2023-12-18-IMF-Private_Equity_and_Life_Insurers_26页_1mb

Summary of "Private Equity and Life Insurers"

Core Content

This Global Financial Stability Note (GFSN) explores the growing trend of private equity (PE) investments in the life insurance sector, particularly focusing on the changes in asset allocation, risk profiles, and regulatory implications for life insurers influenced by PE.

Main Points

1. The Growth of Private Equity and Private Debt

• Rapid Expansion: Since the global financial crisis, PE has experienced significant growth, with assets under management (AUM) almost tripling from 2016 to 2022, reaching close to $12 trillion by mid-2022.
• Volatility: Capital raised for PE strategies showed significant volatility, with a peak in 2021 ($830 billion) and a decline in 2022 (down 12 percent).
• Private Credit Rise: The decline in LBO funding has driven PE companies to expand into private credit, which has seen strong growth in AUM, reaching $2.4 trillion by 2022.
• Investor Demand: Institutional investors, including public pension funds (PPFs), have increased their allocations to PE, with US PPFs raising their allocation from 10 percent to 17 percent between 2017 and 2022.
• PE Companies' Role: US-based PE firms dominate the sector, with the top three (Blackstone, Apollo, and KKR) holding 19 percent of global AUM.

2. Private Equity and Insurers

• Historical Involvement: PE has been involved in the life insurance sector since the 1980s, but activity has intensified since the global financial crisis.
• Strategies: PE companies use various strategies, including:
  • Strategic Alliances: Owning small stakes (<10%) in life insurers and managing their structured credit, private credit, real estate, and PE investments.
  • LBO Transactions: Acquiring life insurers through leveraged buyouts, often with the aim of restructuring or selling them later.
  • Reinsurance Agreements: Using offshore reinsurers to manage longevity and investment risks, especially for life insurers with high exposure to illiquid assets.
• Fee Income: PE companies benefit from substantial fee income, with average annual management fees at 1.76 percent and performance fees at 20.3 percent in 2018–2019.

3. What Is Different about PE-Influenced Life Insurers?

• Asset Allocation: PE-influenced life insurers have significantly higher exposure to illiquid assets compared to traditional insurers.
• Liquidity and Valuation Risk:
  • They tend to hold more private asset-backed securities (ABS), private debt, and structured credit instruments.
  • These investments increase liquidity risk, as they are harder to value and less liquid than traditional assets.
  • The use of nontraditional liabilities, such as funding-agreement-backed securities, is more prevalent among PE-influenced insurers.
• Regulatory Arbitrage:
  • PE companies have leveraged regulatory changes in the US to reduce capital requirements for illiquid assets like ABS.
  • The NAIC's revaluation of ABS through the Securities Valuation Office has allowed PE-influenced insurers to hold less capital for these assets.
  • This arbitrage may be further addressed by introducing additional NAIC designation categories and RBC factors.

4. Policy Considerations

• Systemic Risk: The increased reliance on illiquid assets and the use of reinsurance may create systemic risks, especially if the economy slows and interest rates rise.
• Liquidity Mismatches: The growing share of illiquid assets in life insurers' portfolios increases the risk of liquidity mismatches, particularly when facing margin calls or policy surrenders.
• Data Challenges: Public data on PE-influenced life insurers are limited, making it difficult to assess the full extent of their influence and risk exposure.
• Need for Supervision: Insurance supervisors and regulators should monitor the changes in asset allocation and risk profiles of PE-influenced life insurers to ensure financial stability.

Key Information

• PE Growth: AUM of PE companies have grown from $4 trillion in 2016 to nearly $12 trillion by mid-2022.
• PE Companies: The top 10 PE firms account for 31% of global AUM, with the top three holding 19%.
• US PPFs: The average allocation of US PPFs to PE has increased from 6% in 2001 to 16% in 2022.
• LBO Funding: LBO volumes declined in 2022 due to reduced bank funding, leading to a shift toward private credit.
• Illiquid Assets: PE-influenced life insurers have a higher allocation to illiquid assets, including structured credit and private debt.
• Regulatory Impact: The NAIC's valuation framework has allowed for reduced capital requirements for certain illiquid assets, raising concerns about appropriate risk measurement.
• Market Valuation: In the secondary market for PE assets, transaction prices declined from 92% of net asset value in 2021 to 81% in 2022, indicating increased valuation uncertainty.

Conclusion

The integration of private equity into the life insurance sector has led to significant changes in investment strategies, asset allocation, and risk profiles. While this shift has enabled PE companies to access long-term capital and generate fee income, it also introduces new challenges related to liquidity, valuation, and regulatory oversight. Policymakers and regulators must closely monitor these developments to ensure the stability of the financial system and protect policyholders.