“Sidecars” are reinsurance vehicles formed by a sponsoring insurer with the support of third-party investors infusing capital and, in some cases, providing other services (such as asset management). While sidecars have been a common structure in the U.S. property and casualty (P&C) industry, their use has become a more common theme (again1) in the U.S. life and annuity (L&A) industry, with growing interest as a topic among insurance management teams and third-party capital investors and asset managers.
Figure 1: Hypothetical sidecar structure
Recent examples of L&A sidecars are noted in the table in Figure 2.
Figure 2: Recent L&A Sidecars
|2020||KKR/Global Atlantic||Ivy Re|
|2021||Eldridge/Security Benefit||SkyRidge Re|
The purpose of these newer L&A sidecars is quite different from the ones in the earlier part of this century, and the following sections in this article aim to provide an overview of:
- Why sidecars have grown in relevance recently
- Key considerations for sponsoring insurers and third-party capital providers
- Potential next steps for sponsoring L&A insurers and third-party investors
What’s driving the interest in sidecars for the L&A industry?
Taking a step back, the L&A insurance space, both in the United States and globally, is being reshaped by changing strategic imperatives that have led to a wave of transactions to recalibrate L&A insurer companies existing books of businesses and future business plans. Underpinning the transactions has been the entrance of new, private capital, including the world’s leading asset managers (e.g., Apollo, KKR, Blackstone, Carlyle, etc.).
Sidecars provide a structure via which L&A insurers can access third-party capital and new capital providers can support insurers in de-risking their balance sheets, gaining exposure to L&A insurance platforms. Further, these third parties can also bring other forms of expertise, such as asset management capabilities, to enhance the economics of the overall sidecar.
The premise of a sidecar advances the argument to “unbundle” an insurance block’s core return drivers, allowing different parties to focus on their individual core competencies. For example, the sponsoring insurer may be a leader in mortality risk underwriting, but can leverage the asset expertise of a global asset manager that wants to participate via the sidecar, while a sovereign wealth fund looking for insurance exposure may be able to bring capital at a lower cost of capital than the sponsoring insurer’s current capital cost.
Sidecars can serve a multitude of strategies while engaging in the L&A space, such as in-force block reinsurance, flow reinsurance for new business, and pension risk transfer, to name a few. Each sidecar must harness the core competencies of its sponsoring insurer and third-party investors and service providers. Identifying the sidecar strategy while balancing the required returns (and timing of capital and fee distributions) for the various sidecar investors becomes a critical arena of analysis prior to the official sidecar launch or capital raise.
Key considerations in developing a sidecar
Considerations for sponsoring L&A insurers
A sponsoring L&A insurer should start with asking a key question: does using a sidecar create more free surplus for itself and/or make its product(s) more competitive? Other key considerations include:
- Regulatory differences
- Bermuda has been a common jurisdiction for the formation of the recent L&A sidecars created by U.S. insurers.
- Bermuda is often thought of as allowing for less total required assets (TAR), reserve plus capital, for asset-intensive blocks, but that is predicated on an asset strategy that enhances portfolio yields and reduces asset-liability management (ALM) mismatch under the Bermuda reserve and capital calculations.2
- Asset management expertise
- Is asset management a core competency of the sponsoring L&A insurer?
- A core thesis of the recent offshore sidecars has been the ability and expertise in asset management that takes advantage of the offshore regulatory framework. To the extent the sponsoring insurer does not have the asset investment expertise, it may encourage the partnership with an asset manager for the benefit of the sidecar vehicle.
- Alignment of interests (economic and governance)
- One of the key areas of analysis is the “overall return” afforded to the various sidecar investors.
- For example, an asset manager may not only earn asset management fees but may also have a capital-invested component that has an equity-like return expectation versus a different third-party exclusively investing capital with a deal targeted to provide a more debt-like return profile.
- Sidecar governance structure and protocols (such as board representation and managing conflicts of interest) is another area that is vetted to ensure alignment of interests.
- Sidecar reinsurer as a “call option” for deals
- A consideration we have discussed with clients is that having a sidecar, especially one with access to “on-call” capital, may allow insurers a greater ability to transact opportunistically if a large, attractive deal is presented. (There have been a few instances in our experience where buyers found themselves capital-constrained and unable to do a deal.)
- A Bermuda-domiciled sidecar provides increased optionality because in addition to having reciprocal jurisdiction status with the United States, the Bermuda sidecar would also be granted Solvency II equivalency, thus allowing the sponsor and its investors the option to transact with European (re)insurers for liability books of businesses.
Considerations for third-party investors
Third-party capital investors can play various roles in their partnership with a sidecar’s sponsoring L&A insurer.
- Clarity of purpose of the third-party investor
- Is it exclusively a capital provider, or can it also be, for example, an asset manager for part of the sidecar’s assets?
- In some cases, an asset manager may be able to provide access to a private lending platform that is inaccessible to other portfolio managers, or a capital provider may have a different and/or a lower cost of capital.
- Underwriting proficiency of sponsoring insurer
- For any investor committing capital, or looking to serve as an asset manager, understanding the quality of the sponsoring insurer’s product underwriting (including underwriting for M&A and reinsurance deals) is of critical importance for the business that will be part of the sidecar.
- Unlike investing directly into the sponsoring L&A insurer, a potential advantage for sidecar investors is that exposure is limited to the exclusive blocks of in-force and future business reinsured into the sidecar, as opposed to potentially a wider array of blocks and risk exposures at the sponsoring L&A insurer.
- The subject is broader than just actuarial assumptions used, but consideration must also be given to how the product sales were and are generated (e.g., what is the distribution channel, and how sticky is the business).
- M&A or reinsurance track record of the sponsoring insurer
- To the extent the sidecar serves as a platform for aggregating legacy blocks from other (re)insurers in the industry, investors must look to a sponsoring L&A insurer’s track record in doing deals (both executing and then managing to or exceeding the deal’s original pricing expectation).
- Structure of the capital investment
- Some sidecar opportunities assume the capital invested is perpetual in nature, whereas other structures allow for “exits” at various different points for various different costs (fees).
Potential next steps
For a sponsoring L&A insurer, efforts could be structured around the following three key areas, and would involve coordinating work with advisors (actuarial, banking, legal and accounting):
- Strategy. Prior to the launch of a sidecar, the following are examples of key questions and areas of analysis for the sponsoring insurer:
- Focus on in-force or new business (or both)?
- If in-force, focus on annuity or life or both (e.g., deferred annuities, universal life with secondary guarantees)?
- If new business, what is the impact on internal rate of return (IRR) by creating the sidecar?
- Legal structure and tax implications, e.g., will the sidecar be a U.S. taxpayer?
- Highlight the distributable earnings and IRR implication of moving from a U.S. regulatory jurisdiction to the regulatory regime of the jurisdiction of the sidecar.
- Modeling the distributable earnings impact of using a proposed asset strategy provided by a potential candidate for an asset manager partner for the sidecar.
- A formal report highlighting the actuarial assumptions (and support) and showcasing the economics and distributable earnings of the liability book of business(es) expected to be part of the sidecar.
- An accompanying deal model incorporating proposed structural elements of the sidecar (fees/expenses), including input from tax/legal/accounting advisors.
For a sidecar investor, once it identifies or is approached for an opportunity, its due diligence can be a varied set of activities depending on its prior exposure to the U.S. L&A industry and the level of contribution it can make to a sidecar (asset management expertise). The following is a sample set of efforts we have seen undertaken by investors:
- Understanding the sponsor’s types of insurance products, embedded guarantees, and key risks, as well as getting to know the sponsoring insurer’s sidecar management team
- Reviewing the implications of the U.S. regulatory framework versus the sidecar’s local regulatory framework for reserving and capital
- When applicable, considering and analyzing the implications of alternate asset strategies the investor can help implement
- Review of actuarial assumptions and supporting experience data in a sponsor’s liability book (if an in-force block is included) and/or analysis of pricing reports for a new business product, requesting liability and asset sensitivity scenarios, etc.
- Analyzing the sidecar deal model detailing the distributable earnings or dividend waterfall and the structure of any fees/expenses
As the spate of transactions underpinned by strategic shifts continue in the L&A space, combined with the growing interest from various third-party investors and asset managers looking to enter or enhance their exposure to the L&A space, the topic of sidecars is expected to be a key consideration as part of the U.S. L&A landscape and will likely widen its influence as a topic across the global L&A insurance industry.
1 While not referred to as “sidecars”, a similar concept with a slightly different purpose, referred to as “captives", has previously been quite relevant in the L&A industry during the heyday of the issuance of insurance-linked securities by insurers to support, for example, XXX/AXXX reserve financing (e.g., Rivermont/River Lake transactions sponsored by Genworth in the mid-2000s), where third-party capital was raised in the form of debt financing to support a portion of the term/universal life block’s required statutory reserve.
2 For further background, see the recent Milliman article “Bermuda: Living life (insurance) in paradise,” available at https://us.milliman.com/en/insight/bermuda-living-life-insurance-in-paradise. Milliman’s new Bermuda office is active in assisting L&A (re)insurers with Bermuda specific regulations and actuarial modeling.