“We see continued opportunities for PE firms in life insurance” – Milliman’s Richard Holloway

Over the last year and a half, private equity investments in the insurance sector have skyrocketed, particularly in the United States. According to S&P Global Market Intelligence, PE-backed M&A in the sector globally reached $19.28 billion in the year to August 2021. Data from Refinitiv indicates that the US accounts for a lion’s share, with PE firms paying $12.1 billion in 2021, surpassing the $9.7 billion record set in 2018.

And yet in Asia, PE firms have taken a more guarded approach. In an exclusive interview with DealStreetAsia conducted this June, Richard Holloway, Managing Director, South East Asia & India, Life at actuarial and consulting firm Milliman outlined the opportunities that await PE firms who take an interest in life insurance. He also emphasised the rigour that needs to go into the due diligence process, and the partners best placed to help PE firms derive successful outcomes.

Could you tell us about the broad trends in M&A when it comes to the insurance sector across the region?

There has historically always been a significant flow of M&A opportunities in the life insurance sector in Asia Pacific. Although it is often hard to predict the onset of M&A, looking back over the last two decades, much activity has invariably been driven by changes in regulation, foreign ownership limits or business trends (such as banks becoming distributors with a need to negotiate bancassurance agreements).

At any given point in time, while some markets are ‘hot’ with M&A, other markets can be ‘cold’. The Indian government recently announced its decision to increase the foreign equity cap in the insurance sector from 49% to 74%. It is likely to heat M&A activity in the country, possibly for the next two years. Likewise, the introduction and implementation of Risk Based Capital in Hong Kong could have a similar effect.

In addition to a policy decision driven M&A as in India and Hong Kong, is the performance of the sector also likely to spur a fresh round of activity?

The Covid-19 pandemic has certainly impacted the sector. In the second quarter of last year, new business sales in most markets declined. The implementation of lockdowns, social distancing and other restrictions (such as the inability in some markets to close sales without a physical signature) had a notable impact, both on the agency distribution channel and also bank distribution. Lower customer footfalls in branches led to a decline in new business volumes.

However, in many markets, there have already been signs of recovery. In Singapore, overall new business volumes in 2020 (measured by Annualised Premium Equivalent) fell by just 2%. In general, the larger companies that have been able to apply digital capability and processes have rebounded the fastest. On the other hand, the high net-worth segment has been more adversely impacted. Especially the business model wherein customers are flown into a country to do medicals and underwriting. The more traditional companies, less digitally enabled, are perhaps taking longer to rebound.

If the top line cannot recover quickly, there would be a need to more carefully manage expenses. If not, in some cases it could lead to a need for additional capital, and perhaps trigger some M&A activity. Now, over a year on from the start of the pandemic, many companies will be re-thinking their business model and strategy. The larger companies will be better placed to deal with a sustained period of disruption (which continues to exist in some markets), but it could be a lot more challenging for the small to mid-sized companies.

How has the interest from PE firms been in the insurance space so far – particularly life insurance?

PE firms have always had an interest in the insurance sector. It ranges from the larger, more specialist PE firms, who have the ability and appetite to invest in large transactions; to smaller, more boutique firms.

The challenge has been around the ability to enter and invest in a sector that often has limits on foreign ownership, or being able to compete with strategic investors who can be preferred by the selling shareholders. Despite this, the past decade has seen successful PE investments into the life insurance sector in China, India and Southeast Asia. Some PE firms have also taken advantage of IPOs, taking small (but financially significant) stakes in listed companies. The recent deal between Aviva and Singapore Life in Singapore is an example of a significant investment by TPG.

Looking ahead, we see continued opportunities for PE firms. Especially driven by changes in capital standards and the possible ongoing need for capital, if the pandemic has a sustained lingering effect on the industry.

Could you explain how PE firms evaluate the potential of a company, particularly in the life insurance sector?

As actuarial consultants we are involved in a significant number of M&A assignments, either to support a seller, or a buyer (including PE firms) with value discovery / due diligence process. The most common interaction is due diligence to primarily help with valuation and actuarial related aspects. As a consultant, a key area of difference compared to advising a strategic investor, is helping a PE firm develop a deeper insight into life insurance: its nuances and the various risks faced by the industry. And then linking them to the PE firm’s regular approach to looking at valuation of other types of businesses, which typically focus on shorter time horizons.

Our ability to set up actuarial cash flow models helps PE firms assess the valuation implications based on many scenarios of future outcomes (looking at both internal and external scenarios), taking account of various exit options and timings. This analysis would typically focus on metrics such as embedded value as well as the projected overall IRR over the period of investment. Our historic experience and current knowledge of the regulatory and competitive environment in different markets has often helped PE firms develop such scenarios and better understand the market.

How different is an evaluation done by an actuary or an actuarial firm for an M&A from that done by a traditional accounting team?

Actuaries need to be involved when looking at life insurance transactions because of the long-term nature of the business. The profit stream of a contract can extend perhaps beyond 20 years.  The traditional valuation approaches that may apply to other businesses, such as benchmarking P/E ratios, taking a percentage of assets under management etc. are not suitable for life insurance.

It requires inputs from actuaries, who have the ability to project those cash flows, over such long periods. In simplistic terms, the actuary determines the profile of a profit stream for different product classes, discounting these back to the current day, as a contribution to the overall valuation of a life insurance company.

A PE firm looking to invest in a life insurance company will require advice around how much that company is worth. That’s why in every life insurance transaction, there is invariably an actuary on the sell side.  As a buyer, the PE firm will then conduct its due diligence on the company which will typically include a work-stream focused on actuarial related matters, working with the chosen actuarial consultant.

What are some of the elements you would look at during a due diligence process?

The determination of an ‘embedded value’ of a life insurance company (the value that is attributed to a business portfolio that is already on the books of the company) or ‘appraisal value’ of a life insurance company (the enterprise value, including ‘structural value’ or ‘goodwill’ that represent the value that may be generated by the insurer by writing profitable business in the future) requires inputs on many assumptions.

As an example, this assessment would require the PE firm to have a view on the future economic outlook, the expense structure of the insurer and level of efficiency that may be attained, new business growth rates and product mix. There are also non-economic factors such as the policy lapse rates, likely mortality experience etc.  All such factors could impact the margins that you may expect in the future and therefore the valuation.

The risk discount rate is an important assumption, which can vary quite a lot across companies and between strategic and PE investors. PE investors typically have a higher hurdle rate and a shorter investment horizon.

As consultants, our role is to form a view on the reasonableness of the various projection assumptions. And to demonstrate to the PE firm how sensitive the application of certain assumptions can be on the overall valuation. The PE firms typically spend considerable time assessing the more subjective aspects of the valuation. These include level of future new business, and product mix, by considering the productivity of the various distribution channels (such as agency, bancassurance etc.), the future tenure and likelihood of renewal of bancassurance (and other) distribution relationships etc.

Ultimately, a buyer will need to decide on a price prior to entering into negotiation with the seller. That forms the basis of the dialogue we have with our clients, be it a PE firm or a strategic. A seller will invariably take a slightly more optimistic view of the assumptions than a buyer, which leads to differences in assumptions, value and, ultimately, price negotiation.

Would it be accurate to say actuaries are more likely to be involved in a transaction involving a mature firm than a startup in the Insurtech space?

It is hard to generalise. Our clients engage us for a variety of reasons, typically utilising our knowledge of the sector as well as our actuarial skills. These are relevant to both large and small potential targets. That said, the nature and focus of due diligence may differ between large and small targets. For small targets, considering the likelihood of subjective valuation (driven by structural value / goodwill), perhaps the due diligence may focus more on benchmarking of the target company’s experience against the larger insurers in the market and assessing the overall market landscape and scope for future growth.

Do you think that PE firms value the need for actuarial specialists to support due diligence?

Yes, absolutely. PE firms who are familiar with the insurance industry understand that the unique nature of the life insurance business necessitates the need for cash flow projections. Actuaries are uniquely placed to support in this area and to advise on the selection and appropriateness of underlying assumptions.

There are complexities around setting these assumptions, based on various experience analysis studies, financial reports, existing regulations and the business environment. An experienced actuary is in an unparalleled position to properly assess and contextualise the value of an insurer, its growth potential and future opportunities, and the risks it is exposed to. With these being critical aspects of M&A decisions, the involvement of a qualified and experienced actuary is essential at every stage in any investment or divestment decision.

Senior actuarial consultants, such as the ones who work at Milliman, have over 20 years of experience. They have worked on a wide range of projects across companies and geographies in Asia.  These include numerous M&A transactions with insurers at different stages of development, sizes and structures.

It makes them uniquely positioned to provide insights and value to PE firms looking at investment opportunities. In addition to technical knowledge and a wide network of contacts, other key differentiators for actuarial consultants include an understanding of how a market has evolved, the rationale behind the development of regulations and the likely future change in both regulations and the industry environment.

Often, we find that clients (especially the PE firms that may not be as familiar with insurance) seek our knowledge of the sector, and not just our technical expertise. Over the years, we’ve worked for some of the largest, most prevalent PE firms. But there is always the emergence of new PE firms, both small and large, who have an interest in a particular opportunity in the sector, or a market. With the changing dynamics of the industry and potential for long term growth across the region, there are always investment opportunities for PE firms. But as with so many other things, it is whether or not one goes about it the right way at an early stage that can determine success or failure.