Let me disclose my prejudice, I don’t like management consultants, I don’t like the way they pander to the basest instincts of those who employ them and I don’t like the way they are used to justify corporate behavior which plays to the executive and shareholder and excludes the interests of customers and employees.
So when I read an article from McKinsey & Co urging the private equity industry to take on more of Britain’s life and pension legacy book, I do so with some scepticism.
We are fresh from December’s remarkable vote by members of LV= to block Bain Capital’s takeover of the mutual insurer , not by its executive , but by its members.
What is clear from reading the article and focussing on the table above, is that no consideration whatsoever is given to the impact of a private equity company acquiring an insurer, or working in partnership with an insurer, on its membership.
Putting aside for the moment, historical considerations around the purpose of mutual societies. Let’s first of all, see if a reading of the “value creation playbook” demonstrates any advantages to a mutual society member/policyholder.
McKinsey make it clear that life/pension companies are fundamentally undervalued.
The core attraction is straightforward. The balance sheets of life and annuities companies are well stocked with assets (to match the liabilities of future payouts and indemnities), but until payout, these assets need to be invested to generate returns. And in many cases, the cost of servicing the liabilities is significantly lower than the potential investment return. The spread represents an attractive margin.
Unlocking the “value playbook” is examined in detail , but without consideration for member value. Let’s take each “lever” independently.
Operations/IT – better service or dumbed down products?
A more efficient cost structure talks to me about redundancies, not investment. It would be encouraging to see this translating into an improved Service Level Agreement for members. But Mckinsey point out that most insurers have already implemented most of the core efficiencies that feed through to better member service. What’s left to be done is to dumb down the “product”
To get to the next level, insurers can take a comprehensive look at these levers to understand their interdependencies. For example, unlocking scale benefits requires action to reduce complexity of the book, by offloading legacy products, say, or decommissioning legacy IT systems.
Just what is meant by “off-loading” or what is lost in decommissioning legacy IT systems, isn’t clear. But I suspect it means requiring policyholders to find themselves playing second fiddle in the value playbook.
Investments – alpha – or just a risk transfer to policyholders?
While IT efficiencies primarily play to insurance books, the investment of monies backing promises is primarily a pensions issue. Some advantages can be achieved painlessly (reducing costs) but some involve value creation of a different kind
Most PE firms view …. investment performance, as the main way to create value for the insurer, as well as for themselves. This lever will grow in importance if yields and spreads continue to decline. Leading firms typically have deep skills in core investment-management areas, such as strategic asset allocation, asset/liability management, risk management, and reporting, as well as access to leading investment teams that have delivered alpha.
In other words, swapping the PE team’s investment partners for the current insurers is an easy win. It is hard not to see this as a conflict to member’s interests. Unless the existing insurer is incompetent, the alpha creation is unlikely to be risk free alpha, but much more likely the spurious alpha that comes from taking speculative positions against the market. While an incompetent insurer will simply be in the wrong assets, most insurers are in the right assets for members, which may not be the right assets for the GP of the private equity house.
Capital – paper gains for the shareholder – not the policyholder
The same can be said for the capital position of the insurer. Paper gains can be made by exploiting regulatory arbitrage
Capital efficiency is also well-trod ground, and for private insurers it presents a greater opportunity given their different treatment under generally accepted accounting principles, (GAAP), enabling them to apply a longer-term lens and reduce the cost of hedging.
But member’s interests aren’t mentioned. Reducing the capital reserves of an insurer is not “risk-free” to the policyholder.
Technical – a licence to kill
What is envisaged here is a series of interventions to traditional practices of sharing profits through exploiting weaknesses in policy wording.
Conducting a thorough review of contractual terms and finding opportunities to adjust where appropriate (for example, through reduced surplus sharing) can be a material driver of value.
The spirit of mutuality was about treating the customer fairly and the consumer duty survives as a concept with the Financial Conduct Authority. What worries me is that there is no consumer champion within the insurer capable of pushing back against these shifts in value from the policyholder to the shareholder. The policyholder looks a sitting duck.
Areas where the policyholder can benefit from PE
I am more comfortable with the last two items in the “value playbook”. As regards “commercial uplift”, I see opportunities to encourage people to stay in good policies and to buy new policies, if the customer experience is improved. There is no doubt that firms such as Phoenix are offering “commercial uplift“, the right way. Policyholders are sticking around and might well follow Phoenix created pathways to and through retirement, if offered the right products.
Aligned to this is the way a firm like Phoenix, with its Private Equity backers, can create a new franchise out of the sum of its various parts. Standard Life is being revitalised after years of poor management. Phoenix is competing and winning in the bulk annuity market and far from looking a Zombie, it now looks refreshed. I do not agree with everything it’s doing (see yesterday’s blog) but it cannot be ignored as its various parts might have been , were they not brought together by private equity. Where the franchise has not been properly managed , PE can breathe life into the brand.
Too little pushback
McKinsey is good on demonstrating the value of life books to private equity houses. They can make them money through exercising the levers of the “value playbook” and life companies make PE houses stronger , both in terms of revenue and in terms of the resilience of their business model (they start looking like sources of private credit as well as equity – nudging into banking territory.
Sellers are willing
But McKinsey are not so good at pointing out where PE can go wrong. They point to the management of life companies as willing sellers. Certainly moving away from traditional “heavy” lines of business to lighter lines such as platform management for workplace pensions and SIPPs is a lot sexier for insurance executives.
But as LV= found, it’s one thing to recommend a deal to membership , another to get the membership to agree. The LV= membership mobilised itself and defeated the move of Bain Capital and the LV= management , leaving a lot of egg on face. Mutuals such as Royal London , which have clearly promoted their mutuality, have gone the other way and perhaps the LV= experience may force other mutual executives to follow Royal London’s example.
I am pro private equity where it creates innovation, revitalises failing businesses and develops new businesses which challenge and disrupt market such as insurance. The insure-tech market is largely financed by private equity rather than bank debt. I can see how PE’s investment in Insure Tech can add value to lagging insurers.
But in general, I see McKinsey’s “value playbook” as needing adaption. I suspect it was created in the USA for the US insurance market. But I hope that in Britain, there are barriers to the Private Equity’s shareholder dominated approach.
Any business case , following the failure of the LV= bid, will need to better show that policyholders and members of the insurer are properly considered and that , both at the point of the transaction and going forward, they are part of the “value playbook”.
Right now , I see no such evidence!
Private Equity has a consumer duty which it can’t ignore.