary insurers that face the public to lay off risk and, as a result, write more business.
While the large life and brokerage consolidation platforms draw significant press, investment in Bermuda reinsurance vehicles continues, particularly given the recent hardening of pricing in reinsurance markets.
Financial sponsors have evolved dramatically over the past 20 years, expanding into new asset classes and, in the case of some of the biggest firms, going public. They continue to search for ways to develop into the financial supermarkets of the world, alongside and competing with the large banks. As such, it is only reasonable to expect that their desire to become ever more involved in the insurance sector will continue.
See all of Skadden’s June 2023 Insights
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.
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