Permanent capital. It has such a reassuring ring to it. And the liaisons that are being made between alternative fund managers and insurance companies are illustrating just how well managers’ need for a stable source of capital complements insurers’ wish for a stable, long-term source of yield.
In the past year alone, no fewer than six partnership or takeover deals between insurers and asset managers were announced or completed. In March, Apollo Global Management agreed to purchase its insurance affiliate Athene in an $11 billion all-stock deal. That followed the news earlier this year that Adams Street Partners was forming a $2 billion strategic partnership with American Equity Investment Life Insurance, that Blackstone Group was buying Allstate’s life insurance business for $2.8 billion, and that the asset management subsidiary of insurer Aflac was committing $1.5 billion to a new real estate credit partnership with Sound Point Capital Management.
Last autumn, Sun Life Financial, with $1.25 trillion in assets, bought a majority stake in private credit fund manager Crescent Capital. In February, KKR closed on its $4.7 billion acquisition of a 60 percent stake in Global Atlantic Financial Group, which was announced last summer.
“The space has gotten more competitive over the last few years,” said Jon Gray, Blackstone president and chief operating officer, in response to a question on the company’s earnings call in January. He noted that the extremely low level of interest rates was creating the need for great returns for insurance company assets, and particularly for insurers to be able to have direct origination capabilities. But Gray added that Blackstone liked its positioning, that the firm felt there was “an opportunity to really grow here” and that it was an area in which it intended to do more.
“There’s a natural marriage between asset managers who can generate a higher yield or provide more attractive forms of credit with insurance companies that have a need to put a lot of capital to work”
The relationships are not new, though in the 1980s it was the insurance companies such as Prudential and Metropolitan Life, not the asset managers, that were the aggressors. Whatever the case, the linkups seem like matches made in heaven. “There’s a natural marriage between asset managers who can generate a higher yield or provide more attractive forms of credit with insurance companies that have a need to put a lot of capital to work,” says Luke Schlafly, head of insurance investment solutions at PineBridge Investments, noting that the overall insurance market is in the trillions of dollars. Insurers had already been participating as limited partners in private debt funds and recognised they could start investing in the securities directly as co-investors. “There’s been a very natural evolution to a more bespoke solution.”
For alternative managers, “fundraising costs money and requires negotiation with investors”, says Richard Wheelahan, a founding partner of Fund Finance Partners, an advisor to asset managers. “It’s a lot more efficient for asset managers to have a close relationship that can provide a lump sum.”
During a presentation at KKR’s investor day in April, Global Atlantic chairman and chief executive Allan Levine noted the insurance company had, since separating from Goldman Sachs in May 2013, more than trebled its capital to $4.7 billion by February 2020 without ever having a primary raise. He said that across its two lines of business, individual retail and reinsurance, Global Atlantic had “multiple $1 billion-plus opportunities to allocate capital across the cycle”.
Marc Rowan, Apollo’s co-founder and chief executive who helped to establish Athene in 2009, said when the deal with the retirement services company was announced that it provided “total alignment” for the businesses to optimise strategy and allocate capital efficiently. Athene had $202.8 billion of assets as of 31 December 2020. Apollo already manages more than $450 billion – including $340 billion in assets from yield-based investments – and has set a target of $600 billion within five years.
Sun Life Financial, which in January completed its purchase of a majority stake in Crescent Capital – its first mid-market debt acquisition – was one of the first insurers to look outside the company for asset management with its 1982 purchase of MFS Investment Services, the ‘inventor’ of the mutual fund.
Steve Peacher, president of the Canadian insurer’s in-house asset manager SLC Management, told Private Debt Investor in October, when the deal was announced, that the company “decided it would make sense to develop another asset manager” within its four pillars of business. “The goal is to make SLC Management a powerhouse as a third-party investment manager for institutional investors,” he said. SLC already manages investment-grade public and private debt, as well as global real estate and infrastructure businesses.
“There has been a lot of uncertainty about how private debt would fit with Solvency II, particularly around whether insurers would be able to apply a ‘look-through’ on the funds”
Peacher noted that insurance companies must hold a lot of capital over long periods, because their liabilities are long dated. In addition to the higher yield available in private markets, asset management is attractive because it offers fee-based businesses that are not as capital-intensive. He added that one of Crescent’s big attractions was that “it was really valuable to us to have a firm that has been through nearly 30 years of credit cycles”.
Jean-Marc Chapus, co-founder and managing partner of Crescent, said in an interview last year that it was not unusual for Crescent to have strategic partners, since it was formed 30 years ago. However, for the asset manager to provide clients with the best performance and a wide array of products, it sought another partner “to help us grow a little faster than we could do alone”. He added that Crescent, with more than $30 billion of AUM, “found Sun Life’s approach and values to be very consistent with ours”.
Insurance companies have highly specific needs when it comes to their investments, both in terms of the types of assets required to meet their long-term liabilities as well as the regulatory environment they work within.
In Europe, Solvency II regulation puts significant constraints on insurers and the way they build their portfolios. This has often acted as a barrier to private markets commitments.
“There has been a lot of uncertainty about how private debt would fit with Solvency II, particularly around whether insurers would be able to apply a ‘look-through’ on the funds,” says Ajay Pathak, a partner in law firm Goodwin’s private equity group.
For life insurers, look-through is a non-optional part of Solvency II regulations, which place a ‘know your assets’ requirement on these firms, regardless of whether the assets are held directly or indirectly through collective investment vehicles. It is an area where private debt has been able to deliver for insurers’ needs and is bolstered by other characteristics of the asset class.
Pathak explains: “Private debt has been quite attractive for insurance companies because it attracts a lower risk weighting and thus a lower capital charge compared to private equity.”
Fund finance is the new frontier
Insurers have been more pioneering than many assume. They have now found new territory to explore
“If you’re a new manager you may feel like insurers are coming out of every corner, either as investors or competitors,” says Richard Wheelahan III, managing director and co-founder of Fund Finance Partners, a debt advisory firm based in Charlotte, North Carolina. “But it’s not a new phenomenon.”
Rewind to the early 1990s and Wheelahan says you would have found the likes of Prudential doing large mezzanine deals that banks were unable to: “Insurers being able to do highly structured and highly leveraged buyouts was pretty much the origin of private debt.”
These days insurers are finding all sorts of different ways to engage with private debt, and one of the pioneering areas is fund finance. As investors, insurance companies have long been valued by those looking to lend to portfolios. “Insurance companies are prized, creditworthy investors in commingled funds and separately managed accounts,” says Wheelahan. “SMAs in particular can use sub line and asset-based leverage, giving maximum efficiency and gearing to the vehicle based on the creditworthiness of the insurer. You can do some really fund-enhancing things.”
Insurers are also starting to enter the fund finance market as participants. Edward Levy, a managing director at New York-based Velocity Capital Advisors, says his firm, which specialises in fund finance and management company facilities, has been offering insurers access to debt facilities secured by lower-risk portfolios at coupons typically in excess of 10 percent. He says there is “meaningful demand” for this from the insurers but acknowledges that their participation is not straightforward.
“Creating the product they want involves a fair bit of knowledge regarding both the ratings process and their capital and regulatory reserve requirements,” he says. “They have relatively fixed guardrails they can invest within and we have to understand that in order to structure the products in an appropriate way.”
Stars are aligning
Stuart Fiertz, co-founder and president at fund manager Cheyne Capital Management, says the current economic and regulatory environment is making private debt a good fit for insurance portfolios.
“There are a number of drivers for insurers to invest in private debt,” he explains. “They need to create matching assets due to the regulations, which give them a big capital advantage if they do. Annuities need to match their debt portfolios to their need to meet inflation-linked increases and they need to be long-dated as well.
“Declining interest rates and tight spreads mean insurers are looking for yield which is as safe as possible, and private debt fits that need.”
Although Solvency II is an EU regulatory regime, insurers in other jurisdictions often face similar restrictions on the way they invest. This means private debt managers will need to ensure their funds can deliver on the needs of investors outside their own markets.
“Larger investors in general are demanding a lot more reporting, and these kind of rules are not just limited to Europe,” says Pathak. “Increasingly the US has risk-based capital rules and in parts of Asia too. For example, Korean insurers have requirements that are similar to Solvency II.”
Insurers can also be quite selective about the types of assets they will invest in. This, once again, is to help manage their needs to pay out long-term, predictable liabilities in an environment where more traditional fixed-income assets in public markets are suffering from the effects of more than a decade of very low interest rates.
“Credit markets all over the world are supported by government stimulus programmes, so we are a little concerned about this and are adopting a wait-and-see approach for the moment”
Dai Ichi Life
According to Fiertz, real estate debt has been of particular interest to insurance companies because of its yield and asset safety characteristics. “Real estate debt is one area where insurers have been very active,” he says. “Non-banks make up about 25 percent of real estate lending, and about half of that is insurance money – with the rest being asset managers, and a lot of their money comes from insurers as well.”
Another area where insurance companies have historically sought to make private debt funds fit their regulatory needs was through the use of various structures to enable them to access assets that might otherwise be out of reach due to regulatory constraints.
“Years ago we would see German insurers creating different structures, such as parallel feeders, to get them into private debt funds,” says Pathak. “However, that has largely fallen away as investors find they can invest in the main fund and remain compliant.”
Another path some investors have taken in the private debt space is to implement a separately managed account where they can participate directly in deals alongside a pooled fund investor. However, Fiertz says this route has been unattractive for insurers.
“We see less demand for SMAs from insurers than other asset managers because they can get look-throughs via a pooled vehicle,” he says. “In the EU, lending isn’t simple, with lots of restrictions on who can originate loans, and managers’ vehicles will already have the necessary permissions.”
Insurers in the Asia-Pacific region are cautiously committed to investing in private debt. But although they are wary about the effect of government stimulus programmes, they expect the asset class to continue growing.
The region’s insurance market is growing rapidly, as the continent’s huge population becomes wealthier and demands financial services. Five of the top 10 largest insurers by assets under management are Asian, and growth in China and South-East Asia has been dramatic in recent years.
Bruce Pan, managing director and head of private debt at Ping An Overseas Securities, the overseas investments and asset management platform of Ping An Group, notes that insurance companies “share many common characteristics with other institutional investors. They are very long-term investors, with certain cashflow requirements”.
There is a huge variety of regulatory regimes for insurance companies across Asia-Pacific. However, market players say that insurers tend to behave much like other institutional investors in the region when it comes to private debt investments and do not have specific requirements.
Cautious approach in Asia
Asian insurers have generally been recent and cautious investors in private debt, and have tended to invest outside the region in US and European funds. Masashi Ono, deputy general manager at Japan’s Dai Ichi Life, says the combination of lower-rated companies and lower sovereign ratings in Asia means institutions in the region are more inclined to look outside for private debt opportunities.
The pandemic has naturally exacerbated Asian insurance companies’ caution, though Pan notes that, after a hiatus early in the pandemic, businesses adapted quickly: “Since the second half of last year, the investment community has pretty much returned to normal, with people making decisions, and not only in our private debt sector.”
Some, especially those with a track record in private debt, have continued to invest in the sector, while less experienced investors seem more inclined to wait and see. Tsutomu Ishida, deputy general manager at Tokio Marine & Nichido Fire Insurance, says: “We have not changed our approach entirely and have been still selectively investing in private debt, although there is no denying we would prefer a more stable and predictable environment.
“At the same time, however, there are unique opportunistic credit investment opportunities available in the current market environment and we can enjoy a premium in a difficult environment, although that spread is now disappearing.”
However, Ono says Dai Ichi Life, which had made a number of private debt investments during its first foray into the sector, is putting on further investments in the asset class. “Credit markets all over the world are supported by government stimulus programmes, so we are a little concerned about this and are adopting a wait-and-see approach for the moment.”
The big question for a lot of investors in private debt is the likely extent of distressed opportunities in the asset class. Ishida expects the true extent of distress to only become clear once the pandemic is well and truly over and stimulus programmes are withdrawn. Ono adds that it will be easier to take a stance on the market once “the peak of defaults is over”.
However, market participants say they are reluctant to chase ‘covid-linked’ opportunities, either in distress or in focusing specifically on markets that seem to be doing relatively well. “We don’t chase opportunities in countries where they are recovering faster,” says Pan. “That is more for equity investors who may need to identify which region will recover earlier or stronger and get in there first. We are looking at the returns versus the risk over the life of each investment.”
In the longer term, Asian insurers expect more growth for the private debt market both in their region and elsewhere, primarily due to demand from borrowers and the continued retreat of banks from transactions that are not straightforward. Pan says: “A lot of the deals come from the leveraged buyout market, where there is still very strong activity and private equity investment is also growing, year after year. So, we still see a growth market in private debt.”
Insurers are an important part of the private debt ecosystem. As long as their complex needs are met, they view the asset class as offering a good solution that provides both yield and crucial low capital-cost assets to help manage regulatory expectations.
John Bakie, Mark Cooper and Andy Thomson contributed to this report