Raising Insurance Capital: Part III (Last One, I Promise!)

How do insurers solve for retirement income? How have private fund managers partnered with them to address their own fundraising problems?

I’ve been thinking for a while about sharing a checklist of all the things you need to set up a venture capital/private equity fund.

But a boy does not know how to set up a downloadable link.

If you guys want it, just reply or shoot me a message—I’ll send it to you.

Before we continue, a quick favor. (Hint—there’s a right answer!!)

One More Time

Remember our initial conversation from a few weeks ago about permanent capital?

Private fund managers are fumbling to access the retail investor market for fresh investable capital because institutional investor money is more difficult to come by.

In a sense, the insurance play allowed the big players to address the retail market. Albeit indirectly.

After all, isn’t a premium payment from Daisy the Plumber for a life insurance policy retail money?

And the fund managers didn’t even have to go to Daisy. A vast network of insurance brokers did it for them.

You got the money but you didn’t have to fundraise.

I guess in a word, brilliant?

I also don’t want to drag you through the mud, since it is our third week on insurance. But there’s good reason this is a three-part series.

Insurance is a relatively opaque industry.

Most people do not know how insurers work.

Less even know how they make money.

I will spare you further torment. But that doesn’t mean you have toiled in vain.

Indeed, today we will finalize the insistence that the presence of insurers in the private markets has been a source of exceptional envy for those who don’t have access to insurance capital.

A zesty tale of jealousy.

And we already know the primary source of that jealousy: Apollo Global Management.

Briefly, we can revisit the Apollo playbook:

1. create an insurance company (Athene),

2. obtain monies collected from Athene’s policyholders,

3. rather than fundraise from traditional investors,

4. charge management fees on those monies,

5. to offer an array of (mostly) private credit products.

This was possible partly because traditional bank lending was more restricted post-2008.

Hence the emergence of non-bank (and largely unregulated) “shadow banks.”

AKA the world of private credit.

This has generated a begrudging response from Apollo’s peers.

Why can’t we do that?

Did you ever think elite fund managers would be fighting over bragging rights that involved insurance companies?

Defined Benefits vs. Defined Contributions

Let’s run it back further.

Athene is a retirement services company.

A retirement business is in large part a fixed-income business.

Because old folk want a guaranteed lifetime income (I guess everyone does).

The modern Westphalian nation state has approached the problem of guaranteed retirement income in principally two ways.

1. Defined benefit plans.

These are traditional retirement plans where employers promise a specific benefit.

Based on salary, service years, and retirement age.

Like public pension plans. Teacher retirement systems.

Employers bear the responsibility for contributions, investment management, and the risk of market fluctuations.

This is to ensure the promised benefit, providing employees with predictable income in retirement.

Lots of pressure on the employer.

2. Defined contribution plans.

Like 401(k)s.

Employers and employees contribute to an individual account.

No guaranteed retirement benefit.

The final amount depends on investment performance.

Employees choose their investment allocations (you can pick what Vanguard fund to put your 401(k) amounts into), but poor market performance can lead to lower retirement balances.

Lots of pressure on the employee..

They have to manage their savings and bear investment risk.

Athene’s Model

Annuities kind of offer a middle ground.

Athene offers annuities to help individuals create a steady income stream for retirement.

So you can pick the annuity (like a defined contribution plan). Athene will invest it and offer a minimum guarantee (like a defined benefit plan).

A few examples:

1. Fixed annuities provide guaranteed income.

2. Fixed indexed annuities are tied to a stock market index, offering higher (and riskier) returns with some protection against market downturns.

3. Registered index-linked annuities are similar but meet specific regulatory requirements.

To purchase an annuity, individuals work with a financial advisor or directly with the insurance company.

For example, a person might invest $100,000 in a fixed indexed annuity, and then receive periodic payments based on index performance with a minimum guaranteed return.

While insurers have traditionally acted as investors in private credit funds, recall that lending has rapidly shifted from banks to private fund managers post-2008.

This has created a massive market opportunity in private credit.

And if insurers are going to want a piece of the private credit opportunity…why shouldn’t a fund manager just buy an insurer?

The fund manager can promise the same returns (or even better) to the insurer and economically benefit itself by circumventing the operating costs and risks of raising a new fund.

A win-win.

Seeing (1) the market opportunity of private credit and (2) economic value of owning an insurer, Apollo created Athene.

It pioneered a new and lower-cost method of obtaining investable capital that keeps coming in. Unlike a typical private fund, where you give money back to investors…only to ask for it again in the next fundraise.

With insurance capital:

1. No frills fundraising.

2. No need to woo new investors.

3. No need to attend expensive conferences to speed date with investors for your new fund.

Two Models

While fund managers are constantly seeking capital to invest, insurers are similarly hunting for high-quality assets to invest in.

This creates synergies that have resulted in an onslaught of strategic activity between the two industries.

Everyone wants a piece.

But, it has only really been KKR (it bought out an insurer called Global Atlantic) that has been able to follow Apollo’s model.

Why?

The heavy regulatory workings of owning an insurer. And lower market valuations—many of these private fund managers are publicly traded—because owning insurance liabilities is risky.

So two distinct models have emerged:

Full/Majority-Ownership Model (Apollo and KKR): The fund manager acquires a controlling stake in an insurance company, exercises significant influence over underwriting and operations, and benefits from management fees as well as insurance earnings.

Partnership Model (Ares and Blackstone): The fund manager agrees to a partnership with, and sometimes a minority investment in, the insurer. The manager benefits from management fees and is only tasked with investing the capital it receives, bearing no responsibility for underwriting and operations.

This universe of partnerships has been so successful, that it isn’t limited to bringing the money from ordinary retail folk like me and you.

Large pensions sometimes will offload some of their liabilities to an insurer, which can assume responsibility for a plan or for payouts. This practice is referred to as pension risk transfer (PRT).

As employers shift from defined benefit to defined contribution plans, managing defined benefit pension obligations can become volatile and challenging.

PRT transfers these liabilities to an annuity provider, reducing risk for the employer. This can be done through a “lift-out,” settling only a subset of retirees, or through a full plan termination, where all liabilities are transferred.

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The insurer play is the private markets masterstroke of the quarter century.

A pretty darn good solution to the trappings of periodic fundraising for private fund managers.

And now you know about it!

See you guys next time.