US Interest Rates, Excess Capital Drive Life Insurers’ M&A Push
The COVID-19 pandemic taught the industry a thing or two about core versus non-core businesses and instilled a willingness to deploy capital to either shed or grow segments through M&As, observers say.
- Terrence Dopp
- June 2022
- No End: Just because the dangers of COVID-19 are receding a bit in the public consciousness, don’t expect the life insurance industry to put down everything it’s learned in two-plus years. That includes an appetite for M&As.
- Appetite: One in three respondents to a recent Deloitte survey said they expect “more active M&A” in 2022. Broken out into just life and annuity insurers, 44% saw increased deals as “very likely,” compared with 32% of nonlife executives.
- Rationale: Expanding geographic reach, growing scale and adding new technology capabilities topped the reasons behind the transactions, according to the survey.
Don't expect the life insurance industry's appetite for mergers and acquisitions to disappear at any point in 2022. And industry watchers say receptive capital markets and excess capital, among other factors, will fuel the industry's desire for more active M&As.
One in three respondents to Deloitte's 2021 global outlook survey said they expect “more active M&A” in 2022, with life and annuity insurers leading the charge, according to the company's Riding the Wave: 2022 Insurance M&A Outlook. A full 44% cited increased deal-making as “very likely,” compared with 32% of the nonlife executives tallied, the report said. Among those who said it was likely, expanding geographic reach was the most commonly cited factor, followed by growing scale and adding new technology capabilities, Deloitte said.
“Strategic investors have ample available capital, the stock market appears to be supportive, and there are few anticipated economic, regulatory, or tax headwinds,” the report said. “Cross-border M&A should also contribute to 2022 deal totals, particularly in specialty insurance segments.”
Mark Purowitz, a Deloitte principal who leads its “Future of M&A” efforts, said the COVID-19 pandemic didn't gut the broader insurance sector in the same way it did other industries such as travel, entertainment and logistics. The contagion's impact—to what extent the market was impacted and its ability to react to those stresses—was never as broad as initially feared in the early days.
“When you look at the market through those two lenses—pretty simply the severity of the market and the change of the market—it didn't have that level of systemic impact that you had in other sectors,” he said.
Specifically on the life and annuity side of the house, Purowitz said the tumult brought on by COVID-19 prompted companies to increase their focus on examining core versus non-core functions and acting accordingly. This can be seen in the move by life insurers to shed older, less-profitable blocks of business and, in a few cases, whole segments.
“Private equity firms and fixed income asset managers have developed an appetite for capital-intensive business, a trend that started before COVID and that has accelerated through the pandemic.”
Examples of Deals
In June 2021, Massachusetts Mutual Life Insurance Co. completed its $3.5 billion acquisition of American Financial Group Inc.'s annuity businesses. The deal broadens MassMutual product offerings, further diversifies distribution capabilities and generates additional earnings, said MassMutual President, Chairman and Chief Executive Officer Roger Crandall.
The deal came just months after MassMutual sold Empower, its group retirement business via a reinsurance agreement.
In another example that highlights the role reinsurance plays in M&A, Prudential Financial Inc. agreed to sell part of its in-force legacy block of variable annuities to Fortitude Group Holdings LLC in a transaction valued at $2.2 billion. The agreement will see the company sell stand-alone subsidiary Prudential Annuities Life Assurance Corp. and in-force annuity contracts to Fortitude for a $1.5 billion all-cash purchase price subject to adjustment at closing, plus a capital release and anticipated tax benefit.
James Amen, managing partner at PhiloSmith, said there were 20 transactions in the space in 2020. The following year saw 40, though some of the increase was attributable to delays in the early days of the COVID-19 pandemic.
The primary drivers were excess capital and low interest rates that impinged on the current profitability of interest-rate-sensitive products, as well as a hunt for inorganic sources of growth. He broke down the deals into so-called strategic deals designed to enter new markets or grow offerings and deals intended to increase scale.
Among the standout strategic deals Amen cited was Horace Mann's acquisition of Madison National for $185 million. There was no significant overlap between the two companies' products. He also highlighted CUNA Mutual's acquisition of Assurant's pre-need business, a $1.5 billion transaction that allowed the company to enter the market for pre-funded funeral insurance and annuity products in the United States and Canada.
Full-year volume in 2022 should be on track with the prior couple of years, though he said it may be smoothed out to be less impacted by the pandemic. Interest rates also will impact the timing and attractiveness of the deals, Amen said.
“Going forward, while there continues to be a lot of capital in the market, the modeling of future interest rates will really be the determining factor in future deals,” Amen said. “Much of the valuation surrounding life assets are dependent on what you think investment income will be in the future so it'll take a while for buyers and sellers to come to terms on what they expect.”
Rate Changes Ahead?
The Federal Reserve in May approved a 50-basis-point increase in benchmark interest rates -- the largest in two decades -- designed to control inflation that has coursed through the U.S. economy and hasn't abated. Injecting uncertainty, the Fed also announced plans to taper its balance sheet and could approve several more hikes throughout the remainder of the year.
“Generally, it won't accelerate the deals as much as it might pause them for a bit until both sides—buyer and seller—can get a handle on interest rates,” Amen said. “When buyers or sellers are modeling their life and annuity assets, they're running out cash flows for 10, 20 or even 30 years in many cases. So they're making a bit of an estimate of what interest rates will be.”
More than half, 54%, of the Americas insurance executives surveyed by Goldman Sachs Asset Management for its 2022 annual insurance survey, dubbed Re-Emergence: Inflation, Yields and Uncertainty, said they expect three or four Fed rate increases during the year. With almost one-third anticipating even more, 87% of the total respondents think there will be more than three hikes throughout the year.
Michael Siegel, global head of insurance asset management for Goldman Sachs Asset Management, said inflation was at the top of risks to industry portfolios in the survey this year for the first time. For the overall industry, GSAM found 39% of those surveyed think there will be an acceleration of industry consolidations.
“We've seen a lot of capital come into the global industry. We've also seen a lot of merger activity,” he said. “The primary motivators behind M&A? Scale, synergies and operational efficiencies. Another cut of this is insurtech.”
Bruno Caron, associate director with AM Best, said the fundamental drivers, including divestiture of non-core blocks, de-risking, freeing up capital and scale, that have driven M&A transactions in the past few years did not change in the life and annuity insurance market as a result of COVID.
He also said the life and annuity insurance industry will face accounting changes under new rules for long-term contracts that will go into effect in the near future. It is expected that the changes will impact the timing of recognition of profits and can create volatility. Many firms, especially publicly traded stock companies, are in the process of evaluating this new standard, which he said has the potential to trigger future M&A and reinsurance transactions.
The world is an increasingly complex place and life and annuity carriers continue to navigate through complex issues, including ESG, workforce, digitalization and accounting standards; COVID did not make the industry easier to navigate through, Caron said. It is therefore natural for companies to de-risk, divest non-core lines of business, free up capital and seek scale, he said.
“Private equity firms and fixed income asset managers have developed an appetite for capital-intensive business, a trend that started before COVID and that has accelerated through the pandemic,” Caron said.
A March 10 Best's Market Segment Report, US Life/Annuity: Record Capitalization, Strong Liquidity and Improved Earnings in 2021, found the common theme for insurers in 2021 was finding novel ways to do business.
Against initial expectations, the industry during the pandemic saw many carriers achieve record capitalizations, strong liquidity and higher earnings. Life insurers saw limited credit losses during the health emergency at the same time it in part contributed to “robust” new sales in both life and annuity products.
“Insurers rose to the occasion in 2021 and found alternative ways to do business,” the report said. “They sought opportunities to diversify earnings, maximize shareholder value, and unlock value in the life and annuity businesses by separating lines of business, merging (and demerging) businesses, and entering into reinsurance agreements.”
Potential roadblocks to M&A transactions are high valuations, along with a demand-supply imbalance for sought-after products and capabilities, according to the report.
On the life side, life and annuity insurers are likely to continue topping the leaderboard as low interest rates continue to tamp down on growth and profitability, making older blocks of non-term life and annuities prime targets to be divested, the report found. Companies could use the proceeds to fund hybrid insurance/investments plays or partner with health and wellness companies on new ventures.
“L&A insurers challenged by legacy technologies also may acquire insurtech solutions to accelerate digitization,” Deloitte said. “In 2022, we expect there to be fully formed, PE-backed aggregators ready and able to bid on these properties.”