S&P Global Ratings believes that the involvement of alternative capital in the U.S. life insurance sector could double over the next two to years.
The most recent merger and acquisition (M&A) announcements in the U.S. life insurance sector has seen increased involvement of alternative capital investors. This is not the first time we have seen interested acquirers who aren’t traditional insurers (i.e., alternative capital), nor do we believe it will be the last. All major stakeholders, including insurers, insurance agents, brokers and regulators will have to adapt to this new paradigm.
At the end of 2017, we estimate over $100 billion in insurance liabilities were held by insurers where alternative capital owned a majority equity stake. This is slightly less than 5% of the total life insurance liabilities in the U.S. We believe this level could grow meaningfully, mostly due to the seeming increase in the alternative investors’ risk appetite and the available supply of relatively riskier, longer-tailed liabilities.
Alternative capital is usually attracted to insurance products or liabilities that accumulate assets. In the past, most of the acquisitions have involved liabilities such as fixed annuities. But, the two recently announced acquisitions by investor consortiums—Voya Financial Inc. ‘s closed block of variable annuities (VA) and Hartford Financial Services Group’s run-off life and annuity block—demonstrate that outside money is now willing to take on more-complex legacy liabilities.
Both Voya’s and Hartford’s blocks contain VAs with guaranteed living benefit. Such VAs are generally more complex, more difficult to hedge, and have more potential for capital and earnings volatility than its fixed annuity cousin. This very riskiness perhaps makes pricing more favorable for the alternative investors. We also believe the prospect for inorganic growth is much greater, since the industry definitely has plenty of such complex legacy blocks that they would be happy to divest.
But, the question is, does the increased involvement of alternative capital help or hurt the credit quality of the U.S. life insurance sector?