(Bloomberg) -- Marc Rowan became the envy of the private equity world with his pioneering move into the insurance business. Now, his firm is finding that being out front invites more scrutiny when times get tougher.
Apollo Global Management Inc.’s 2009 entry into the sleepy world of annuities through its co-founding of insurer Athene Holding drew concern from some investors and jealousy from rivals including Blackstone Inc. Over the past decade, Athene has grown into the firm’s biggest profit driver and the largest annuities provider in the US, while Rowan has ascended to Apollo’s top job.
Apollo’s bet that Athene can be smarter and nimbler than the industry’s incumbents now faces a big test. Athene, which had only known low rates until last year, has loaded up on structured credit investments, arguing that firms with its expertise can grab higher yields at lower risk than comparable corporate bonds. The question — indeed one that faces all insurers — is whether borrowers can keep up with debt payments as their interest costs climb.
At stake is not just the performance of a unit that provided the majority of Apollo’s profit last year and is targeting a 20% jump in 2023. Any stumbles could bolster the regulators and policymakers who remain skeptical of alternative-asset managers’ push into an industry long dominated by mutual firms owned by their customers.
“In the life insurance and annuities business, I observed over time the shift to higher-risk, more complex and less-liquid securities,” said Tom Gober, a forensic accountant who has briefed the US Department of Labor and Senate Banking Committee on private equity’s involvement with insurers. “When Apollo took control of Athene insurers, the shift ramped up substantially.”
Senate Banking Committee Chairman Sherrod Brown, an Ohio Democrat, has pushed for closer scrutiny of insurers owned by alternative-asset managers. Regulators are weighing whether to boost capital requirements on holdings of collateralized loan obligations and other structured assets.
“We’ve been watching all of these developments very closely,” said Iowa Insurance Commissioner Doug Ommen, a key industry overseer because Athene and other annuities providers are based in the state. “Our work as regulators requires an understanding of the risk posed by insurer activities of all types of ownership. That includes the impacts of the macroeconomic environment on insurance company balance sheets.”
Apollo, never known for passivity, is meeting the concerns head on. It has argued that Athene embraces a more conservative capital approach than peers. Late last year, Athene published a white paper that said regulators should prefer its investing approach, given its expertise in structured credit — which has a lower default rate than corporate debt — rather than putting policyholders at risk by reaching for yield in the bond market.
“Our private credit business is different than most other private credit businesses in that the majority, and the vast majority, of it is fixed-income replacement or private investment-grade,” Rowan, an Apollo co-founder who took over as chief executive officer in 2021, told analysts during a May 9 conference call. “This fits very well with the space that is currently in retrenchment by the banking system, because the banking system historically was not a risk-taker.”
Rowan, 60, said earlier this year that he wants Apollo to take a more active role in shaping insurance regulations. Athene is subject to the same rules as insurers that aren’t controlled by alternative-asset managers. Persuading policymakers that Athene is just as safe as peers is a key part of Rowan’s push for Apollo, which managed $598 billion of assets at the end of March, to reach $1 trillion by 2026.
Providers of floating-rate securities such as structured credit get better returns when interest rates rise, but that also means a higher debt burden for borrowers and greater risk that they won’t be able to keep up with payments. Athene’s earnings from its fixed-income portfolio surged 62% in the first quarter from a year earlier, while its estimated credit losses and cost of funds also increased.
The insurer, which completed its merger with Apollo in early 2022, projects the amount of debt it’s unlikely to recover climbed almost 10% in the three months ended March 31 to $503 million on its available-for-sale securities portfolio, which was valued at $118.6 billion. The estimate for loans deemed unlikely to be recovered ballooned 273% last year as interest rates surged.
Athene touts the strength of its investment portfolio, 96% of which is rated investment grade by the National Association of Insurance Commissioners, a consortium of state regulators. Almost 40% of those securities are the lowest level of investment grade, while 46% have an A rating or higher from the major credit-ratings firms.
S&P Global Ratings and Moody’s Investors Service grades Athene’s regulated insurance subsidiaries A+ and A1, respectively. The holding company is rated A- by S&P and its unsecured debt is rated Baa1 by Moody’s.
“In an industry otherwise starved for capital, Athene has raised billions of dollars and invested in origination and structured credit capabilities that reflect modern financing markets,” Apollo said in an emailed statement.
Athene had $20 billion in regulatory capital as of year-end.
“Today we are among the best-capitalized retirement services companies, and our ability to generate industry-leading performance for retirees has helped us become the US market leader in fixed annuities,” Apollo said. “We have strong conviction in our model and ability to successfully navigate market cycles.”
Rowan was among the first private equity executives to bet on insurance in 2009, when he persuaded Apollo to help found Athene as a platform to buy blocks of annuities from insurers. His pitch, following a model established by traditional asset managers, was that Apollo could provide insurers with better yields without exposing them to additional default risk.
It was a controversial wager.
The California Public Employees’ Retirement System, the largest pension fund in the US, declined an opportunity to invest in Athene alongside Apollo, according to a person with knowledge of the matter. Calpers was concerned that the tie-up would create conflicts and questions about whether Apollo would act in Athene’s best interest, the person said. A Calpers spokesman declined to comment.
Competitors, meanwhile, eyed Rowan’s move with envy. Blackstone CEO Steve Schwarzman expressed frustration to associates that his firm, now the world’s largest alternative-asset manager, didn’t strike first, another person said.
An arms race ensued.
Private equity firms pursued stakes in insurers to gain influence over how they invested and grew their balance sheets. Insurers struggling to generate returns in the era of historically low rates — ushered in by the 2008 financial crisis — were highly receptive to those advances.
Blackstone took minority holdings in four insurance businesses and struck deals to manage their assets. In 2018, Carlyle Group Inc. took a stake in reinsurer Fortitude Re. KKR & Co. became majority owner of Global Atlantic in 2021.
When Apollo took full ownership of Athene, it became the only alternative-asset manager to absorb an entire insurance firm. Apollo also sells structured credit assets that it originates to other insurance companies.
The March collapse of Silicon Valley Bank served as a reminder of what can happen when customers pull deposits en masse. Analysts have scrutinized insurers including Athene in recent weeks for signs that more clients may be cashing out early to invest in higher-yielding products such as money-market funds.
Apollo says those concerns are unfounded because more than 80% of its annuities have protections against early withdrawals, and new contracts are offsetting redemptions. The firm reported $12 billion of inflows into Athene during the first quarter — including a record $8 billion of retail annuity sales — against $5.5 billion of outflows. Just $568 million of those redemptions were unexpected and resulted in early-withdrawal charges.
The firm forecasts $17 billion of inflows in the second quarter and for Athene to beat last year’s annual record of $48 billion, Rowan said in the May 9 conference call.
“People who own annuities are saving for retirement,” he said. “This is not money they think is accessible. When they do surrender or move it, they’re typically moving to another policy.”
The focus on how balance sheets will fare as economic growth cools has weighed on insurance stocks, with the 24-company KBW Insurance Index sliding 3.8% this year through Friday. Shares of Apollo were little changed, while Blackstone and KKR advanced 12% and 7.8%, respectively. Carlyle slumped 8.5%.
Blackstone’s $2.2 billion investment in Corebridge Financial, made in 2021, has lost about half of its value since then, weighed down by the prospect that AIG, another major holder, will pare its position.
Rate hikes are slowing the economy and rippling through to commercial real estate, where defaults and vacancies are rising. Insurers including Corebridge, Prudential Financial Inc. and Equitable Holdings Inc. increased estimates for mortgage losses in that sector. Corebridge has told shareholders that it’s conservative about projecting losses and constructs its commercial mortgage loan portfolio to meet insurance liabilities.
More than 20% of Athene’s invested assets are in senior real estate debt, including mortgage loans as well as residential and commercial mortgage-backed securities. At the end of March, 12% of its RMBS and 11% of its CMBS were rated below investment grade, or junk, by the NAIC.
Athene’s ability to withstand — and profit from — an economic downturn is key to Apollo’s future. The firm, which built its name investing in leveraged buyouts, pulled back from the $25 billion target for its latest private equity fund while earnings from asset sales plunged 96% during the first quarter. Athene accounts for about two-thirds of Apollo’s earnings, and credit comprises more than 70% of the firm’s assets.
If Apollo fails to deliver on its promise of offering safe, stable yield, that may hurt savers who depend on Athene for their retirement income. But the firm has sought to reassure skeptics that it’s positioned to serve retirees no matter what happens in the broader economy.
“We’ve seen the impact of higher interest rates and liquidity concerns negatively affect a range of markets and financial institutions,” Athene CEO Jim Belardi said Thursday during a call with investors. “Whereas other financial institutions may have suffered disruption to their business model or growth ambitions, Athene’s fortress balance sheet and long-running strategy of operating with significant excess capital truly stand out in times like this.”
--With assistance from Layan Odeh.