The economic impacts of the COVID-19 pandemic appear to have had very little effect on the sustained growth and interest in life insurance mergers and acquisitions, in-force reinsurance, and pension risk transfer and reinsurance transactions.
In recent years, low interest rates and an increasing industry focus on the best ways to optimize capital performance have led to significant growth in North American life and pension business transactions.
Then the COVID-19 pandemic struck.
Buyers and sellers have been overcoming hurdles associated with remote working and continue to drive demand for transactions.
The predominant market view was that the economic uncertainty, potential regulatory delays and the inability to do business face to face would put the brakes on deal making for a while — and for the second quarter of 2020 at least, this was largely true. Experience since, however, has shown this to be temporary. Buyers and sellers have been overcoming hurdles associated with remote working and continue to drive demand for transactions — be they acquisitions, divestments, reinsurance of in-force blocks of life and annuity business, or pension risk transfer.
A Willis Towers Watson webinar examined what’s going on. This article summarizes our discussion, and you can also access a recording here.
Source: S&P Global Market Intelligence
What we’ve seen in the life and health merger and acquisition (M&A) market is a steady recovery to pre-pandemic levels. In the same way that companies have found ways to do business via such services as Teams, Zoom and Webex, regulators have done their part to ensure that deals receive timely reviews and approvals. And in one respect, the extension of the tax benefits available to corporations through the Coronavirus Aid, Relief, and Economic Security (CARES) Act, COVID-19 may have stimulated deal activity.
COVID-19 hasn’t fundamentally altered the main drivers of life market deals. Beyond the temporary effect that the CARES Act tax provisions had on some companies’ decisions, the economic and market environments haven’t changed to any great degree. There is strong subjective evidence of further growth. A number of deals have closed or progressed during the pandemic, involving a wide range of industry and financial buyers. Notable transactions include Prudential’s sales of its Taiwanese and Korean life businesses and KKR’s acquisition of a majority stake in Global Atlantic Financial Group.
On the sell side, interest rates are still low and unlikely to rise quickly, asset spreads remain tight, and many companies continue to look for ways to optimize how they allocate capital and assets to in-force and potential new blocks of business. On the buy side, capital, including that from asset managers, is available, while opportunities to take advantage of a breadth of asset expertise and, in some cases, regulatory arbitrage, remain.
While life M&A shows no sign of easing, another strategy gaining traction in the market is the transfer of in-force risk. This has really taken off since 2017, with completed reinsurance transactions of over $120 billion of liabilities.
As the value of deals has increased, so has the quantity and caliber of reinsurers and other market players interested in the business. Currently, we estimate there are around 30 reinsurance entities vying for in-force life liabilities, many of which now bring deeper expertise in this market and a broader spectrum of potential solutions.
The reason for insurers to investigate this opportunity are similar to those of M&A: Reinsurance is, fundamentally, another source of capital. Low interest rates continue to pressure life and annuity writers, particularly those with high levels of guarantees in their in-force blocks. Companies are looking for alternatives to committing more capital to underperforming blocks. The opportunity to improve the capital position by unlocking trapped value in the business is clearly appealing.
As the life reinsurance market continues to evolve, it has additionally attracted interest from traditional property and casualty reinsurers potentially looking for diversification.
Other motivations for pursuing reinsurance include access to a more diversified asset strategy, which can produce extra yield. Reinsurance can also provide an alternative way to de-risk a portfolio and thereby improve enterprise risk management metrics. The reinsurance method can target certain blocks of business that otherwise might not be a viable option for an M&A transaction.
As the life reinsurance market continues to evolve, it has additionally attracted interest from traditional property and casualty reinsurers potentially looking for diversification. Among the companies competing for business are newer entrants in the private equity and capital markets, whose main driver is to find alternative sources of investment funds.
With the interest of so many potential reinsurance partners, and a strong supply of available blocks, all indications point to a continuing rise in transactions.
Whichever way you look at it, the recent history of the pension risk transfer (PRT) market has been one of strong growth. The overall market grew by over 25% between 2017 and 2019, reaching a value of $30 billion. Within this figure, the number of deals valued at over $10 million has grown around 50% in that time period. More insurers than ever are also competing for deals — at last count 18, up from less than 10 just a few years ago, and including two that have entered the market in the past year.
From a plan sponsor’s perspective, costs have been rising steadily over the past decade. This, combined with low interest rates and the volatile equity markets’ destabilizing effect on funding levels, has strengthened the PRT case for many. Meanwhile, the number of potential buyers of PRT risks has been rising - at last count 18, up from less than 10 just a few years ago, with two entering the market in 2020. Further, many players have also shown a willingness to take on larger, more complicated cases.
Notable transactions included an over $2 billion transfer of risks from the Lockheed Martin pension plan.
Figures up to the end of the third quarter of 2020 suggest that the market is on target to be about the same size or slightly less than 2019. As with the M&A market, there was a slowdown in the second quarter as plan sponsors’ funding ratios were affected by asset volatility (Figure 2), but this was followed by a clear catch-up period. Insurance pricing has remained solid, with no dip in interest. Notable transactions included an over $2 billion transfer of risks from the Lockheed Martin pension plan.
There was a slowdown in the second quarter 2020 as plan sponsors’ funding ratios were affected by asset volatility, but this was followed by a clear catch-up period.
Source: Willis Towers Watson Pension Index
Behind the numbers, however, there were some subtle differences in the market. Most notable from the buyer side were an increasing number of bids for deals, a widening of some insurers’ bidding criteria — including a willingness to look at deals with higher proportions of deferred lives (those not yet taking their pension benefits) — and a slight spread in price ranges offered. Along with these, we also saw insurers sharpening key assumptions, including expenses and future mortality improvement assumptions. For plan sponsors, the Department of Labor’s “safest available” criteria appear to have led to something of a “flight to quality,” as the long-term stability of partners came more sharply into focus.
Put together, these appear to be having little impact, though, on the overall trajectory of the market. Nor does the COVID-19 pandemic look likely to change the long-term view of mortality appreciably, and the indications are that the market has stayed strong in the first quarter of 2021. Factors at play that are likely to sustain such growth include rising costs due to the Pension Benefit Guaranty Corporation’s increases in both per participant fees and charges for underfunded benefits, lingering uncertainty about equity performance, and the potential business competition implications for companies with large pension obligations competing against those with less or none.
The U.S. PRT reinsurance market barely existed before 2017, and while the number of completed transactions is still relatively small, interest is growing. This is being helped by an active and growing reinsurance market that includes newer entrants that specialize in asset intensive product lines.
Key value drivers of this growth for insurers have been the pricing opportunities afforded from leveraging reinsurance, the possibility of increasing deal capacity, and risk diversification and mitigation from taking advantage of a reinsurer’s alternative view of longevity risk or asset mix.
The market indicates that select reinsurers are willing to bid more competitively based on factors such as their asset yield potential, tax arbitrage, cost of capital and risk diversification objectives. Both quota share and facultative reinsurance arrangements can meet the needs of cedants, although their suitability will depend on overall business objectives.
A hedging mechanism that is less common in the U.S., but widely used in the U.K. market, is a longevity swap, which can offer additional cash flows to cedants with a predictable set of payments. This tool may gain traction in the U.S. with the inclusion of longevity risk in the National Association of Insurance Commissioners’ risk-based capital calculation formula.
The conclusion we draw from what has followed the initial economic shock waves of the COVID-19 pandemic is that normal service — and by that, we mean a solid growth trajectory — has resumed for U.S. life and pensions market transactions.
The only difference might be that, in the not-too-distant future, it could be reasonable to anticipate the steady flow of deals to be negotiated and sealed face to face rather than over Zoom.