STRF/STAR MAX/IPx
Blackstone is the world’s largest private equity firm.
To some observers, the flip side of the Federal Reserve’s interest rate hikes, and their potentially damaging impact on labor markets, is that the end of cheap credit is punishing some of the most predatory moneymaking schemes in the economy. Obviously sketchy enterprises in the form of crypto companies or SPACs have faltered or outright collapsed. Even the allegedly more reputable corners of the market (at least to men in suits) also appear to be struggling.
At the head of that is the private equity industry. As David Sirota reported last week, returns for private equity firms averaged around -6.1 percent in the 2022 fiscal year, with “dramatic” declines expected to be reported in 2023. An adviser to public employee retirement systems recently sent out a warning that these losses could impact pension funding status, or the amount of money on hand available to pay promised retiree benefits.
On top of overpromising returns, some PE funds have gotten tied up in the property market, where droves of investors are scrambling to escape. Blackstone, the world’s largest PE firm, whose Real Estate Investment Trust (BREIT) limited withdrawals in December, saw withdrawal requests jump to $5 billion in a second fund in January. Hilariously, Blackstone president Jonathan Gray told the Financial Times that “the tone of the conversations … is much improved,” which I guess means that investors are saying “please” when they ask for all their money back right now. Blackstone has increased its tenant evictions in a scramble to raise cash.
Between the less favorable investing environment and regulatory pressure from the likes of the Securities and Exchange Commission, investors may finally recognize that private equity returns—which were never all that good even during the bull market—could be a money pit today. Some national leaders, like Pennsylvania Gov. Josh Shapiro, have dared to say out loud the unmentionable: that public pension funds should get out of the private equity business, and stop supplying worker funds to an industry that relentlessly harms workers. As I wrote last summer, weakening the private equity money stream is the key to getting these entities’ bad practices out of the economy.
The problem is that PE always manages to find a new victim. Even as it reports losses to pension funds and other investors, managers are feeling little pain thanks to astronomical fees. And another juicy meal for the industry has recently emerged: insurance companies.
For the past decade, private equity firms have either bought out or forged partnerships with the insurance industry, which always has a massive amount of assets available for investment. This is known as the “float,” representing the revenue coming into insurers before it goes out to pay claims and benefits. This does not just represent home and auto insurance premiums. There’s retirement money in there in the form of life insurance plans and annuities, the often high-cost plans that give seniors a dedicated funding stream in their later years.
Float is what built Warren Buffett’s empire, and PE sees a way to adapt this model for a new age of finance. In other words, private equity is insulated from the loss of cheap money by literally buying money out. But handing the insurance float pile over to private equity puts more workers at risk of not seeing the benefits they were promised.
Weakening the private equity money stream is the key to getting these entities’ bad practices out of the economy.
“It’s about having a steady flow of investment funds without having to recruit,” said Eileen Appelbaum, co-director of the Center for Economic and Policy Research. “It’s also about increasing assets under management so big boys look even bigger. And it’s about lack of regulation or oversight.”
That last part is key: While the SEC and other federal financial regulators can monitor pieces of the private equity market, insurance is typically regulated at the state level. And though the private equity move to insurance began over a decade ago, state insurance commissioners appear to have done little to mitigate the risks.
According to the National Association of Insurance Commissioners, at the end of 2021 (the last year studied) private equity outright owned insurers with total cash and invested assets of $472 billion. This was actually a little down from 2020, but a 37 percent increase over 2019. This is only about 6 percent of the insurance industry’s monumental $8 trillion in available cash and assets, so there’s lots more room to run.
The model for purchasing insurers and gaining the ability to manage their investments was pioneered by Apollo, which created Athene, an annuity company, in 2012. The Wall Street Journal notes that half of the $523 billion that Apollo has under management comes from Athene.
Some PE firms have followed that path by buying into annuity or life insurance companies. But Blackstone, Carlyle, and others have more recently made deals to manage insurance company assets. Others provide reinsurance (the insurance that insurance companies buy for themselves) and invest the premiums from that. They are also selling private-debt instruments to insurers that promise greater returns than government bonds. This is just an extension of the acquisitions private equity always makes, except their goal is really to get their hands on more money so they can buy more firms.
Appelbaum has proposed three key guardrails for private equity annuity and insurance investments: a cap on management fees for money that comes from retirement savings vehicles, an increase in reserve requirements to absorb potential losses from riskier investments, and a ban on firms “self-dealing” by investing insurance assets in their own funds. That last one seems to be the entire rationale for this maneuver. “They’re claiming they want to only move 5 to 10 percent of assets into risky things,” Appelbaum told me last year. “That’s a lot of money. And if they have a fund that’s failing, they can give [the money] to their own fund.”
But the National Association of Insurance Commissioners, which would be a first line of defense from this trend, blew off an initial inquiry about it from Senate Banking Committee chair Sen. Sherrod Brown (D-OH), who asked about the impact of private equity on insurance. The NAIC response boiled down to assuring Brown that there was nothing to worry about, and that PE firms were “in it for the long term.” Appelbaum said that there has been no movement on regulation since then.
Insurance commissioners are either elected or selected by state governors, and have a varying ideological commitment to strong regulation, along with little experience dealing with private equity. An industry that thrives on regulatory capture likely faces little threat from this cohort.
Appelbaum has been writing about the pitfalls of mixing private equity and insurance for a year, warning of the threat to retirement assets. “Everything we know about [private equity] is that they engage in financial engineering and their goals is to enrich the private equity firm partners and the various partners in their equity funds,” she told InsuranceNewsNet in June. It’s been a slow march from one willing dupe to another.
Unfortunately, this gives private equity another steady stream of cash to plow into buying clothing stores or ski resorts or toddler gyms or whatever else they want. The idea of a “reckoning” for private equity is seductive but wrong. Changes in the interest rate environment may take some of their cheap money away. But there’s always someone else willing to step up and provide those dollars. As a wise man once said, there’s one born every minute.
