Apr 24

Wolves in Sheeps’ Clothing: Private Equity As the New Insurer Insolvency Risk

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In last night’s article from Bloomberg, “Apollo-to-Goldman Embracing Insurers Spurs State Concerns,” the relatively recent involvement of private equity (PE) firms in insurers was noted as a potential problem for policyholders and regulators going forward.

Let’s just say that this understates the problem.

First, let’s remember how PE operates: Find inefficiencies and take full advantage of them. How about state regulatory inefficiencies. With 50 plus jurisdictions involved in regulating insurers in the US, there will be some jurisdictions that are more efficient than others. The less efficient ones are thus the target of the PE firms.

Second, state investment regulations for insurers also can vary by jurisdiction. Although the National Association of Insurance Commissioners (NAIC) promulgated two versions of a Model Investment Law nearly two decades ago, neither has been adopted by enough states to be a requirement for state accreditation. Thus, there are plenty of loopholes, if you are willing to find them.

Third, the article points out potential abuses, but misses an important point. Insurers typically use investment grade fixed income securities to back their obligations to policyholders. Are these PE firms taking on ‘risky’ assets for that purpose, or are these ‘risky’ assets an investment of the insurer’s surplus (assets less liabilities)? And, if they are such an investment, is the amount of risk taken too much relative to that surplus?

Fourth, the article alludes to the importance of rating agencies. But, given an ‘out of the ordinary’ investment strategy, do you think the rating agencies are properly staffed for this challenge?

The folks running PE firms are quite savvy (how else to truly justify the lower tax rate on ‘carried interest’?). Questions should be asked about their strategies and the ability to fully understand the unique arena of investing for insurance companies. But, one wonders, with all due respect, if the regulators (state or now federal) or the rating agencies have the capabilities to perform this function.

Why does this start to sound like the sub-prime arena? Regulators and rating agencies without the capability to fully understand what the investors are up to.

The wolves have entered the insurance business in sheeps’ clothing. We now have to determine if their strategy of finding inefficiencies and taking advantage of them, in both the markets, regulators and rating agencies is a potential hazard for policyholders. And, those wolves are not about to tell us much more than is required by statute.


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