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a 10 years? Until then, private equity was a niche area of finance. Today, it has become a huge undertaking in itself. Private equity firms, which have stolen business and prestige from banks, control $12 trillion in assets worldwide, are worth more than $500 billion on the American stock market, and have handpicked Wall Street’s best talent. Masu. While the value of publicly traded American banks is about the same as before the pandemic, the value of publicly traded private equity firms has nearly doubled. The biggest, Blackstone, is more valuable than Goldman Sachs or Morgan Stanley and has the confidence of a winner. In December, the company proclaimed “It’s the age of alternative” with a peppy, Taylor Swift-themed festive video. “We buy assets and make them better.”
But this is not a booming business for them these days. Traditional private equity (using large amounts of debt to buy companies, improve them, and sell or take them public) has lost its steam. High interest rates cast doubt on the value of privately held companies and reduce the appetite of investors to provide new capital. It doesn’t seem to matter. Core private equity activities are now just part of an industry spectrum that includes infrastructure, real estate, and direct corporate lending, all falling under the broad label of “private assets.” Empire building continues here too. Most recently, as we report this week, the industry has swallowed up life insurance companies.
All three kings of private equity – Apollo, Blackstone; KKR—Acquired an insurance company or acquired a minority stake in it in exchange for asset management. Small and medium-sized enterprises are also following suit. Insurance companies are not portfolio investments destined to be sold for profit. Rather, they are valued for their large balance sheets, which provide new sources of capital.
Judging by the fundamentals, the strategy makes sense. Insurance companies invest over the long term to fund payments such as the annuities they sell to pensioners. They have traditionally bought large amounts of government and corporate bonds traded on the open market. Companies like Apollo can use their knowledge to shift portfolios into specialized high-yield private investments. A higher return rate means a better deal for your customers. Additionally, the loans provided by insurance companies are patient, as their debts continue for several years. In the banking industry, long-term financing is financed by large amounts of readily accessible deposits. For personal assets and insurance, the life of the asset matches the life of the liability.
But this strategy doesn’t just pose risks to businesses. Pension promises are important to society. Implicitly or explicitly, taxpayers backstop insurance to some extent, and regulators enforce minimum capital requirements to help insurers withstand losses. However, it is difficult to determine the safety buffer for companies with illiquid personal assets. This is because the losses are not obvious from financial market movements. And in the event of a crisis, policyholders may flee to try to extract some of their money, even if it involves financial penalties. Last year, Italian insurance companies suffered just such a bank-run meltdown.
Making matters even more difficult is the complexity of alliances, which involves a labyrinthine interrelationship between different parts of a company’s balance sheet. Much of the reinsurance activity is taking place in the offshore hub of Bermuda, and there is more than a whiff of regulatory arbitrage. But compared to the fanatics who police the world’s banking system, insurance regulators are tame.
As the importance of personal assets increases, that too must change. Regulators need to cooperate internationally to ensure safety buffers are adequate. High standards of transparency and capital need to be enforced by appropriate and powerful bodies. The goal is not to kill new business models, but to make them safer. Financial innovation often creates new ways to disrupt systems while also providing new benefits. It would be a mistake for regulators to ignore either edge. ■
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