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Private equity: They bet your life

Regulators worry about too much risk in annuity portfolios

– Until April 2011, Pete Dodd, a former money manager at Liberty Life Insurance Co. in Greenville, S.C., invested customer premiums in what he calls a “squeaky clean” portfolio: bonds backed by state governments and blue-chip corporations.

Then a company funded by private equity firm Apollo Global Management acquired Liberty and inherited its clientele, which was mostly people approaching retirement who had bought annuities from the company to supplement their Social Security.

Now the unit’s holdings include securities backed by subprime mortgages, time-share vacation homes and a railroad in Kazakhstan.

“When you look at the business model these guys use, where they’re substantially increasing the risk in the bond portfolio, sooner or later, in my opinion, that has to come home to roost,” said Dodd, 55, who helped manage $4 billion before the sale to New York-based Apollo’s Athene Holding Ltd.

“All the upside would go to Athene if it worked out. And the downside would go to the annuity holders if it didn’t.”

Wall Street firms such as Apollo, Goldman Sachs, Harbinger Group and Guggenheim Partners are acquiring life insurance companies and shaking up a staid industry with investments as varied as the Los Angeles Dodgers baseball team and mortgage-backed securities that cratered during the financial crisis.

The newcomers are meeting resistance from some state insurance regulators accustomed to vanilla portfolios, who have warned about exposing policyholders to greater risk.

New York state may need to modernize its regulations to deal with the increased presence and “troubling role” of private-equity firms in selling annuities, which promise regular payments to policyholders, said Benjamin Lawsky, New York state superintendent of financial services, in a speech last week.

“The risk we’re concerned about at DFS is whether these private-equity firms are more short-term focused, when this is a business that’s all about the long haul,” Lawsky said. “Their focus is on maximizing their immediate financial returns, rather than ensuring that promised retirement benefits are there at the end of the day for policyholders.”

Private-equity firms can be very successful even if some of their ventures fail, he said.

“This type of business model isn’t necessarily a natural fit for the insurance business, where a failure can put policyholders at very significant risk.”

Apollo and Goldman Sachs both shifted the legal addresses of their South Carolina insurers out of state after the state’s regulators limited their investing strategies. For New York-based Goldman Sachs, the move came after it hired the state’s former insurance director as a lobbyist and appealed for help to the South Carolina governor’s office.

“Companies want to do things, and then when a regulator tries to do their job, then they go find a domicile that will let them do what they want,” said Scott H. Richardson, who was the South Carolina insurance director when Goldman Sachs left the state for the nation’s capital in 2009. “We weren’t being friendly enough to them, so they went to D.C.”

The money managers say their investments are no more dangerous than those of traditional insurers, and that they’re managing them with a long-term view. In a key measure of financial health known as the risk-based capital ratio, the units far surpass the minimums required by state regulators.

While some of its investments are unorthodox, “our portfolio is less risky than traditional life-insurance companies,” said James R. Belardi, chief executive officer of Apollo’s Bermuda-based Athene unit.

It is “a reason why people should invest in our company, as opposed to the unsuccessful strategies of traditional life insurance companies, which has been an underperforming sector in the economy for many, many years.”

Guggenheim’s insurance units bought part of the Los Angeles Dodgers last year, when Guggenheim CEO Mark Walter led a $2 billion purchase of the baseball team. Its insurance arms invested about $100 million, according to a person close to the company who spoke on condition of anonymity because of Major League Baseball confidentiality rules.

Guggenheim’s insurance arms invest conservatively, and it plans to own them for a long time, spokesman Michael Sitrick said. A money manager based in New York and Chicago, Guggenheim also advises traditional insurers about their investments.

Investing premiums in a baseball team is “a little odd,” said Nick Gerhart, the insurance commissioner for Iowa, one of five states that oversee Guggenheim insurers.

Later this year, Gerhart is expected to review Apollo’s biggest insurance takeover yet – its $1.8 billion agreement to buy the West Des Moines-based U.S. operation of London-based Aviva.

“This move from private equity into insurance is relatively a new phenomenon, and I don’t know how many regulators have even spent time thinking about it,” Gerhart said.

Athene’s plans to acquire Aviva’s U.S. operation disturbed Michael Garcia, a retired phone company salesman in the Los Angeles suburbs. Garcia, 61, spent most of his life savings on an Aviva annuity last year, he said.

“The new owners, Apollo, are not an insurance company. They’re a private-equity company. That’s a big difference,” he said. “So obviously my concern is: Are these people going to keep enough reserves? Are they going to play by the rules that insurance companies have to play by?”

“Don’t play poker with our money,” Garcia said.

By routing at least some of their insurance units’ investments to funds managed by the parent company, the Wall Street firms can generate fee revenue. Athene, for instance, put about a third of its $15.8 billion of assets into Apollo funds, including collateralized loan obligations and private equity, generating fees for Apollo.

Harbinger Group tried the same tactic. Controlled by Philip Falcone’s Harbinger Capital Partners hedge-fund firm, it entered the insurance business in 2011 when it bought an annuity provider in Maryland from London-based Old Mutual.

Harbinger soon sought to transfer $3 billion of the Maryland firm’s business to an insurance company it owns in Bermuda, according to Securities and Exchange Commission filings.

About $1 billion was to be managed by Falcone’s hedge fund firm and invested in assets rated non-investment grade, or junk, below Baa3 by Moody’s Investors Service and less than BBB- by Standard & Poor’s.

Maryland regulators rejected the proposal last year. The deal may “adversely affect interests of policyholders,” wrote Neil Miller, an associate Maryland insurance commissioner. “There is no assurance that the investment manager will successfully mitigate the risks.”

Harbinger later won approval for a smaller deal involving more traditional assets, which the hedge fund wouldn’t manage.

Since it made the original proposal to Maryland, Harbinger Group has changed its strategy, said Phil Gass, a managing director, adding that it owns fewer junk-rated securities than most insurers.

Unlike private-equity funds, Harbinger, a publicly traded company, can hold onto acquisitions indefinitely and takes a long-term view, he said.

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