Hey, Steve Eisman here. So today we're

going to interview an analyst who I have

known for a very very long time, decades

in fact. He covers the life insurance

sector. His name is Tom Gallagher. He

really knows his stuff. And the origin

of this interview is that few months ago

we interviewed Tom Gober who is was a

life insurance examiner and is very very

nervous about what's going on in the

life insurance sector with respect to

private equity owning life insurance

companies and I wanted a second opinion

and so I approached Tom who came in and

is we're going to talk to him about that

and about his sector as well and I'll be

back afterwards with some conclusions

this coming Wednesday, June 17th on

Premium, we're dropping an interview

with Professor Ben Zaperski of Forom Law

School who teaches tors and [music]

we're going to discuss all the lawsuits

against Meta and Google that accuse the

companies of addiction [music] models.

We're going to discuss with Professor

Zaperski the legal theories underlying

these lawsuits and what he thinks about

them. Hope you tune in. [music]

Hi, this is Steve Eisman and this is

another episode of the real Eisman

playbook. Few months ago, I did an

interview with a former life insurance

examiner, Tom Gober, who was extremely

critical of the role that private equity

plays in the life insurance sector. Got

a lot of great feedback from that

interview. But I felt given how a

important this topic is and b how

controversial it is, it would be a good

idea to get a second opinion. So today

we have the second opinion. Someone I've

known for decades and I trust, Tom

Gallagher, who is the life insurance

analyst at Everore. Tom, welcome.

>> Thanks, Steve.

>> So

where do you stand on the whole role of

private equity? I mean, we're going to

go through data. you wrote a great

report about it, but let's do a

summation. Where do you stand on the

whole role of private equity in life

insurance sector these days?

>> Sure. So, really beginning with Apollo

purchase of um a vehicle of a fixed

index annuity writer in 2012, American

Equity Life. That was what was

originally called and I believe they

bought it from Aviva. Um and so that was

their operating platform that they

acquired back in 2012. And then they

eventually uh and then it was called

Athen. They took Athen public and then

>> the stock did not do well.

>> Did not do well and they took it private

and then took it back private.

>> That was the first uh serious uh

entrance of private equity into the life

insurance space. And now there's

obviously a number of more players in

the space.

>> Why don't you list the players so

everybody know? who they are.

>> So, the big ones are KKR. Apollo's the

biggest. KKR is the second biggest.

>> And what does KKR own?

>> They own Global Atlantic, which was um

>> mainly a uh an entity that Goldman Sachs

had bought. So, they bought it directly

from Goldman Sachs, which was the former

uh All-America Life Insurance Company.

Um so, that uh so that was the the the

other big direct operating platform that

was bought. Carile group bought a piece

of the AIG spin-off as well.

>> What spin-off? Corbridge.

>> No, it was a it was a piece of Corbridge

that was bought out of the old AIG.

>> Okay.

>> And but at this point, uh it is not

wholly owned by Coral Group. It's 10%

owned by Carlile Group and the other 25%

is owned by a Japanese insurer, but it's

effectively the vehicle that Carile

Group uses. And then the other

Blackstone has kind of been in and out

of the business on a direct basis. They

currently have an operating model which

is acquiring stakes in insurance

companies like Corbridgeidge. They own

10% of

>> and then Corbage is merging with uh

>> Equitable. That's right.

>> And so they're more uh a minority stake

buyer, but they manage a large portion

of different portfolios. So that's been

their approach. Those are the big four.

>> So before we get to like what you think

about it,

>> right?

>> Why don't we talk about why like like

clearly private equity likes something

about the life insurance sector,

>> right?

>> What is that thing? Like what entices

them to what entices Apollo or KKR to

say to themselves, I want to own a life

insurance company?

>> I think it's the permanent capital

vehicle. Their view is they think they

will win on the investment side. They

have better investment capabilities and

they see how conservative the

traditional life companies are and their

view has been we don't have to stretch

or run particularly hard to earn a

better riskadjusted return on the

investment portfolio and so we think

we'll be able to win and grow better

than the traditional life companies and

that growth will be funneled into our

investment management businesses where

we'll collect 40 50 basis point fees. So

the view is we'll be able to use these

insurance companies as vehicles to

really fuel growth in our asset

management capabilities.

>> Okay. I mean that has merit, right?

These are very very long liabilities,

long-term liabilities. What is your

research show? I mean Tom Goldber's

argument, at least part of his argument

was that

private equity is taking on much more

risk than the than the the traditional

companies and we should all be nervous,

>> right?

>> What does your data show? What do you

think?

>> So, they do take more risk based on the

work we've done. They take more risk.

I'll just give you some numbers. The

average yield when we looked at private

credit portfolios and we saw the average

private credit yield of the traditional

life companies was between five five and

a half and the alternative managers was

66 and a half. So it's probably an extra

100 basis points is what they're

managing if you did a like for like

analysis.

>> And how much risk do you think they're

taking to achieve that extra 100 pips?

>> I think most of it's illiquidity.

um which which is a real risk if you're

managing a fixed annuity block where the

liabilities could be surrendered

liquidity matters. So I'm not I'm not

going to dismiss that as as a real

issue. I think it's mainly on the

liquidity side. I think they're more

willing to go into structured

>> uh securities instead of uh direct

corporates. So that's another area.

>> What do you mean by structured

securities? So it could be a gamut of uh

buying more CLOS's

uh ABS, it could be something esoteric

like aircraft leasing. So it kind of

runs the gamut in terms of all the

different types of structures.

>> Do you worry about this? Do you worry

about the risk that they're taking on

cuz Tom Gover was freaking me out?

>> Right. Right. So I would say I don't

worry too much about it from this

perspective.

The one thing the industry I think has

done a reasonable job at is and starting

from the traditional life companies they

really do run at a zero loss cost model

or a zero loss expectation model meaning

they don't really invest to maximize

riskadjusted returns. They're not out on

the efficient frontier. there is this I

would say overly conservative bias that

this is a traditional traditional not

the alternative managers and so when I

see an extra 100 basis points that the

Apollo and the KKRs are getting and then

I looked you know we looked at like the

top 30 to 40 private credit positions

just to see bond by bond all right what

are they investing in does this scare me

just to do kind of a gut feel eye test

the risk that they're willing to take is

is they go bigger. So they'll they'll

take bigger concentrated positions,

probably twice as big as a traditional

life company. So once they find

something with better risk adjusted

return, they'll go bigger. So they don't

mind being more concentrated. Uh but the

um I wouldn't say there was anything in

there that raised alarm bells where I

thought like you're not finding

portfolios that the BDC's have, right?

where there's I 10 11% floating rate

debt where in software companies where

you know there's probably some level of

losses that are

>> you're not finding that in the insurance

>> not really finding that I'm not even

finding that in a big way for these

alternative managers I would say um

where they will tend to pivot is more um

into areas where there is more

uncertainty like CLOS's like they'll I

think there's a comfort that they have

in buying the single single tripleB

tranches of CLLOs's none of the

traditional life companies touch that

>> and it's almost like they need 30%

subordination which you know we live

through the GFC together we know the

subordination

matters and then there's mark tomarket

which can become a bit of a spiral

depending on you know what the market

environment might be but I would say

what I find is there's a willingness of

the alternative managers to go bigger

and to take, you know, we'll call it

category risk where the underlying

credit is probably fine.

>> Okay. So, you're you're comfortable with

the credit as far as you can tell.

>> As far as I can tell, I have not found a

smoking gun. Now, are there when I go

down the curve and I look at some of

these like midsized

um sort of quasi alternativebacked

insurers, I I do find more evidence of

higher risk portfolios.

>> Like, who we talking about?

>> I'll just throw one out there. Security

benefit life. Like I don't want to get

into naming every name, but like if you

look at some of these investment

portfolios and they're like a top 10

fixed index annuity player. Sammons

Group's another one. So I found and I'm

not saying like these are like horribly

run companies, but if you were to say

where when I kind of do a deeper dive on

these investment portfolios, where do I

see there being more risk? And in the

event of a severe credit downturn, would

I be worried that there would be some

pressure? I think you're probably not

going to find it among the largest

alternative managers. You may find it

among these midsize players who were

pretty legitimate players in the annuity

space.

>> Let's talk about the role of reinsurance

in the space because that was another

thing Tom Gober spoke about and he also

flagged reinsurance in the Cayman

Islands as being being an issue.

>> Yes.

>> You've been covering this sector for a

long time.

>> Yeah.

Just describe to our viewers the role

just the general role of reinsurance and

should I be worried about what's going

on in the Cayman Islands?

>> I'd say Bermuda no Cayman potentially.

>> Well, just describe what reinsurance.

>> Essentially what's happening is the US

statutory regulatory regime is very

conservative. So there's this view that

these low discount rates that are used

and in a [clears throat] conservative

way by the regulators and some other

assumptions that are used embedded in

the reserving are just far too ownorous

and conservative. So there's been this

movement to reinsure

away through both the use of captive

reinsurance, through third-party

reinsurance to alleviate this overly

burdensome conservatism that the reg

certain state regulators require. And so

it's been an accepted practice for

better part of 20 years that the

regulators are willing to allow these

transactions because they acknowledge

that there's some over overconervatism

in their rules

>> and they don't want to change their

rules.

>> Yeah, that's the thing. They didn't

necessarily want to alleviate the rules,

but they are willing to permit some

transactions that allow

companies to reinsure, meaning taking a

book of business and transferring it to

it. It may in some instances be an

internal reinsure that they set up in

Bermuda or the Cayman's. Essentially, it

unlocks the conservatism.

And in some instances when it's a third

party reinsurer or they allow a letter

of credit um there there's various

mechanisms and means to alleviate the

conservatism.

>> Now what are people worried about when

it comes to the Cayman Islands?

>> I think the view is that Bermuda might

have started out as

uh less conservative than US statutory,

but over the last several years it

actually has become maybe as

conservative, if not more conservative.

And so as a result of Bermuda no longer

being kind of a jurisdiction where you

can use regulatory capital arbitrage

except for discount rate that was like

the only thing that's allowed anymore.

The view is well we need to find or we

hope to find another less more lenient

regulatory jurisdiction and um in

Cayman's is one of those. Now there's

not a lot of transparency. There aren't

even that many companies using it. I

know of maybe four or five that have

moved some uh form of liabilities or

some proportion of liabilities to

Cayman's. Yeah. So that anyway that's

that's kind of the the genesis of how

how this how this happened.

>> Okay. I have another reinsurance

question which has plagued me for a long

time and I've never gotten a good good

answer to it. I'm a life insurance

company

and I'm going to and I reinsure my book

to my own captive reinsurer,

>> right?

>> How is that allowed? How how how just

how is that allowed that I can reinsure

my book to myself?

Like like how like like why would a

regulator just say you want to reinsure

your book? Go reinsure with a third

party. That's legit. Like how how is

that allowed? So the I think the reason

it's been allowed is and you have

certain jurisdictions like Japan for

instance and the rules and regulations

have been so punitive

they want to help companies alleviate

some of the pressure. They ultimately

still want to preserve regul regulatory

jurisdiction over their businesses. And

the fear I think for the regulators that

are allowing this is like okay we

recognize it's very conservative. We

don't want companies exiting our

jurisdictions.

>> Okay.

>> So it's almost an accommodation because

the fear is

>> we're going to end up regulating no one

in the end and they need to generate

revenue and they need to be have

regulatory oversight. So I think it is

that it is simply the the recognition

that if there are jurisdictions in the

world that are far more lenient than we

are, um we run the risk of having

everyone leave uh our state.

>> Let's change gears. Let's talk about the

public companies.

>> Yep.

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>> You've been covering this group for a

long time. 50,000 foot view. How has the

sector changed over the last 20 years?

>> The biggest change that I've seen is 20

years ago there was very little

recognition of tail risk. And by that I

mean they were selling variable

annuities.

They were sell selling secondary

guarantee universal life and they were

selling long-term care,

>> right? And that went on for probably a

decade. And then the GFC hit and then we

got into a much lower rate environment.

And literally the scourge of the

industry from probably 2010 through 2020

was those three long duration

liabilities

blowing up the industry.

>> So let's go let's go through all three

for a second. So long-term care I get in

that you made an assumption that people

were going to live to I'll make up a

number 75 and now they're living to 85

and they're all in they're in nursing

homes and you got to pay for it and you

price for that right

>> that's easy what what's the what was the

risk that emerged from selling variable

annuity products

>> the variable annuity product problem as

[clears throat] I see it was a

combination of they were selling

embedded payout guarantees

that were in both interest rate

dependent and equity market correlated.

>> So give an example like what what a what

one of these guarantees would look like.

>> Sure. you would sell a product that

would guarantee you to pay out um it

would guarantee an annual roll up of 6

to 7% a year and then call that the

notional guarantee and while you were in

the the accumulation phase and then in

the payout period it might guarantee you

a certain minimum interest rate

guarantee as well uh for as long as you

live. So think about it in the in the

accumulation period you were guaranteed

to get six to 7% right

>> and then once you start a payout it

might guarantee you three to 4% in in

the stream of uh income payments

>> and why did that turn out to be a

problem

>> it turned out to be a problem because

companies were allowing the uh the

participant to invest in predominantly

equities

>> right

>> and they were hedging it with we'll call

it one year in some cases three month

options on the in terms of equity

derivatives that were backing it. And

what ended up happening in the GFC was V

spiked. They had essentially a

threemonth derivative book and had they

rolled it in the middle of the GFC, they

would have crystallized massive losses.

So they had very short hedges.

>> They've got three-month hedges,

>> right?

>> GFC takes place,

>> right? you're about to roll over your

hedge and the cost, let's say, tripled,

>> right?

>> Okay. So, just pay triple. Why is that a

problem?

>> Um because it would have crystallized

large real-time losses and the companies

were running out of capital.

>> And they were running out of capital.

>> Yes. And they they already had credit

problems. They were dealing with

markettomarket issues.

>> Couldn't afford it.

>> Um and and so essentially the variable

annuity books went naked or at least

some of them did. and and it sort of

showed shine a bright light on they were

selling 20-year duration guarantees and

managing it on the asset side with three

months assets three month assets

>> generally I get alum that was mismatch

that's a big mismatch okay so you're

saying they had a 20year liability which

they were managing with threemon options

>> that's right okay I get that and what

was the third product that was a problem

>> the third products were something called

secondary guarantee universal life

insurance.

>> Okay, that's a that's a long sentence.

What does that mean?

>> That is very high interest rate

guarantee life insurance which assumed

that lapses

uh would be run between

>> what's a lapse?

>> A lapse is we just say I'm cancelling my

my contract.

>> Okay.

>> And they assume lapses would run in the

mid to high single digits

>> and they ran

>> and they ended up running at 1%. because

people were getting paid high interest

rates.

>> They were very you couldn't get interest

rates like that in the market.

>> Okay. Oh, so this is why after interest

rates collapsed after after the GFC you

they were paying out here and rates were

here so no one's going to lapse,

>> right? And it also was something we were

discussing earlier about this is also

part of the trade where you had stranger

own life insurance when there were also

brokers buying life insurance contracts

from investors because they realized

there was this lapsarb that existed in

the market and there was aggressive

pricing that existed on that type of

product.

>> Okay. There's a recognition by the

industry now that they have they have to

deal with tail risk. So what have they

done?

>> So it's fascinating. It's there's been

the biggest transformation that I've

seen in my career for the last three to

four years. You've had an enormous

amount of risk transfer that's taken

place. So variable annuity blocks

transacting secondary guarantee

universal life.

>> Explain risk transfer. What is that?

What does that give us an example what

does that mean?

>> I'll give you an example. So equitable

Voya did a very early one but then more

recently equitable this was probably

four years ago. Um uh there was a

company that was set up by Apollo called

venerable who said we will assume your

variable annuity risks. You'll have to

give us all the capital backing it and

you'll have to give us some other

profitable block along attached to that

and we will take that risk over visav

reinsurance structure and it was a well-

capitalized company. It was um you know

I think there were plenty of private

equity backers including Apollo uh that

backed this company and so now this

company venerable has probably bought in

four or five big blocks of variable

annuities.

>> Now why do they think they can manage

this risk?

>> The main difference is they're not

trying to hedge quarterly. So they

venerable bold figured out you can't

really profitably hedge the business on

a quarterly basis. We need

>> too expensive

>> way too expensive. So we need two to

three years

>> and we think two to three years of

hedges is a proper alignment. It's still

mismatched but it's not three months.

>> Right. Okay. So the hedges are cheaper

when you go out two to three years as

opposed to 3 months.

>> Yes. And they're buying more static

hedging. They're not trying to be more

real time dynamic

>> and the public companies can't do that

because they don't want the volatility

in their earnings.

>> That's right.

>> Right. Okay. Got it. Which brings up a

question.

>> Um I'm going to list some numbers for

you because what what you're saying is

that this industry has basically been

transformed

in that the longtail risks that they've

had are not there anymore.

It's not that they're not there, but

they've definitely they've shrunk.

>> They've shrunk and they've been laid off

to other people. And so it's it's not

you could you maybe you could sleep at

night whereas before you you maybe you

didn't sleep so well at night.

>> It was a bit of a whack-a-ole. Every

other year there was there was a blow up

in the industry.

>> Okay. So here's here are the my numbers.

Okay.

>> These are the 2026 pees for the stocks

that you cover. Okay. Corrid 5.6, Six

equitable 5.8 AFLAC which we'll talk

about and you have a cell rating 16

times unusual for your sector Lincoln

poor Lincoln 4.6

Unum 9.5 RGA 7.5 PU 7.4

Voya 8.6

Met 8.4 for Con the former Conco 10

times and poor Bright House 3.3 times.

My question is

like some of these companies sell at

multiples like take let's take Lincoln

which has been around for a very long

time,

>> right?

>> Um we both know the CFO, he's excellent.

It sells at 4.6 times the 2026

earnings per share. number and and by

the way if Lincoln ran its its book the

way let's say Athen does

all that would do would mean that the

earnings would be somewhat higher

>> right

>> but whatever people are worried about

with respect to this 4.6 six multiple

they'd still be worried about.

>> Yes.

>> So my question is let's just start with

Lincoln.

>> Yeah.

>> 4.6 times is a shocking multiple. Why?

So I think it's a combination of

you have now worry in private credit and

but it's been this multiple forever.

It's it's really corrected

uh more recently during the 2022 blow up

that they had on SGL. So they took a $2

billion charge.

>> And what was that related to?

>> That was related to their ultimate

reserving assumptions for the mortality

for the lapses

um and for interest rates was off

>> on in which part of their book?

>> In the secondary guarantee universal.

>> The secondary guarantee book. Okay.

>> So, they so they blew up on that book.

>> They blew up on that book and now they

so they took their medicine on that.

They've been slowly rehabbing it and

healing. Uh, at least I think they have

been. And meanwhile, what you've had is

I'd say the whole annuity space,

including the alternative managers that

operate in the annuity space, went

through this period of 2023 into mid24

where they all had this great run where

spreads expanded. And so we all saw

interest rates moved a lot higher. Uh

industry sales doubled during that

period. Now that's wasn't net flows

doubling. Some of that was just

recycling of old business. But you had a

real spread expansion and headline sales

were going up. There was some real

enthusiasm for the annuity space. But

the downside of that emerged, you know,

we'll call it at some point into 2024

into 25 where the roll off. It was like

the initial surge of yield was viewed

positively and spreads, but then these

legacy very lowcost liabilities started

rolling off and suddenly spreads started

getting squeezed across a lot of these

annuity players including Apollo and

Athen

>> right Apollo has been having problems

with their net interest margin now for a

couple of years.

>> Yep.

>> And it's for that reason.

>> It was for that reason. It was the roll

off of these lowcost liabilities which

we all saw the beginning of that which

was great. Spreads expanded and then the

combination of the Fed beginning to cut

>> right

>> and the roll off of these lowcost

liabilities pressured spreads. In the

meanwhile, the industry worry emerged on

private credit and in my view that was

much more of a function of uh the real

world implications of retail private

credit flows turning negative and which

is which is a real issue with uh we'll

call it terminal growth rates for these

companies which has nothing to do with

the life insuranceers mind you but they

are now they are permanently linked

because they're competing with each

other side by side.

>> Who's competing with whom?

>> Meaning the Apollos and the KKKRS

and and the Cariles are all uh competing

with the life insurance companies in the

retail annuity space.

>> Yes.

>> So if you're a big retail annuity

company,

the view was we've got spreads

compressing. We've now got a new private

credit worry. And even if you got not

much of what they have, I think the

market was sort of conflating the

deceleration of growth and the outflows

with there's real world blowups coming

in actual private credit and that hasn't

actually happened yet. Maybe it will

happen to some degree, but it actually

hasn't happened yet. I'd say the

combination of those two things. And

third, this view that there's a

competitive knife fight now and they

brought a spoon to a knife fight.

>> Well, what's the knife fight? The knife

fight is the alternative managers are

going to take more investment risk and

all the traditional life companies are

going to seed share. That's that's the

worry anyway.

>> I see. Okay.

>> And that's why Lincoln is in the

situation. It's in equitable corridor.

So let me ask a simple question. There's

PE and there's capital and there's cash.

I mean Bright House 3.3 times. Why

aren't these companies or maybe they

can't but the obvious question would be

if if you're running a company where the

market is saying you're worth four times

earnings right you should say screw you

to the market I'm going to buy back my

stock like a lunatic

>> I bet these companies don't buy their

stocks back like like that why why

aren't they buying back their stocks

like like insane

>> you understand my point it's a great

question obvious question you you should

slowly be going private if if if the

market is like like Bright House 3.3

times earnings. You should be buying you

should be taking every dollar you have

buying back your stock and just go

private,

>> right?

>> Why why are they doing that?

>> Bright house is being acquired by

Aquarian. So that that one's

>> okay.

>> Separate.

>> Separate.

>> But Lincoln is not buying back stock

today, right?

>> Corbage Equitable have been buying back

stock. Could they do more? Probably. So

why aren't they buying back stock? It's

it's a fascinating situation in my view

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I think one of the problems that the

life sector has had is that they're

bordering or entering into the realm of

irrelevance for the for the broader

market. So I'll tell you what I find

investors

who have who can invest in insurance

they like PNC over life. Why? Because

there's a bunch of 100 billion plus

market cap PNC.

>> I can buy chub.

>> Yeah, you can buy chub. large liquid,

>> right?

>> And

>> travelers,

>> right? And a lot of these life

companies, they buy back stock and they

go and their market caps never go

anywhere. And the the smaller they are,

the less relevant they are to benchmarks

of these investment professionals. So,

>> so there's this weird balancing act

going on. They know it's an ROI home run

to buy back stock at these valuation

levels. Yet, they don't want to shrink

themselves into obscurity from being

relevant to investors.

>> They're already obscure. [laughter]

>> What? What? Don't fight it. Embrace it.

Just buy back your stock. It's insane.

>> It's an interesting situation. the I

would say Bright House before they got

themselves into some real difficulties

with hedging uh had been buying back

stock pretty aggressively. Um you know

and they they were a little bit of a

one-off because that one had so much

legacy variable annuity backbook and

they have also SGL so they have some of

the the biggest tail risks out there. So

I would say they were somewhat unique in

that they still had a lot of liability

risk.

>> But for the companies that don't like

>> Lincoln no longer that risky anymore. I

mean they've shrunk the size of the the

truly toxic SGL

and equitable corridisms

themselves like they should be pursuing

a path of much greater share repurchase

as a result. They well those two have

been sort of methodically

doing buybacks that are maybe eight% of

market cap a year. So it's like

something it's not they haven't gone

crazy with it.

>> They should be going crazy. By the way,

what's the point of the Corbridge

equitable deal? Like why? I think it's

to me it's pretty simple when you look

at a commodity industry and fixed

annuities and fixed indexed annuities

are a commodity right it's like what

interest rate can you guarantee me

>> in in the in in the in the heart of it

in terms of what the what the core value

proposition so how do you win in a

commodity market you get bigger you have

scale you have either distribution or

scale advantages and I think this deal

is a recognition of that and I also

think they've kind of taken a bit of the

alternative manager playbook in mind and

their view was like because bear in mind

this came out in the merger proxy

equitable is the one pursuing corbridge

not vice versa and I think what

equitable looked at was we own 69% of

alliance Bernstein we would like to feed

that asset manager much more flows if we

can well corebridge

generates 55 billion of annual fixed

income flows and right now they're

sending them off to Blackstone and Black

Rockck.

>> Oh, so this way you internalize it.

>> You internalize it. So you think about

what that would do to the embedded value

of Alliance Bernstein if you send them

an extra 55 billion of flows every year.

>> Pretty pretty powerful that that alone

could be reason enough for doing the

deal.

>> Let's go back and just talk about

long-term care for a second because it's

a bit of a morality play. This this is I

mean I remember every couple of years

one of the major insurance companies

would literally just blow up into

smitherreens because of their long-term

care book. GE blew up like $15 billion

is stunning. What happened to this and

and and and what has the industry done

to sort of protect itself now?

>> Sure. When that business was first

priced it was sort of

>> and this would be like the early 2000s.

>> Early Yeah. And even even before that

Yeah. It was like in the 90s into the

early 2000s, the view was we're going to

have this other hot uh health product

and they were selling Medicare

supplement and they said, "Oh, we can

get senior citizens or people entering

into senior citizen territory to buy

this product that's going to ensure them

against nursing home coverage." And

we'll price it like meds, which lapses 8

to 10% a year. At the time, interest

rates were much higher and you know the

average claim might be a year maybe 18

months based on

>> so if somebody goes into a nursing home

they live 18 months you pay for it the

person dies. That was basically the

assumption.

>> That was it. That was the assumption. So

fast forward 10 years later, 15 years

later, what ended up happening was

interest rates went down a lot. So that

interest rate assumption uh was off. The

>> by a lot

>> by a lot. Um Alzheimer's was diagnosed

as a disease I think in the early 2000s

and that was a claim where people could

live a lot longer but live in needing

>> care

>> care in you know assisted living

facilities and the like and so which

meant claim durations were a lot longer

than they had assumed

>> right

>> and then as a result of those first two

things lapses weren't 8 to 10% they were

less than 1%.

>> Right? Because

>> because this this this policy was gold.

>> The policy was gold.

>> It was completely mispriced.

>> Very mispriced. And so it was and

importantly, you were way mismatched on

ALM, asset liability management, because

you were you weren't getting all the

premium upfront. You were collecting it

over a 30-year period. Right? So, your

interest rate assumption uh that you

priced in the beginning of the policy

was off immediately and you didn't have

the cash to invest until like you knew

that those future cash flows were going

to be underwater on your interest rate

assumptions. So, they kind of were o

they were 0 for three on all three

assumptions which

>> by a lot

>> by by not by a little by a lot,

>> right?

>> And so, yeah, the industry has kind of

been paying the price on long-term care.

Now, it took a long time for these

charges. If I look at the history and

when the detonations happened on a

reserving basis, GE was the big one in

2018, right?

>> So, the problem really began in 2000 and

took 18 years to actually manifest

themselves in accounting charges. 18

years.

>> Wow.

>> And it had to do with the fact that the

accounting

>> um didn't require you to take margin

impairments. It was a profit or loss

determination. Meaning if you had any

margin in the product, you could wait

and didn't have to change any of your

underlying assumptions until you

generated a loss on the entire block.

That's why you had 18 years before these

charges began.

>> And where are we today with long-term

care?

>> So,

>> who has it? Who still has it?

>> GE still has it at they they took their

$15 billion charge and they're in there

predominantly as a reinsurer. Um the

Genworth is still there in a very major

way. Manulife which bought John Hancock

is the other very large player in the

market. Metife, Credential, Unum. CNA

the PNC company has a big block of

long-term care.

>> The mutuals are all there like some of

the big mutuals, Northwestern Mutual,

New York Life. The interesting thing is

starting about two years ago, you had

the beginning of risk transfer and

Manual Life has done two deals and Unim

has done one deal. And who's taking the

risk?

>> Munich Re and RGA partnering with

alternative managers who are taking the

investment risk and they are taking the

liability risk on the traditional

reinsurers.

>> Sounds, you know, from all this stuff

that you're talking about, it just

sounds like the um the insurance

companies that are managed by the

alternatives are eating these companies

lunch

>> or is that not accurate? I would say

that's certainly the perception and they

did outgrow them for a number of years

but I would say when I look at the

investment portfolios and I look at

where where business is moving um it's

not as bad as I think commonly perceived

like corbridge equitable they're still

growing on a on a net flow basis so

they're not

>> you know you would think they'd be

shrinking given how big players they are

in the market now. Lincoln is shrinking.

You know, that's one company that is

right now in net outflows in their uh

retail annuity business all in which has

more to do with their legacy variable

annuities being in runoff than it does

losing and seeding share on the fixed

annuity side. But I would say I'll tell

you what I think's happened from an

evolution standpoint.

There are certain channels where rating

and brand might have been less relevant

and the alternative managers and even

some of these smaller alternative

sponsored companies took significant

share. They've more aggressive pricing

and you know while especially when rates

were higher they were able to offer

somewhat better guarantees and they grew

significantly faster than the

traditional companies. But there's

probably let's call it half of the

industry

uh where the wirehouses and some other

captive distribution channels where I

don't know that the alternative managers

are ever going to really dominate

because rating brand legacy still

matters and I would say there are

certain distributors um that still look

at that and they say okay fine Apollo

and KKR they're very well-known brand

household names at this Right. All these

other players, who are they?

>> Right. Exactly.

>> Yeah. Do we really want to be on the

hook for an extra 50 basis points of a

guarantee? Probably not.

>> But you know, the pro the problem that I

have just with the sector is sort of

getting back to the point that I made

before, which is you got a sector that's

competing with these alternatives who

are taking more somewhat more risks and

for every dollar of capital they're

making more money because they're

getting a higher yield,

>> right? But if the public companies were

to do exactly the same thing to compete,

it wouldn't help. They It's not like

It's not like, you know,

>> give it back in multiple.

>> Exactly. So, in other words, Lincoln

sells it 4.6 times. I'll make up a

stupid number. It's, you know, let's say

the earnings are $3. So, it says 4.6

times $3. So, if the earnings were 320,

maybe it would sell at 4.5 times 320.

Like, like the the public markets don't

care,

>> right? It's not like they can they can

compete with these guys and and all of a

sudden say, "Oh, thank god these guys

are competing. We're going to give them

a much better multiple." It's not going

to happen,

>> right? I think the the tell will be the

equitable Corbridge merger. Their I

think their vision was okay, we can

accelerate growth in Alliance Bernstein

if we merge, but importantly, we can

either take more investment risk and

compete or we can have a better

efficiency expense ratio, right? and

we'll get a lot and they chose the

latter. I think it's either or you are

like there is this issue well there be

there's a certain part of the

distribution

uh we'll call it uh regime where you're

probably always going to want to sell a

traditional insurance product

>> which is fair but on that other part of

the market like are you going to get

your clock cleaned probably unless

you're able to compete on scale or

you're going to have to take more

investment risk it's one or the other so

I do think Lincoln has a has an issue to

consider here and I think they probably

looked at the equitable Cbridge merger

and said Houston we have a problem. So

like okay like my solution go buy back

your shares because there's no deal that

would have a better return than buying

your shares at 4.6.6.

There's no there's no there's no M&A

deal that that gives you a better

return.

>> Yeah. and Lincoln is probably a year

away from that. If I look at like what

their capital plan is and their capital

generation and cash flow, I do think

they're they're getting closer to being

at that point.

>> Okay.

>> So, it's not it's not never like they

they just they had a capital issue that

was crystallized several years ago and

they're on their way to repairing it and

healing it. And I think they they have a

pretty cost prohibitive preferred that

they want to take out in 27 that is like

9 12%. So they got to get rid of that

first or or re refi half it get rid of

half of it maybe.

>> Okay.

>> So they will be back and and I think

they will have that uh they they will be

at the point where they will be buying

back stock reasonably aggressively.

>> Okay.

>> Tom, thank you.

>> Steve, thanks.

>> That was great.

>> So that was a great interview. Couple of

takeaways. Tom is not that nervous about

what private equity is doing in life

insurance. He thinks they are taking on

some amount of extra risk, but not an

insane amount of risk. Although he is

nervous about some of the smaller

companies out there that he thinks may

be taking on too much risk. But in terms

of the large alternative insurers, he's

actually comfortable with it. And I was

kind of surprised by that. But he's

covered the sector for a very, very long

time. And then we just talked about the

sector generally. This is a sector

that's been out of favor forever. The

problems are that they've had major

blowups over the last few decades with

longtail businesses from long-term care

to variable annuities. And people

basically just don't trust these

companies. And that's why some of these

stocks sell at three to five times

earnings. and I pressed him about the

fact that these companies should be

buying back stock like crazy and he

agreed they should but they don't. So I

I don't think there's a lot to do in

terms of investing in the public

companies but it's a it's a fascinating

space and it's a space that we need to

keep track of because of the

alternatives. See you soon.

This podcast is forformational purposes

only and does not constitute investment

advice. The hosts and guests may hold

positions in [music] stocks discussed.

Opinions expressed are their own and not

recommendations. Please do your own due

diligence and consult a licensed

financial adviser before making any

investment decisions.

[music]