The US pension risk transfer (PRT) market saw a record volume and number of deals take place in 2022. This year is set to break more records as the rapid rise in interest rates makes offloading schemes more affordable and new players entering the market has increased competitiveness.
Last year, the US recorded over $50bn worth of PRT deals, a big jump on the $38.1bn that actuarial consultants Milliman recorded for the market in 2021. The same trend is being seen in other countries, with Canada and the UK seeing an upshot in the amount of deals being struck as pension fund trustees look to take advantage of a change in fortunes after a decade of ultra-low interest rates skewed the pricing on transfer deals.
Firms have not been slow to recognise the opportunity and enter – or in some cases re-enter – the PRT market. In 2022, Reinsurance Group of America, Global Atlantic and American National all said that they were looking to write business in the PRT market and in July this year, Fidelity, the world’s third largest money manager, announced that it was entering the sector via a Bermuda domiciled reinsurance entity, Soteria Re.
Another trend which has emerged alongside the growth of the US PRT sector has been an increase in private equity activity in the market. According to a report by consultants McKinsey, private investors now own over $900bn of life and annuity assets in Western Europe and North America.
According to McKinsey, all of the five largest private equity firms by assets have interests in life insurers with exposures ranging from 15 to 50% of their total assets under management.
This trend has not gone unnoticed. At the start of August this year, Democrat Senator Sherrod Brown, Chairman of the US Senate Committee on Banking, Housing, and Urban Affairs, released two letters questioning the role of private equity in insuring pension payments.
According to figures from the Treasury Federal Insurance Office (FIO) at year-end 2020, the cash and invested assets of US-domiciled private equity-owned life insurers were over $471bn; 12 months later the figure stood at over $800bn.
But what is concerning both Senator Brown and the FIO is the evolving risk profile of the life insurance sector under private equity stewardship.
“As private markets have expanded over the last decade, far outpacing the growth of public markets, private equity firms have reshaped their business models and increased involvement in the life insurance sector. Previously, the focus of private equity was largely on buy-outs. Now, some private equity firms are increasingly pivoting their business objective to the private credit market,” the FIO said in a reply to Senator Brown’s questions on the role of private funds in the PRT sector.
The emergence of private credit has been one of the post Financial Crisis success stories.
Figures from Preqin show that allocations to the sector have shot up from less than $50bn in 2010 to over $200bn in 2021. Charles Decker, a researcher at the UNITE HERE trade union, which put out a press release in May questioning the role of private equity in the PRT sector, says that private equity-backed firms have invested heavily in private debt but that the asset class remains untested in a high interest rate environment.
“The whole private debt sector has grown hand-in-hand with the low interest rate environment and there are reasons to be concerned about an asset class which has not been tested by either a period of prolonged high interest rates, or a major recession. But Unite Here’s greatest concern is just how opaque these assets are, it’s very difficult to find out exactly what these private equity-backed insurers are investing in,” says Decker.
Decker’s concern is that US insurance regulation is conducted at a state level via the National Association of Insurance Commissioners (NAIC), and while pensions are underwritten federally via the Pension Benefit Guarantee Corporation, once an insurer takes over a scheme it then falls under the purview of individual states which don’t have uniform regulations.
“While pensions are federally guaranteed, annuities are not; each state has its own version of a guaranty association, each with different levels of coverage providing annuitants with varying levels of compensation if the insurer behind it goes bust. Most of them have lifetime caps which are typically lower than the level of pension obligations,” he says.
Decker adds that Unite Here, which represents over 300,000 workers across both the US and Canada, is concerned that the economy was changing faster than regulators are capable of keeping up with, particularly given the existing US PRT rulebook has been in place since the mid-1990s.
Decker’s criticism was rejected by Joe Engelhard, Senior Counsel, US Policy & Regulation at the Alternative Investment Management Association (AIMA), which acts for the industry globally.
“In the US, the pension risk transfer market is regulated at both the federal and state levels, and insurers have a great track record over many decades of providing benefits to annuitants,” says Engelhard.
Regulators appear wise to the potential threat of untested assets. The NAIC caused consternation in the industry with its April plan to provide alternative credit ratings for securities insurers have invested in and Engelhard said that the authorities were looking to mitigate potential risks by adjusting the regulatory framework.
“Regarding structured securities, insurers have a long history of investing in that asset class, and the NAIC is currently adjusting its accounting and capital rules in response to the natural development of new structured products,” says Engelhard.
The debate is likely to continue. McKinsey’s report says that private capital’s interest in the insurance industry goes back more than 50 years, citing the 1967 acquisition of National Indemnity by Berkshire Hathaway as one of the earliest examples of this trend.
The consultant’s explanation for private firms’ continued interest in life insurers is because ownership of a carrier gives access to what McKinsey calls, ‘permanent capital’; funds which don’t have to be returned to investors on a specific timetable.
McKinsey estimates that private firms can increase the returns on equity on life insurers assets by up to seven percentage points annually by altering the asset allocation, meaning life insurers and the PRT market are likely to remain attractive to private capital.
“The core attraction is straightforward. The balance sheets of life and annuities companies are well stocked with assets…but until payout, these assets need to be invested to generate returns. And in many cases, the cost of servicing the liabilities is significantly lower than the potential investment return. The spread represents an attractive margin,” says McKinsey.
