Hedge Funds Annuity Firms Purchase ?

[Gracious1]

I wanted to find out from some of the more experienced agents what implications the purchase of Insurance and Annuity firms by Hedge funds has on the industry and specifically our clients' principal funds and accumulated interest. After a firm purchase, will the hedge fund invest the FIA funds in more risky investments like first or second mortgages or high yield bonds as an example there by putting our clients principal at risk? Will the state insurance departments permit these hedge fund purchases and if they do will the hedge fund be required to follow the same rules and guidelines as insurance companies ? I really don't trust the government or hedge funds to protect our clients funds from high risk investments and possibly another financial crisis like the 07/08 forclosure crisis. Your measured input please.

 

[iceco1d]

Hedge fund and private equity owned insurers can't invest their general accounts anymore aggressively than a privately (or otherwise) owned insurer.

There is no reason to be concerned.
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Here is a good example: AIG

They had the most exotic, leveraged, and far reaching financial products division in the world (literally), dealing in super complex credit default swaps (the "evil" derivatives that everyone talks about).

Meanwhile, SunAmerica and VALIC had tip top ratings throughout the entire financial crisis (both are wholly owned subsidiaries of AIG). No problemo.

 

[othmar]

Hedge fund and private equity owned insurers can't invest their general accounts anymore aggressively than a privately (or otherwise) owned insurer.

There is no reason to be concerned.

"Athene bought Liberty Life Insurance Co. of Greenville, South Carolina, from Royal Bank of Canada in April 2011 for $624.8 million, and agreed in July to acquire Presidential Life Corp. for $414.3 million. It’s a potential bidder for the U.S. life insurance division of Aviva Plc (AV/), the U.K.’s second-largest insurer by market value, people familiar with the situation said last month.

Regulatory filings by Liberty Life, renamed Athene Annuity & Life Assurance Co. in February 2012, show different investment approaches by Athene and RBC, as the insurer did less trading under its former owner. State regulatory filings show that it sold $150.4 million of debt securities and bought $861 million of them in 2009, a year in which annuity sales boomed, increasing the size of its bond portfolio to $3.4 billion. In 2010, Liberty Life sold $269.9 million of bonds and purchased $926 million of them, lifting its holdings to $4 billion.

In 2011, the year it was acquired by Athene, the insurer sold $2.9 billion of bonds and bought $3.5 billion of the securities. In the first half of this year, it sold $7.8 billion of bonds and acquired $7.4 billion worth.

Athene also changed its bond mix, selling most of Liberty Life’s municipal, corporate and agency debt while spending almost $2 billion to buy residential mortgage-backed securities, state regulatory filings show. The purchases included $1.5 billion spent on RMBS backed by subprime and Alt-A mortgages, the types of securities that were most affected by defaults and downgrades during the 2008 recession."​

bloomberg.com/news/print/2012-10-22/Bloomberg /black-s-apollo-seeks-control-of-athene-to-gain-annuities.html

Then Guggenheim used the investment portfolio of one of the insurance subs they acquired in finance their acquisition of the L.A. Dodgers.

Here is a good example: AIG

They had the most exotic, leveraged, and far reaching financial products division in the world (literally), dealing in super complex credit default swaps (the "evil" derivatives that everyone talks about).

Meanwhile, SunAmerica and VALIC had tip top ratings throughout the entire financial crisis (both are wholly owned subsidiaries of AIG). No problemo.

Really? It's not known particularly well but AIG's life insurance companies had to be bailed out too.

Here's what the NAIC had to say about AIG

"Although it is most known for the significant losses to AIG Financial Products’ (AIGFP) credit default swap (CDS) portfolio, the onset of an overwhelming demand for returned cash by AIG’s securities lending counterparties compounded the overall firm’s liquidity constraints."

"Through its securities lending program, AIG generally loaned out securities owned by its insurance company subsidiaries. Between 2005 and 2007, rather than invest the cash collateral it received from the borrowers in conservative, short-term securities, AIG changed the direction of its investment strategy (without disclosing such change in its notes or to the U.S. state regulators) and mostly invested the cash in long-term subprime residential mortgage-backed securities (RMBS). AIG’s securities lending portfolio had not been included on the company’s balance sheet due to a liberal interpretation of the accounting requirements; therefore, there was no transparency with regard to how AIG had invested the borrowers’ posted cash collateral."

"AIG was unable to meet the growing demands for cash by its securities borrowers; to do so meant that they would have to sell the subprime RMBS collateral that was now illiquid due to severe market devaluations. Liquidity constraints that developed due to losses on its CDS portfolio were made worse, therefore, by those developing within AIG’s securities lending business."

" In November 2008, the Federal Reserve Board and U.S. Treasury announced a restructuring of the U.S. government’s financial support to AIG. Consequently, the Federal Reserve Bank of New York created Maiden Lane II LLC (ML II) in November 2008 to “alleviate capital and liquidity pressures on AIG associated with the securities lending portfolio of several regulated U.S. insurance subsidiaries of AIG”."​

naic.org/capital_markets_archive /110708.htm

Sorry for the broken links... I'm too new to post links.

 

[iceco1d]

Timeout. See below.

"Athene bought Liberty Life Insurance Co. of Greenville, South Carolina, from Royal Bank of Canada in April 2011 for $624.8 million, and agreed in July to acquire Presidential Life Corp. for $414.3 million. It’s a potential bidder for the U.S. life insurance division of Aviva Plc (AV/), the U.K.’s second-largest insurer by market value, people familiar with the situation said last month.

Regulatory filings by Liberty Life, renamed Athene Annuity & Life Assurance Co. in February 2012, show different investment approaches by Athene and RBC, as the insurer did less trading under its former owner. State regulatory filings show that it sold $150.4 million of debt securities and bought $861 million of them in 2009, a year in which annuity sales boomed, increasing the size of its bond portfolio to $3.4 billion. In 2010, Liberty Life sold $269.9 million of bonds and purchased $926 million of them, lifting its holdings to $4 billion.

In 2011, the year it was acquired by Athene, the insurer sold $2.9 billion of bonds and bought $3.5 billion of the securities. In the first half of this year, it sold $7.8 billion of bonds and acquired $7.4 billion worth.

I don't see any figures here on how annuity sales were in 2011. Since they say they "boomed" in 2009, I'm going to guess they were at least as high in 2011. Just because they are trading doesn't mean they are taking additional risk. Lots of times bonds can be traded for a nice profit, rather than being held to maturity.

Athene also changed its bond mix, selling most of Liberty Life’s municipal, corporate and agency debt while spending almost $2 billion to buy residential mortgage-backed securities, state regulatory filings show. The purchases included $1.5 billion spent on RMBS backed by subprime and Alt-A mortgages, the types of securities that were most affected by defaults and downgrades during the 2008 recession."​

Again, we don't know anything about the quality of these mortgage pools. Did they buy them for 50 cents on a dollar? Are they pools that are backed by one of the Federal bailout programs (essentially carrying a government guarantee)? We don't know any of this, and it's relevant information. Buying mortgages is a longstanding insurer practice, and demonizing the practice as reckless or greedy isn't accurate.

bloomberg.com/news/print/2012-10-22/Bloomberg /black-s-apollo-seeks-control-of-athene-to-gain-annuities.html

Then Guggenheim used the investment portfolio of one of the insurance subs they acquired in finance their acquisition of the L.A. Dodgers.

Untrue. They formed a subsidiary called Guggenheim Baseball Management. They used PROFITS from Guggenheim holdings (which includes several insurers) to purchase the team along with Magic Johnson, and a few other big names. They did not use general account funds from any of Guggenheim's wholly owned subsidiary insurers.

Really? It's not known particularly well but AIG's life insurance companies had to be bailed out too.

Please substantiate that. VALIC and SunAmerica were fine. Plenty of other insurers were in trouble (like Security Benefit) in that mess too, and they had no connection to an I-Bank.

Here's what the NAIC had to say about AIG

"Although it is most known for the significant losses to AIG Financial Products’ (AIGFP) credit default swap (CDS) portfolio, the onset of an overwhelming demand for returned cash by AIG’s securities lending counterparties compounded the overall firm’s liquidity constraints."

"Through its securities lending program, AIG generally loaned out securities owned by its insurance company subsidiaries. Between 2005 and 2007, rather than invest the cash collateral it received from the borrowers in conservative, short-term securities, AIG changed the direction of its investment strategy (without disclosing such change in its notes or to the U.S. state regulators) and mostly invested the cash in long-term subprime residential mortgage-backed securities (RMBS). AIG’s securities lending portfolio had not been included on the company’s balance sheet due to a liberal interpretation of the accounting requirements; therefore, there was no transparency with regard to how AIG had invested the borrowers’ posted cash collateral."

"AIG was unable to meet the growing demands for cash by its securities borrowers; to do so meant that they would have to sell the subprime RMBS collateral that was now illiquid due to severe market devaluations. Liquidity constraints that developed due to losses on its CDS portfolio were made worse, therefore, by those developing within AIG’s securities lending business."

" In November 2008, the Federal Reserve Board and U.S. Treasury announced a restructuring of the U.S. government’s financial support to AIG. Consequently, the Federal Reserve Bank of New York created Maiden Lane II LLC (ML II) in November 2008 to “alleviate capital and liquidity pressures on AIG associated with the securities lending portfolio of several regulated U.S. insurance subsidiaries of AIG”."​

naic.org/capital_markets_archive /110708.htm

Sorry for the broken links... I'm too new to post links.

Again, this wasn't a problem exclusive to AIG's sister insurance companies. This is the same thing that happened to Merrill, Goldman, CIT, and a slow of other insurers, banks, i-banks, etc. They had ASSETS on their balance sheets that were LIABILITIES to AIG. When AIG was going to go under and couldn't pay the piper, the assets these firms had on their balance sheets were going to go to $0. Much like if you owe me money, and then you file for bankruptcy. If you owe me $1,000, but go bankrupt, I may have had that $1,000 as an asset on my personal balance sheet. If you can't pay, it's now a $0 asset on my balance sheet. That has nothing to do with how I invested my balance sheet, it has to do with counterparty risk that burned me.

You can cherry pick cases all you want, but there are reasonable explanations. Plus, the OP is asking if an insurer is going to be going from owning investment grade debt securities to owning algorithm driven options portfolios and private equity if they get bought by a hedge fund. And that's just simply not the case.

 

[othmar]

1) Two points of concern regarding Athene

The increase in trading activity is breathtaking. We don't run a bond fund, we construct investment portfolios to back insurance/annuity liabilities. That level of trading raises questions regarding how well they're matching their liability cashflows, especially if they're willing to realize capital gains on their holdings. Willingness to mismatch will produce greater profits at a higher level of risk, which is a hallmark of private equity strategies.

I'm not particularly concerned about the credit quality of the MBS portfolio as the liquidity. If there's a loss of market liquidity similar to 08/09 (it was after all a liquidity crisis that substantially reduced the availability of credit) these securities could pose a real problem if Athene is heavily concentrated in them as ING, AIG, and Hartford were, among others.

I wouldn't characterize this as evil or anything like that, but working in risk management it does make my stomach a little bit queasy.

2) Guggenheim

I admit I'm not particularly familiar with the transaction, although my source is somebody I consider to be reliable. If you are aware of any publicly available information on the transaction I would appreciate it if you could post. I have the unenviable task of slogging through their investment schedules when they are released next spring.

If they did fund GBM with profits from portfolio companies, it couldn't have come from insurance subs. They only had about $1.7 billion in combined surplus and AVR as of 12/31/2011, so even in the unrealistic scenario that they took all the capital out in a special dividend it would have been insufficient to cover the purchase price.

3) AIG

AIG had numerous issues. The first arose in September 2008 when S&P downgraded the holding company's credit rating from AAA. This triggered clauses in the CDS agreements where they were forced to post $14 billion of collateral. The holding company did not have adequate cash and short term investments to meet the collateral call, but they were considered solvent.

Another arose in November 2008 in the life insurance subsidiaries. AIG was running a very large securities lending program where they lent securities from the insurance companies' investment portfolio to dealers so that they could be sold short. Rather than placing the collateral that they received in safe liquid assets they invested the collateral in subprime MBS in order to generate additional yield. When the securities were returned from the dealers AIG could not liquidate the assets that the collateral was invested in, so the Federal Reserve had to step in and create Maiden Lane II to bail out the insurance companies. They purchased over $19 billion of MBS from the life subs, so that program was actually much larger than the bailout of the holdco from the CDS exposure.

If you would like sources, there's the NAIC page I posted above (I inserted an erroneous space if you want to fix the link), AIG's 12/31/2008 10-K (page 205), and the New York Fed's webpage discussing Maiden Lane II.

We all do this by the way, but we typically don't expose ourselves to such liquidity risk. A well managed program may be able to generate 10 to 20 bps of additional yield.

 

[iceco1d]

1) Two points of concern regarding Athene

The increase in trading activity is breathtaking.

Can you elaborate on this? It's obviously a sharp increase in trading activity, but surely you've witnessed the stark inefficiencies in the bond market over the past 5 years? I just don't think that increased trading activity means anything on its own. If you do, I'd be interested to hear the rationale.

We don't run a bond fund, we construct investment portfolios to back insurance/annuity liabilities.

I get that.

That level of trading raises questions regarding how well they're matching their liability cashflows, especially if they're willing to realize capital gains on their holdings.

Why? How does trading level have any correlation to matching cash flows to liabilities? They could've made all of those trades to make their cashflows better match their liabilities for all we know (or do you have additional information?). Note, I don't believe that's the reason for the trading activity...but there is just as much evidence to support my statement than there is yours, don't you think?

Willingness to mismatch will produce greater profits at a higher level of risk, which is a hallmark of private equity strategies.

Agreed, but I would think this would reflected in their ratings and outlook, no? Not to mention I would think regulators would require mismatching to stay within a manageable range.

I'm not particularly concerned about the credit quality of the MBS portfolio as the liquidity. If there's a loss of market liquidity similar to 08/09 (it was after all a liquidity crisis that substantially reduced the availability of credit) these securities could pose a real problem if Athene is heavily concentrated in them as ING, AIG, and Hartford were, among others.

I wouldn't characterize this as evil or anything like that, but working in risk management it does make my stomach a little bit queasy.

I think the Fed has made the lack of liquidity impossible moving forward. I would be more concerned about a crisis we haven't experienced or thought of yet, rather than one that's already occurred repeating itself. And again, if you're not concerned about credit quality, the concern over liquidity is only relevant if they have indeed mismatched their cash flows to their liabilities, no? (genuine question)

2) Guggenheim

I admit I'm not particularly familiar with the transaction, although my source is somebody I consider to be reliable. If you are aware of any publicly available information on the transaction I would appreciate it if you could post. I have the unenviable task of slogging through their investment schedules when they are released next spring.

If they did fund GBM with profits from portfolio companies, it couldn't have come from insurance subs. They only had about $1.7 billion in combined surplus and AVR as of 12/31/2011, so even in the unrealistic scenario that they took all the capital out in a special dividend it would have been insufficient to cover the purchase price.

I am honestly not sure what you're looking for here. They bought it with profits of Guggenheim, not from general accounts of the insurers Guggenheim owns. They could've just as easily paid those profits out to the partnership and no one would've said boo about it. Instead, they held the profits and formed the Baseball Management company. I honestly don't understand the question here at all. SBL is segregated and had no part of the deal, except to remit profits back to the parent just like any other subsidiary of any other company.

3) AIG

AIG had numerous issues. The first arose in September 2008 when S&P downgraded the holding company's credit rating from AAA. This triggered clauses in the CDS agreements where they were forced to post $14 billion of collateral. The holding company did not have adequate cash and short term investments to meet the collateral call, but they were considered solvent.

Another arose in November 2008 in the life insurance subsidiaries. AIG was running a very large securities lending program where they lent securities from the insurance companies' investment portfolio to dealers so that they could be sold short. Rather than placing the collateral that they received in safe liquid assets they invested the collateral in subprime MBS in order to generate additional yield. When the securities were returned from the dealers AIG could not liquidate the assets that the collateral was invested in, so the Federal Reserve had to step in and create Maiden Lane II to bail out the insurance companies. They purchased over $19 billion of MBS from the life subs, so that program was actually much larger than the bailout of the holdco from the CDS exposure.

If you would like sources, there's the NAIC page I posted above (I inserted an erroneous space if you want to fix the link), AIG's 12/31/2008 10-K (page 205), and the New York Fed's webpage discussing Maiden Lane II.

We all do this by the way, but we typically don't expose ourselves to such liquidity risk. A well managed program may be able to generate 10 to 20 bps of additional yield.

If I'm correct (and I think I am), their securities lending program was a tiny fraction of their problem in 2008. They were primarily toppled by being on the wrong end of $100 billion or so in credit default swaps.