Private Equity Deals Draw Subpoenas, Questions
May 22, 2013 by Linda Koco
Uncertainty may follow this week’s news that New York officials have subpoenaed several private equity firms that have interests in buying fixed annuity companies or businesses. The top question: Does this mean that there something wrong with those deals?
Part of the uncertainty has to do with the lack of definitive information about the subpoenas. Wall Street Journal reported on Monday that three such firms were subpoenaed. Later in the day, Bloomberg reported, three others were subpoenaed as well. But there was no official statement from the New York State Department of Financial Services (DFS) to straighten it out.
InsuranceNewsNet has since confirmed with sources familiar with the matter that DFS did send subpoenas to six private equity firms with interests in the fixed annuity business. The firms are Apollo Global Management, Guggenheim Partners, Harbinger Group, Goldman Sachs Group, Global Atlantic Financial Group and Tiptree Financial Partners.
The subpoenas are a precursor to a DFS move to develop enhanced regulations concerning private equity company purchase of annuity carriers, these sources said via telephone.
Already in process now, the regulations will be comparable to those that apply to private equity purchase of New York banking businesses. DFS is hoping to move forward on the regulations soon, but the sources did not give a time-frame for “soon.”
The goal is to put guiderails in place on such deals, not to prohibit private equity ownership of insurance businesses, the sources add.
Foreshadowing
Benjamin Lawsky, DFS superintendent, foreshadowed these plans when he said in a speech last month that “DFS is moving to ramp up its activity” in modernizing its regulations in this area.
One reason is the sudden growth in private equity activity in the fixed annuity business.
Private equity-controlled insurers now account for nearly 30 percent of the indexed annuity market, up from 7 percent a year ago, Lawsky said in the published version of his speech. That includes deals completed or announced as of April.
In addition, private equity now represents 15 percent of the total fixed annuity market, he said, noting this is up from 4 percent a year ago.
At issue is not only the rapid growth but also the short-term focus that the DFS believes some private equity firms may have.
Private equity firms typically manage their investments for three to five years, Lawsky said. As a result, “they may not be long-term players in the insurance industry and their short-term focus may result in an incentive to increase investment risk and leverage in order to boost short-term returns.”
He did not name any private equity company as causing or being part of such problems in New York. Rather, he framed his concerns as “the risk that we’re concerned about.”
This suggests that DFS’s action may be preemptive in nature rather than reactive to a major problem or crisis.
The proposed regulations probably will take the same direction as New York’s regulations on private equity acquisition of banks. In his April speech, Lawsky described those banking regs as being “designed, in part, to encourage a long-term outlook,” in such a way as to ensure that the person controlling the company “has real skin in the game.”
Translation
It appears that New York is on a mission to bring greater oversight to deals in which private equity firms buy fixed annuity companies or books of fixed annuity business.
Does that mean that DFS has decided private equity firms are “bad” for the annuity business? At this point, it does not seem so.
More than likely, DFS is doing what regulators basically do—that is, lay down regulations when they spot potential risks in emerging business areas.
Usually, state insurance regulators leave a new trend alone for a while, in the incipient stage. That is true whether the trend is a new product feature, a new marketing or operations strategy, or new areas over which they may have jurisdiction. But when they notice a lot of firms getting into the new thing, or a lot of business flowing in the new direction, they perk up their ears.
Sometimes consumer complaints or legal actions get the regulatory ball rolling. But other times, it’s the sheer volume and/or suddenness of the new thing. One way or another, the regulators step in as the business begins to fill out.
In this particular case, the insurance industry is a bit confused over the increased interest that private equity firms are showing in annuity company ownership. Many practitioners say they just don’t know enough about such firms to make business decisions concerning the insurance companies the firms buy, even if they’ve known and worked for the carriers for years under different ownership.
For that reason, professionals in the field and the home office may approve of, or at least not resent, New York’s subpoena-laced inquiry. This is provided that the initiative elicits meaningful and publically discoverable information.
Confusion
Some of the annuity industry’s confusion stems from the stereotype that industry professionals have of private equity companies. This is the expectation, deserved or not, that these firms will do “just about anything” in order to increase profits for their investors.
That image grew large in the wake of the controversial leveraged buy-out (LBO) deals of past decades, when private equity firms made headlines for buying, stripping and flipping companies and/or burying their underperforming acquisitions, seemingly done with little or no concern for customers, employees, vendors, community or other vested interests.
The do-anything image is also a legacy of private equity lore, which says that private equity firms typically flip their companies just two or three years after purchase, primarily to make a quick profit, and with nary a concern for the flipped company’s future.
As a result of such concerns, some insurance producers are reluctant to place business with carriers that might be entangled with such firms. Their reason: They prefer to work with carriers that are “in it for the long term.”
Some insurance companies have private equity concerns too. For instance, in a November 2012 letter to producers, Allianz raised questions about the sustainability of companies controlled by “hedge funds, private equity groups and other investment managers,” such as the now-defunct Baldwin-United Corp.
The confusion arises because certain private equity firms now have owned fixed annuity businesses for one to three years or more, and they may own more than one carrier plus some existing books of business acquired elsewhere. This means industry professionals now have access to industry buzz against which to weigh their previous preconceptions. Therein lies the proverbial rub.
For instance, at least one of those firms has said it plans to hold its insurance acquisitions for six or more years, at a minimum. So what happened to the three-year rule of thumb? Are six-plus years better than two or three? Is that considered long term? How does that compare to certain acquisitions and spinoffs between publicly held insurance holding companies? And how good is the promise, either way?
Then there is the matter of money. If the new private equity owner pumps much-needed funds into a new acquisition, which some have done, what to make of that? What if the carrier starts sprouting “wow-sy” new products, dandy distribution, silkier systems, swinging service, etc.? Is it better to work with a firm with a well-endowed owner than one that is a scarecrow?
A consideration here is that loans from banks have been hard to come by in recent years. So if a private equity firm provides funds that banks could not or would not provide, and if good things start coming about as a result, is the private equity deal so bad after all? Would the client be better off with placement at the private-equity-owned insurer than at an insurance company with more traditional ownership? Is the more traditional company arrangement really more predictable?
Then again, what is the likelihood that the private equity company might turn off the money spigot as quickly as it turned it on? Or what if the company uses the spigot to enhance annuity interest rates or bonuses in ways that woo market share but ultimately create a book of business that is unsustainable (e.g., Baldwin-United and it’s too-good-to-be-true single premium deferred annuity rates)?
The New York effect
Those are only a few examples of the questions that are floating around. Will New York’s inquiry help with any of this? Maybe and maybe not
The regulations the state is proposing to develop may bring forward more information about private equity activity in the fixed annuity business, and that could bring some clarity.
In addition, to the extent that the proposed regulations, if implemented, help New Yorkers learn more about and understand private equity involvement with annuity businesses, that could contribute to peace of mind. This would be for annuity buyers overall as well as to those buying fixed annuities from carriers owned by private equity firms. This assumes that what they learn is reassuring and clarifying.
It is possible that the proposed regs also may bring some consistency to private equity activity in that state’s fixed annuity market. That’s one of the hoped-for outcomes of all insurance regulation, after all.
But the alternative is also possible. New York’s investigation and subsequent proposed regulations may serve to increase public (and industry) concerns about the overall industry, and/or certain carriers. That could happen if the annuity-word gets dragged about in the mud by detractors who create a rag doll out of a few key words: annuity plus subpoena plus regulatory scrutiny.
In addition, the regulations could end up quelling private equity interest in acquiring annuity businesses at all. In view of the dearth of capital from other resources right now, this might not be the best outcome.
One indication that this could happen can be found in the published remarks of DFS Superintendent Benjamin Lawsky in April. Private equity firms rarely acquire control of banks, he said. This is not because the companies are prohibited from doing so, he said, but because “the regulatory requirements associated with such acquisitions are more stringent than a private equity firm may like.”
If that happens, it could have repercussions elsewhere. New York is a major state for insurance regulation, and many other states follow its lead. However, the opposite is also true, with some state regulators quipping that, “as New York goes, so does not go my state.” Let the games begin.
