Mutual Benefit: How Private Equity is Supplying Capital to US Mutuals
NEWS & INSIGHTS
Publication: InsuranceERM | Written by David Walker
When non-mutual insurers need fresh capital to fund a planned expansion, acquisition or transformation project, finding it is comparatively straightforward. Shareholders and capital markets investors can be tapped for traditional equity or debt structures, often with help from an investment bank. Mutual insurers face many of the same funding challenges, but getting the requisite fresh capital, when one’s owners are one’s policyholders, is a tough task.
The challenge is not lost on Peter Houston, chief growth officer for The Mutual Group (TMG), an Iowa-headquartered firm that provides “aligned capital” for US mutuals.
“Mutuals have great brand recognition, great customer loyalty, a long-term view [to be able to] think about things in years, not quarterly earnings estimates they’re trying to achieve, a very low cost of capital, unique distribution channels that are very hard to disintermediate, and management teams with interesting strategic ideas,” Houston says.
Mutuals have great brand recognition, great customer loyalty, a long-term view
All desirable attributes – but ones that may count for little when structural limitations present hurdles in attracting capital from investors, Houston says.
Aside from organic capital generation, mutuals can look to use surplus notes, which is a form of repayable, subordinated debt capital issued at the insurance entity level. But the regulator must approve surplus notes’ use and all interest repayments, Houston says, and there is a limited pool of investors willing to invest in this kind of long-dated, very subordinated debt.
Issuers face paying a “much higher rate” in coupons than the issuers of similarly rated corporates would, “due to the fact that it’s regulatorily subordinated.”
Alternatively, mutuals can form a holding company affording them “theoretical access to something more akin to a corporate bond.” But Houston says “there is not really a market of investors who would give, let’s say, $20m to a [mutual] at the smaller end of the range – it’s just very, very rare.”
Reinsurers may help manage a mutual’s capital position, too, but if the need for capital stems from sharp underwriting losses, “that quota share is going to be very, very expensive.”
Compounding all this, Houston describes mutuals as having slightly higher average expense ratios than non-mutual rivals, stemming from “scale disadvantages some of them have.” Also, there can be slightly higher geographic concentrations in portfolios at some mutuals, which can present an outsized catastrophe risk and cascade into reinsurance costs.
FILLING THE CAPITAL VACUUM
To fill the vacuum of available long-term capital for mutuals, TMG provides preferred equity capital – an instrument halfway between debt and common equity.
TMG was formed in 2023 and made its initial $200m investment in GuideOne, an Iowa-based mutual that is one of the largest insurers of churches in the US. The firm had found its capital surplus being depleted, in part through a series of natural catastrophes that hit the US between 2020 and 2023.
GuideOne discussed its position with Bain Capital, which had recently raised $1.15bn for a multi-pronged insurance fund to back “middle-market transactions in North America and Europe across the entire insurance value chain.” Bain then acquired GuideOne’s operational platform, on which it built TMG as a provider of capital, technologies and services to mutuals.
“GuideOne draws tremendous value from TMG’s expert team and expert investments. These capabilities strengthen our operations in ways that would have been difficult to replicate on our own,” Ken Cadematori, president and chief executive of GuideOne Insurance tells InsuranceERM.
For now, GuideOne sits alone on the insurance platform, but Houston says TMG intends to “grow this to become much larger than it is today, which will necessarily require several members of scale joining the platform over the next few years.”
Houston also acknowledges that for TMG to successfully grow its business, “the model only works if GuideOne is successful, making an underwriting profit and growing, in order to grow their surplus and premiums.”
PRIVATE FINANCE AS TMG’S FOUNDERS
Houston emphasizes that, while TMG’s capital comes from Bain Capital, the arrangement TMG has with GuideOne was not in any way a takeover by Bain, of the mutual.
“In the case of our founding member, we invest preferred equity which does not change the ownership of the mutual – it stays independent, maintains its board members and management team [and] the capital is permanent capital for it. They don’t have to pay it back, we’ll get a return on it from coupon payments.”
“The model only works if GuideOne is successful, making an underwriting profit and growing”
“A mutual’s board and management team will continue to set their strategic direction, and we will execute that strategic direction as part of our platform, in conjunction with their mutual. The mutual retains the balance sheet function, so we don’t touch its assets, it sets its own reserves, risk management guidelines and strategic direction, and places its own reinsurance.”
TMG provides services in realms such as technology, claims, actuarial and data science, though Houston emphasizes GuideOne has not been obliged to take on investment services from Bain Capital.
Houston acknowledges that his discussions with prospective mutual beneficiaries of TMG’s permanent capital do not focus on private financiers being TMG’s founders – but nor does he “shy away from it, and part of the beauty [of the arrangement] is, our members have an arrangement with TMG, not with Bain. TMG answers to Bain, our members don’t answer to Bain.”
“That allows us to marry up the members’ long-term orientation with what we’re trying to do, which is to give them the tools they need to pursue that orientation and our relationship with our mutual members doesn’t change. If we became owned by a different entity tomorrow, our relationship with GuideOne would be exactly the same as it is today.
“The capital provided by TMG is structured as permanent equity. Once it’s contributed it cannot be pulled back by TMG or investors – that’s very key. That permanence is what allows regulators to recognise it as equity capital supporting the insurer,” says Houston.
Nor is the arrangement akin to insurance consultancies charging lucrative fees for short-term engagements, Houston says.
“We’re providing operational scale and expertise, and technology help”
“We’re providing operational scale and expertise, and technology help – it’s not just a capital investment [and] because of that arrangement we can provide more favourable terms on the capital piece than if we were just making a financial investment.”
Houston hones in on technology updates as a particularly costly expense for insurers that TMG can help manage.
“Core policy administration system upgrades are very complex and very expensive, and typically take a long time. There’s a tremendous amount of risk in the level of investment going into them, and it’s a challenge for mutual companies that some have struggled with.”
GROWING PE INTEREST IN INSURANCE
Bain Capital is just one of the many private equity firms taking an interest in the insurance industry, but its approach with TMG is different to the conventional PE playbook.
When Bain Capital launched the $1.15bn inaugural PE fund for Bain Capital Insurance in 2023, exceeding a target of $750m, in-house commitments came to about $150m, “continuing the firm’s heritage of being the largest investor collectively across its funds.”
Bain vowed to “launch and build new insurance platforms,” find investees in “corporate transformations such as management partnerships, carve-outs, and turnarounds...inflection or event-driven investments driven by supply/demand imbalances, evolving business models, and shifting industry trends.”
So far, Houston says, PE interest in insurance more generally has “largely been in broker roll-ups, life and annuity asset-plays [in] gathering assets and trying to manage those assets”. He describes TMG’s model as “the polar opposite of that. We don’t even touch the assets. If a mutual wants access to a relationship with Bain, that’s fine – but we’re not going to necessitate that."
“In the mutual landscape you need professionals who understand what the mutual landscape is, what makes it tick, who is very deep in the insurance space and the mutual space.”
SWEET SPOT
Houston does not foresee TMG setting out to win the Liberty Mutuals or State Farm Mutuals of this world as clients, given these huge firms have access to plentiful capital when they require it.
Rather, TMG’s focus is on smaller mutuals that it can bring capital and operational scale to. These companies have probably sub-$1bn of surplus or premiums, a strong brand and history, and “multi-generational relationships with their own agents, who have multi-generation relationships with their insureds.”
While TMG may venture to clients outside the US sometime in the future, Houston describes TMG’s national backyard of mutuals as “very vast.”