Private capital insurance boom hits fragile peak

NEW YORK, Oct 29 (Reuters Breakingviews) – The world’s biggest private asset managers have reshaped the U.S. life insurance industry. Now comes the test of whether the newcomers are heir to the same old cycle of slowdowns. The model pioneered by $75 billion Apollo Global Management (APO.N), opens new tab, whose CEO Marc Rowan helped set up insurer Athene in 2009 and brought it in-house in 2021, led to a boom in private credit loans funded by retirement-saving products called annuities. Maintaining the pace will be hard.
Rowan has moved Apollo away from the old hamster wheel of raising finite-life funds every few years, focusing instead on gathering money by selling retail annuities. Mimicked by $108 billion KKR (KKR.N), opens new tab and Canada’s Brookfield, the idea involves investing retirees’ cash in private loans that the manager often underwrites. The trend has roiled banks, perturbed regulators and funded everything from semiconductor factories to data centers.
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Before the private credit explosion, the annuity business was calcified. U.S. sales of the retirement policies totaled $220 billion in 2002, opens new tab, according to industry association LIMRA, and had barely changed by 2020, opens new tab. Under the surface, though, something was shifting. Apollo’s Athene climbed the sales leaderboard helped by a focus on fixed annuities, which offer a pre-defined payout stream in retirement and are distinct from variable policies, which are tied to market moves. By 2019, opens new tab, the fixed type had edged ahead at 58% of overall sales.
That switch enabled what came next. Fixed annuities involve taking in a customers’ retirement savings, finding somewhere to invest the money, and paying it back with interest over time. That middle part is where the action is. Rowan and others spotted that annuities could be invested more profitably in the $2 trillion private debt world, taking that credit market well beyond its roots in financing leveraged buyouts. Apollo pegs, opens new tab the wider possible universe of private debt at $40 trillion, comprised mostly of investment-grade credit. The hot area is asset-based finance, or slicing and dicing cashflows into illiquid bonds, secured against something of value. Apollo’s Atlas SP Partners securitizes everything from solar-power leases to music rights. The better-protected slices should be much safer than buyout loans but still more lucrative than conventional bonds, in Apollo’s telling, making asset-backed finance a good home for annuity funds.
The magic part is that the premium yields on offer in private credit allowed Athene and others to offer juicier rates to retirement-savings customers, turbocharging growth. Fixed product issuance alone skyrocketed to $308 billion by 2024, opens new tab’s end, accounting for 71% of total U.S. sales.
It’s easy to see why, given the returns on offer. Compare annuities, for example, with retail certificates of deposit – essentially fixed-term, interest-bearing bank accounts. The gap between the average three-year U.S. fixed annuity and nationwide three-year certificate of deposit was less than a percentage point in March 2020, according to data from Beacon Annuity Solutions and the Federal Deposit Insurance Corporation. By 2022, it peaked at 3 percentage points and has hovered near there ever since. Combined with their tax-free status, annuities became the only game in town for many retirees seeking to turn savings into a steady income.
The obvious question is how long Athene and its rivals can afford to pay such juicy rates to customers. That in turn depends on how long they can keep finding a steady stream of lucrative credit assets in which to invest their customers’ cash. The low-hanging fruit is long gone. Among U.S. life insurers, asset-backed securities rose from about 8% of bond portfolios in 2015, opens new tab to almost 15% by 2024, opens new tab, according to the National Association of Insurance Commissioners. So-called schedule BA assets, which is regulatory jargon for alternative investments like privately placed bonds and collateralized loan obligations (CLOs), have grown from 4% of overall portfolios in 2015 to 7% now. Some 22% of Athene’s book is in these CLOs and asset-backed securities, the company reckons, opens new tab.
The juice is getting harder to squeeze. The spread for securitized bonds, or the extra return on offer relative to risk-free base rates, surged heading into the initial 2022 annuity boom. Yet for the safest generic CLOs, they have steadily tightened ever since, according to Bank of America research. A similar pattern holds for the most exotic breeds of asset-backed finance originated by Apollo, KKR, Brookfield and others, like data center securitizations and aircraft leases.
The implication is that private credit managers’ favorite investment ideas are becoming commodified. The flood of private debt capital is increasing competition for deals, pushing down yields and therefore returns.
One possible solution to creeping commodification would be to pay lower rates to retail customers. If, say, Brookfield wanted to sell fewer three-year annuities because it was having trouble finding the right assets, the group run by Bruce Flatt could simply toggle down the rates it is offering to new customers. Its sales would fall immediately given competition in the annuity market, with new players continuing to flood in, opens new tab. But doing so would obviously crimp growth. Another option, open to the very biggest asset managers like Brookfield and Apollo, is to sell so-called funding agreements to big investors. That fast-growing market is effectively the institutional version of the annuity sector.
Yet the retail channel is essential, offering steady flows at a scale not available elsewhere. Apollo and its ilk are gunning for growth in credit, with Rowan setting explicit targets for how much debt his firm will originate. The biggest of the big admittedly have advantages, particularly in crafting the most complicated, large-scale deals. Just look at Apollo and KKR’s $7 billion partnership with beverage giant Keurig Dr Pepper (KDP.O), opens new tab, or Brookfield’s joint venture with chipmaker Intel (INTC.O), opens new tab.
Still, even the biggest firms will have to keep issuing at high volumes just to offset a general weakening of returns. Meanwhile a true nightmare scenario lingers, in which central bank rates fall dramatically, undermining the appeal of annuities altogether. Private equity has built a gigantic insurance machine. It just isn’t a perpetual motion one.
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Editing by Liam Proud; Production by Pranav Kiran
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Jonathan Guilford is Breakingviews U.S. Editor, based in New York. He has covered financial news across Europe and the United States for 10 years. He joined Reuters Breakingviews in 2021 from Dealreporter, where he led risk arb coverage strategy from New York while covering the technology, media and telecommunications space. He previously covered the European healthcare services market. He studied English and Italian at Royal Holloway, University of London.