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What’s behind the annuity M&A blitz?

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Who knew annuities were so popular? In recent months, financial giants ranging from Guggenheim Partners to Warren Buffet’s Berkshire Hathaway have either acquired or reinsured annuity blocks of business. Not bad for an industry that still struggles mightily in a low interest rate environment. So what gives? Why are these investors, mostly private equity (PE) outfits, interested in annuities, particularly fixed annuities?

A recent report by Moody’s Investors Service, “A New Entrant in the U.S. Life Insurance Market: Alternative Investment Managers,” delineated some reasons. But first let’s list some recent transactions:

  • Athene Holding, Ltd. picked up Aviva USA for $1.8 billion.
  • Guggenheim Partners snagged the U.S. annuity business and certain life insurance lines from Sun Life Financial for $1.35 billion. Prior to that deal, it bought Quebec-based Industrial Alliance and Financial Services, Inc.’s U.S. fixed annuity business for $800 million.
  • Berkshire Hathaway Life Insurance Co. agreed to reinsure Cigna’s run-off variable annuity business. Cigna paid Berkshire Hathaway $2.2 billion.

It’s not difficult to see why the sellers sought to unload their annuity lines as protracted low interest rates continue to squeeze profit margins and capital requirements are heightened. But what’s in it for the buyers? What can alternative investment managers (AIMs) like private equity and hedge funds get out of the deal?

According to Moody’s senior vice president Scott Robinson, an author of the report, they see an opportunity to utilize their asset management and investment expertise. In the case of equity indexed annuities one of their sought-after targets – they are looking to diversify into a product class that isn’t sold by the majority of companies, he notes.

PE firms can further rely on other advantages they bring to the table, namely, being able to invest more aggressively while holding less capital. “Private equity firms are less concerned about accounting volatility, which for a public insurance company can be a big risk,” Robinson says. Another option AIMs may exploit is taking the business offshore, thus gaining a tax advantage.

“PE firms are looking for something that is going to meet their returns, and they have fairly high return hurdles,” Robinson says. “They are looking for businesses that are going to provide some diversification to their other investments. Some are buying closed blocks, but they are also buying companies so they can continue to write business. It’s hard to generalize. One reason they might choose a particular block of business is that they are trying to leverage their strengths, one of which they believe is on the investment side. They also may take a longer-term view, or a view that looks beyond some of the accounting anomalies of the different products.”

In it for the short or long term?

One of the most frequency voiced objections to private equity firms buying up insurance businesses is that are in it for the short term. Their strategy is to make a quick profit and exit. Yet insurance, point out many in the industry, is a quintessential long-term business.

Eric Thomes, senior vice president of sales, Allianz Life Insurance Company of North America, says that his company is “paying close attention” to these new entrants. Having more competitors in the market makes for better innovation in the product line, which benefits consumers and advisors alike. Yet he wonders about their staying power since historically such firms tend to have a short-term investment horizon.

“Are they really committed to a long-term business? They very well could be,” Thomes says. “They could be around for a long time and do very well in the annuity space. But that’s the question a lot of people have to answer, what is their long term strategy? I can’t answer that. The companies that are coming in and buying and getting into the space will have to answer that question.”

Robinson, meanwhile, says it’s hard to say whether an individual company has a long- or short-term investment strategy. Generally, it’s true that private equity firms seek to harvest cash for their investors and then depart, yet each company has a different approach, Robinson says.

“I see mix of strategies,” he says. “Some are buying closed blocks of business and others seem to buying a business they view as an ongoing operation. They latter may place some value on new business. In either case, it is difficult to exit the purchase of an insurance block over a short period of time.”

Variable annuities get into the M&A act

In 2012, most of the annuity M&A activity involved fixed and fixed indexed annuities. But in recent months, buyers have shifted to variable annuities, specifically Guggenheim’s buy of Sun Life’s variable annuity line and Berkshire Hathaway reinsuring Cigna’s variable annuity death benefit run-off business.

Moody’s Robinson says he doesn’t know if this portends a pronounced trend of more variable annuity takeovers. However, those deals could nudge the market in that direction.

“You could potentially see more transactions in that market,” Robinson says. “There is an active M&A market out there, with more supply than demand for products such as variable annuities. With the recently announced transactions, it looks like a market is developing.”

Lorry Stensrud, president and CEO of Achaean Financial, a recently launched financial services company that offers retirement advisory software in addition to a remediation platform for some portion of legacy variable annuities, disagrees. He says the Sun Life/Guggenheim deal came to fruition because Sun Life’s variable annuity block was relatively small and the benefits in those were policies were modest in comparison to other companies.

“Are there very many more of those out there? Probably not,” Stensrud says. “Most of them would have to be a reinsurance transaction.”

That’s because a certain percentage of variable annuity blocks of business are what Stensrud terms “toxic” and simply too risky for a buyer to either acquire or reinsure. “They could give it to you for free and you still wouldn’t want it,” he says.

“You are going to see a lot of lookers. How many are potential buyers? I don’t know,” Stensrud says. “Most of what has been done by those firms has been done on the asset side. They think they can manage money better. That’s why they’ve gone after fixed annuities and indexed annuities.”

Risks on both sides

The Moody’s report asserts that the both the buyer and the seller take on some degree of risk in these transactions. For the buyer, it’s the assumption of traditional insurance risk, which varies by the type of annuity fixed, fixed indexed or variable dealt and the possibility of overpaying, Robinson says.

Even though the seller may benefit by ridding itself of a revenue-draining business, how the transaction is structured is critical. If it’s done as an outright sale, the seller is in a better position than if it’s a reinsurance deal, which could entail some counterparty risk on the part of the ceding company, Robinson says.

“In a pure reinsurance transaction, if the private equity firm or hedge fund doesn’t perform, they can always just give the business back to the life company,” Stensrud says.

For an insurer acquired by an AIM, the risk may be that the purchaser has a more aggressive risk strategy than it is accustomed to, notes the Moody’s report.

Yet having a robust transaction market for annuities is heartening for any company looking to sell and could mean more deals are coming down the pike, say observers. But the question remains: Can the purchaser run the business any better? Some can, but perhaps some cannot, Stensrud says.

“Most of the people who are looking at buying these blocks of business think they have a better investment strategy skill set than the life industry has,” he says. “Most of them are migrating to some form of fixed income investments that have more risk than a traditional life insurance company would be willing to take. There are some people who are very good at that and there are some that are not very good at that.”

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