In new research, Pranjal Drall and Andrew Granato argue that the move of private equity firms into life insurance has increased the probability that insurers will go insolvent. If they do, under an obscure system of insurance guaranty funds, the losses will spread out beyond the insolvent insurer’s creditors to other insurers and, ultimately, taxpayers.
Life insurance has long been considered one of the least exciting parts of finance. Policyholders, wanting to provide for their families in the event of tragedy, buy long-lasting policies that pay out money to their beneficiaries if they die early. Life insurers sell large quantities of policies, thereby pooling risk and spreading out potential financial losses. The insurers then invest the proceeds in safe, high-quality corporate bonds. The insurers earn a small spread and the beneficiaries can be confident that their life insurer will be solvent if and when it comes time to pay the bill.
As with many industries, the rise of private equity (PE) has fundamentally reworked this staid business model of life insurance. In about fifteen years, PE has grown from controlling no life insurers to controlling about 15% of the sector. In most industries, PE invests in private companies to boost profitability before selling or merging them with another company. In contrast, PE firms take control of insurers to combine the money from selling insurance policies with alternative private-credit lending, in part to finance their traditional buyout funds.
PE firms and some business commentators have hailed this strategy as a masterstroke that relies on the “permanent capital” of life insurers: policyholders who expect to pay the insurer upfront for long periods of time, even decades. These long-duration liabilities, they argue, make life insurers an ideal host for long-term, illiquid private credit, with efficiencies that allow insurers to hold these higher-yielding assets to maturity and enhance performance for policyholders and investors alike. We do not dispute that there are theoretical efficiencies in this structure. However, in our paper, we argue that its practical implementation has relied heavily on regulatory arbitrage that has the potential to shift large losses onto the public.
The current risk of the life insurance market
Risks within the life insurance market lie in the distinctive structure of insurance’s insolvency, tax, and financial-regulation law. Life insurance and annuity policyholders hold contracts that involve paying the insurer upfront, with the expectation of benefits that will materialize over the long run. To bolster policyholder confidence that the insurer will still be around to make payouts, all states implement “insurance guaranty funds” to backstop policyholders even if the insurer goes insolvent. The logic is somewhat similar to the logic of federal deposit insurance, which backstops banking depositors to maintain their confidence that they will have access to their money even if their bank goes out of business.
Each guaranty fund functions as follows. Each insurance policyholder is guaranteed to have their policy remain in force up to a specific statutory cap, generally around $250,000-$300,000. When an in-state insurer becomes insolvent, the state regulator takes over the insurer’s operations. To make up the shortfall to policyholders, the regulator bills every surviving insurer in the state, proportional to how many insurance premiums each insurer sells in the state. In essence, the insurers pool their risk and insure one another. In 44 states, in the case that an insurer goes bankrupt and other insurers must bail out its policyholders, those insurers are permitted to take a tax credit against their assessment payment, usually over the course of the next five years. For these states, the taxpayer ultimately insures the insurers.
The core issue with such a guarantee is what economists call “moral hazard.” Insurance policyholders, like bank depositors, have little incentive to monitor what their banks and insurers do with their money, as other insurers or the broad public will bail them out. From the perspective of the insurers and their investors, since they have limited liability, they have increased ability to invest funds from their policies in riskier assets, as losses fall upon other insurers and the public. To restrain this behavior, banks and insurers are both subject to heightened financial-regulation standards, such as regulatory penalties for investing in assets that are considered to carry more risk.
The degree to which banking’s financial regulatory regime successfully restrains bank risk is debatable, and certainly it did not prevent the financial implosion of the industry in 2008. In addition, the design of insurance’s backstop entails even greater flaws than those present in banking. These design flaws sharpen the incentives for insurers to take on excessive risk, with more direct liability for taxpayers.
How guaranty funds compare to deposit insurance
We argue that guaranty funds and their associated financial regulatory regime entail worse moral hazard issues than federal deposit insurance in several ways. First, unlike banks, which must pre-pay quarterly for deposit insurance, guaranty funds step in only after insolvency. This means that the insolvent insurer never makes a single contribution into the fund that rescues its policyholders.
Second, while deposit insurance fees are measured by how risky a bank is, guaranty funds apportion payments purely by how much insurance an insurer sells. Essentially, safe insurers are subsidizing risky insurers.
Third, deposit insurance only relies on public funding if the bank’s deposit fund is not enough to fully cover depositors. In the case of life insurance, taxpayers are the default reimbursement mechanism in all 44 states that permit guaranty-fund tax credits, as the insurers essentially pass on the bill through forgone corporate taxes.
Fourth, while deposit insurance is paired with centralized, federal banking regulation for large banks and bank-holding companies, state-level insurance regulation means that regulators have strong incentives to only think about local risks. State regulators, with scarce resources, have little remit to consider out-of-state policyholders.
And fifth, state-level regulators empirically tend to exercise less oversight than federal ones.
There are also concerns regarding downside-shock amplification, or the chain reaction insurer insolvency can cause to other segments of the market and broader economy. The fact that guaranty fund assessments and payouts only kick in after insolvency creates bizarre incentives for insurers whenever an insurer approaches failure. The insurer that is going down has the incentive to rapidly issue more policies in order to get more cash from risk-insensitive policyholders to make Hail-Mary investments to save the firm. Meanwhile, other in-state insurers have the incentive to dial down their in-state presence to reduce their assessment bill as they watch the troubled insurer’s balance sheet dwindle. So, the declining insurer can increase its cost to the guaranty fund, while a smaller market amplifies the hit to remaining insurers. During a poor macroeconomic environment, additional assessments could in theory push more insurers into insolvency, generating a vicious cycle. Tax credits for assessments alleviate these incentives, but at the cost of placing taxpayers on the hook.
Lastly, it is important to note that insurance guaranty funds have never had to administer a large-scale life insurer’s resolution. Previous prominent life insurance failures like Executive Life in 1991 held assets in the low billions, a small fraction of the hundreds of billions of dollars that today’s large insurers manage, even when adjusting for inflation. This administrative difficulty is itself a risk. Imagine, for example, if American International Group, the largest global insurance provider at the time, had been permitted to fail in 2008 and each state had had to manage AIG’s insolvency simultaneously. The sheer size of the largest insurers means that resolution of any of them risks setting off a wider crisis.
The private equity-private credit-life insurance merger
Despite these problems with the insurance guaranty fund system and AIG’s near-death experience in 2008, because life insurers’ asset portfolios remained relatively staid, most of the industry retained its reputation for safety. It was at this point that PE entered the industry and pursued a business model that exacerbates the current system’s difficulties.
PE has been traditionally known for leveraged buyouts, in which they buy a firm using substantial debt, increase the firm’s profits, and then resell it. However, this business model has evolved since PE’s rise in the 1980s. PE’s major players, like Apollo, Blackstone, and KKR, now report higher assets under management in their lending divisions than their buyout divisions. These firms now specialize in a style of lending known as “private credit”: direct loans to borrowers that are not registered with the United States Securities and Exchange Commission. These loans are non-tradable and high-yield, and have bespoke terms. Such lending used to be primarily done through banks, but banks retreated from this sphere after the 2008 financial crisis and 2010 Dodd-Frank reform, which increased regulatory penalties for such high-risk, illiquid loans.
Private credit has swelled to become a multi-trillion asset class in its own right, and PE is at the center of it because they frequently direct such loans to companies that have been acquired by the PE firm through their buyout funds. PE is making a bet that it is better for the loans that power their buyouts to come not from outside lenders, but from the private credit side of their own asset-management platforms. This side includes private credit funds backed by the same kinds of institutional and high-net-worth investors who back the buyout funds, but it also increasingly includes life insurers that are capitalized by the collective premiums of thousands of retail, dispersed policyholders. PE firms may choose to purchase a life insurer directly or achieve influence over an insurer’s portfolio by contract; whichever they choose, they gain preferential access to an insurer’s vast balance sheet. In other words, a private equity firm becomes the general partner in private equity funds, the general partner in private credit funds, and the owner or manager of an insurer.
The “permanent capital” hypothesis that PE firms advance holds that, because insurance policyholders do not monitor an insurer’s performance and have long-duration contracts, an insurer is an optimal setting in which PE firms can place illiquid private credit. McKinsey & Company calls this strategy a “virtuous flywheel” that quickly propels growth and increases returns.
Importantly, the outside investors in the insurer are structurally different than the institutional investors who make up the backers of private equity and private credit funds: they are insurance policyholders who are in a poor position to monitor the insurer’s conduct and often rely on the guaranty fund’s backstop to protect them by socializing risk. This asymmetry generates incentives for the PE firm to extract value from the insurer to deploy to its funds. The flywheel strategy therefore introduces or amplifies risks to insurer health through five channels.
First, when a PE firm acquires an insurer, it often hollows out the insurer’s staff and replaces that staff with contracts that entail the insurer paying fees to the rest of the PE firm for services in asset management, valuation, reinsurance, and potentially a wide variety of other services. The insurer keeps a skeleton crew, but growing fees paid out to the PE firm create opportunities to overcharge and siphon value out of the insurer. Collectively, these strategies weaken the operations of the insurer.
Second, because a PE firm stands on both sides of an “affiliated transaction,” when an insurer makes a loan to another company in the PE firm’s purview, the PE firm effectively negotiates with itself over what the terms are. The PE firm therefore has incentive to use the insurer to make excessively generous loans to a buyout fund’s portfolio company, or force the insurer to take on a poorly performing asset from one of its private credit funds.
Third, as mentioned above, a PE firm acquisition results in substantial increases in the risk and illiquidity of an insurer’s portfolio. In 2024, while PE-owned life insurers made up about 14% of the life insurance sector, they owned 40% of life insurers’ investments in private credit and asset-backed securities.
Fourth, because the assets that PE-controlled life insurers hold are increasingly illiquid, they are difficult to value. Insurers employ rating agencies to gauge the risk of their assets, and regulators employ these judgments to determine how risky an insurer is overall. However, when an asset is nontraded and therefore harder to value, it receives systematically preferable capital treatment. PE firms disproportionately employ “private letter ratings” to value these illiquid assets that are themselves not publicly observable and that are associated with further valuation arbitrage. This has meant that these alterations in life insurers’ balance sheets are often not reflected in standard regulatory risk measures.
Fifth, PE firms are particularly aggressive in conducting “shadow reinsurance” transactions that involve shifting assets and liabilities to subsidiaries that do not face the same transparency requirements, further obscuring risk. Insurers must report the specific assets that they hold on their balance sheet in a manner that investors can observe, but reinsurers in settings like Bermuda are not required to do the same. An insurer can therefore create a subsidiary reinsurer in a Bermuda-like jurisdiction and move its assets and liabilities to that subsidiary, eliminating their reporting obligations.
Conclusion and reforms
PE firms have aggressively leveraged the moral hazard that insurance’s outdated regulatory framework enables. Their business structure contains efficiencies, but also contains systemic incentives to loot insurers to benefit the rest of their businesses. In so doing, they have created peril to insurance policyholders and the rickety guaranty fund system that backstops them.
In our paper, we propose a variety of mechanisms to reduce this risk, including systemic penalties for asset opacity and aggregate affiliate transactions, conversion of insurance guaranty funds to the pre-funded Deposit Insurance Fund model, and making insurance holding companies at least partial first-lien guarantors for assessments caused by insolvencies of affiliated insurers. Aligning these incentives would help shore up this beleaguered system.
Author’s Disclosures: The authors report no conflicts of interest. You can read our disclosure policy here.
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.
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