Private equity pushes insurance to get risky

Anant Bhalla:
It’s just too high octane fuel going onto these balance sheets in order to make the investments work. They will blow up. And there are zombie insurers hiding today in the marketplace. We know them, we see them, we whisper about them. We need to speak more openly about it.

Liz Hoffman:
Welcome back to Compound Interest from Semafor Business. I’m Liz Hoffman, Semafor’s business and finance editor joined by my colleague Rohan Goswami. Rohan, do you have life insurance?

Rohan Goswami:
I really don’t like how we’re starting every episode with a question for me. I do have life insurance. I have a couple different policies. Yeah. Why?

Liz Hoffman:
Do you know who owns it?

Rohan Goswami:
No, I have no idea whatsoever. One of them is through Semafor and then one of them is my own policy.

Liz Hoffman:
So you are not alone. Life insurance is a thing that most people get through their jobs and have absolutely no idea where it lives, what it’s doing, because partly they’ll be dead by the time it pays out.

Rohan Goswami:
Oof, this is going to be a sunny episode, isn’t it, Liz?

Liz Hoffman:
No, we’re going to turn it around because this is an episode about investing in the ways that Wall Street is changing.

Rohan Goswami:
If anything, it just shocks me we’re getting to this topic so late in the show because anyone who has walked past Liz Hoffman on the street, listened to her on stage, read a story from her-

Liz Hoffman:
Sat next to me on the subway.

Rohan Goswami:
On the subway or in Semafor’s offices for a year and a half, that’s me, knows that you are obsessed with insurance and private credit and everything that emanates from there. And I got to ask, I’ve kind of been afraid to do this, but in the safety of the audience here, how the hell did you get so into this weird space, this niche of finance?

Liz Hoffman:
I was reading a story about three years ago. It was about a soccer team in the UK called Everton, and it was in the process of being sold. And the firm that was trying to buy it was a firm that I’d never heard of called 777 Partners. And somewhere in the middle of the story is a line like, “the source of its funds is unclear”. I’m not a soccer person, but I am a finance reporter.

Rohan Goswami:
That’s a catnip line.

Liz Hoffman:
And when people show up with a lot of money and it’s not clear where it comes from, that is the kind of thing that gets me interested. And it did not take long to figure out that it was insurance money. They had a Bermudan reinsurer that had bought a bunch of policies from some US life insurance companies and they were investing that into all kinds of stuff, including European sports teams. The Everton deal ultimately did not go through. But it was to me such a leading indicator of how did we get here? I knew about Apollo and Blackstone and KKR and I knew that they were in this business, but I didn’t totally understand why. And look, insurance sounds boring, just not as a reporter where you’re going to spend a lot of time.

Rohan Goswami:
I’m not going to lie. I was not thrilled when you first told me that we were going to do an episode on insurance. I was like, really?

Liz Hoffman:
No, I’m winning hearts and minds one at a time. Because what really clicked for me is when you say, “Oh, this is just a pile of money. It is a big box full of money and it has to be invested.” And historically it was invested pretty conservatively by, as I’m sure we can get into it, with a bunch of tweed suits up in Hartford, the insurance capital of the world.

Rohan Goswami:
Not that there’s anything wrong with tweed suits, just for the record.

Liz Hoffman:
Or Connecticut. You check both of those boxes.

Rohan Goswami:
I check both of those boxes.

Liz Hoffman:
But these are people who were very conservative by nature, buying really super safe IBM bonds, and then going golfing essentially. And Wall Street figured out, “Oh, this is fun. This is a big pot of money that we can use to do all the kinds of deals that we want to do and come up with newfangled deals to do.” And they just barreled into this space.

Rohan Goswami:
Our audience and most of Semafor might be fooled into thinking that I’m your favorite Indian guy in finance, but that is not true. It is Anant Bhalla, who is our guest today. You’ve interviewed him on stage before. And I’m struck he does really seem like the perfect guest for this episode. And maybe tell our guys a little bit why.

Liz Hoffman:
He ran a life insurer called American Equity that he sold to Brookfield, the big private equity firm. He had a front row seat and kind of won that Wall Street is getting into insurance game, and has actually now become a little bit of a critic of the game from the outside. He’s building a new version of this with backing from one of Europe’s oldest families. And that has freed him up to cast a little bit of a critical eye on the industry and speak a little more honestly about where he thinks the merit is and where he thinks the risks are. So I’m excited to have him on. I am bringing one listener at a time to the idea that life insurance is interesting.

Rohan Goswami:
Let’s see if we can change hearts and minds in the studio. But look, let’s take a quick break and when we come back, we’ll have Anant with us.

Liz Hoffman:
Anant, welcome to the show.

Anant Bhalla:
Thank you. Thanks for having me.

Liz Hoffman:
Let’s start with a very basic explanation of life insurance and their sort of close cousin, annuities, because I think it’ll make it clear why we’re having this conversation and why Wall Street has fallen in love with this business. What are these things as financial products?

Anant Bhalla:
Very simply in the old days, going back hundreds of years, they were about protected outcomes. Individuals and corporations getting a guarantee. You can be a trillion-dollar bank. You can be a trillion-dollar asset manager. You cannot make a guarantee. You need to buy life insurance or any kind of insurance to get a guarantee.

Liz Hoffman:
The conversation we’re going to use insurance, but it is sort of a stand-in for particularly annuities and other retirement products. Can you walk us through the difference between the two of them?

Anant Bhalla:
Absolutely. If you think about insurance, it always gets a bad rap because health insurance and financial products that are insurance get wrapped together. So let’s first unbundle that. Let’s put health insurance on the side. In the US, we largely get it through your employer. And it’s a very highly charged-up topic over time.
If you look at financial protection in the case of life insurance or annuities as these products exist, they’re about guaranteed outcomes. People need protection. Someone gets married, even before they get married, they get a job, the number one asset you have when you get a job is your ability to earn. So you need protection and ability to earn, something called disability insurance. What if someone, God forbid, has a life event and they can’t work again? Or they get married, they have more financial assets, they have a family, they need protection. That’s what life insurance was always been around for centuries. Frankly, going back to the de Medicis.
Annuities are effectively savings products. So you accumulate wealth over your working life. And at some point, even if you’re working at a certain age, and depending how their tax circumstances are, for example, after age 59 and a half, you can start to de-accumulate.

Liz Hoffman:
So historically, these are both products that you pay into over time when you’re younger and you get money later. Annuities historically paid you until you died, at which point life insurance paid after you died to your beneficiaries, right? The reason we want to have you on is that Wall Street has totally fallen in love with this business. And just tell us the origin story. How did alternative asset managers, and we do need to come up with a better name for that group of people, but how did they discover this as an investing tool?

Anant Bhalla:
For centuries, insurance was about protection and about guaranteed outcomes. Annuities paid you till you lived, life insurance paid after you died. You may buy some critical illness along the way while you’re alive in order to have some life insurance protection or disability protection.
Roll the tape forward to the last big investment boom bubble, the dot-com bubble, and the blow up of Enron and WorldCom. At that point, the insurance industry, frankly, blew it. Why? In insurance, you make money doing three things. You take care of people with these guarantees, and that’s how you raise money. You bring it in. For every dollar you put in, you manage, whether you’re on the property casualty side, between three to $5 of policyholder money, what Warren Buffet calls float. Or on the life insurance side, 10 to $12. So I put a dollar in, I manage between 10 to $12 of life insurance and annuity assets.
And those assets are invested with two things. The business is a combination of consumer behavior. When will people start to use these guarantees and how much will they use? That in the insurance business is called the frequency, when they will start to use. And how much they will use is severity, because ultimately the insurer will have to pay claims. But it also is around markets. What do you do with the money while you wait? So $10 comes in, you as an insurer put up $1 of capital that the regulators make you put up as being the capital of last resort in case things go wrong. And before those $10 have to be paid out over time, you get to invest the money, the concept of float.
Insurers were always very close to understanding their clients, what we call distribution. How do they bring in the $10? How do they bring in the money? What in insurance-speak is called liabilities. Their promises, their guarantees are their liability to be paid over decades. And that money was through the MetLifes, the Prudentials of the world owning their distribution, the mutual companies owning their distribution, knowing their customers. They also invested that money in plain, simple, boring bonds. And so it wasn’t a very risky business.
Come forward to WorldCom and Enron, something happened that is unique. You had an investment boom and you could see the parallels to today with what we are seeing with the AI investment boom. And you had fraud. Now insurance companies ran out of capital and CIOs realized the easiest way to get fired is take credit risk. So what did they start to do? They stopped taking credit risk. They said, “I’m going to outsource investing to other people who are investment specialists.” And that to me was the first unbundling of the value chain. Everything used to be in one roof with alignment. We started to break the house up. Investing went away and insurers lost touch with how to invest.

Rohan Goswami:
It’s the early 2000s. Who is the sort of first player to step into that space? Who’s the first outsourced manager?

Anant Bhalla:
Think of it like the PIMCOs and the BlackRocks of the world.

Rohan Goswami:
So still bond guys.

Anant Bhalla:
Exactly. Still bond guys and insurers are still in the asset management business, but now roll forward to the GFC and post the GFC, or the global financial crisis, we won’t give too many acronyms because this industry’s notorious for it. Roll forward to the GFC, you have a new trend that starts, which is effectively banks get out of principal investing. So the true creme de la creme of private investing was like the principal investing group at Goldman. Great investors.

Liz Hoffman:
And this is post-Dodd-Frank, they get pushed out of this business.

Anant Bhalla:
They get pushed out of this business and you have capital rules that make it very onerous for banks to invest in credit beyond a certain spec. You have securitization markets that have taken off from the early 2000s with the dynamics I mentioned year round in the first unbundling. And now post-GFC, you have the titans of alt management beginning to realize we are going to, in the debanking trend, be the new financiers of business activity, whether it’s the emergence of middle market lending or asset-based finance. Seems these days you can do an esoteric financing of any set of cashflows.

Liz Hoffman:
That is a recurring theme on this show, how we’ve taken all kinds of basic commerce and turned them into financial products much to my chagrin.

Anant Bhalla:
Yeah, exactly. And so you saw this emergence of now the new asset managers, let’s call it asset management 2.0, where you have the emergence of the alt managers who are making investment returns that are not in public markets, but in private markets, and the size of the private market starts to grow. Some of them, Apollo in particular, did a great job getting into insurance and building out what is today known as Athene and a remarkable responsible strategy that they’ve executed. There were many skeptics when they started and they’ve done a great job in what they’ve executed.

Rohan Goswami:
What were they skeptical about? What were the skeptics saying?

Anant Bhalla:
The amount of structured products, for example, CLOs that end up on these balance sheets. I mean, that’s where, if I think of the origin story of the evolution of insurance and coming together of insurance with asset management, asset management driven by alt firms driving up the proportion of structured products onto these insurance balance sheets starting 2010 onwards. So this is a 15-year ... the origin goes back 15, 16 years ago, and then growing from there, buying more and more insurance balance sheets as a form of permanent funding, permanent assets. For every dollar you put in, you get 10 to 12. That’s how this all grew. And the success of Apollo got everyone interested in saying, “Wow, this model is very different.”

Liz Hoffman:
I joke sometimes there’s two kinds of asset managers right now, those who have an insurance company and those who wish they did. And I’m curious what you think that has done to the incentives. Because the way that these investment firms used to raise money is every 18 months they would pass the hat around and they would go and take a bunch of pension fund CIOs out to dinner and try to collect $50 million here and $100 million here. I haven’t looked, but I think Athene will probably raise $80 billion this year just sort of turning on the lights. They have this huge flywheel of money coming in from insurance policies. And I’m curious what you think that does to the incentives around investing, that when it used to be that people had a lot of deals they wanted to do and the limit was finding the money to do it, and it seems to me that that dynamic has really flipped because of this insurance boom.

Anant Bhalla:
The incentive needs to be not around size, but about returns. Because within the last 15 years, private equity or alt manager-controlled or influenced-affiliated insurance companies, you have a dynamic where some people are doing it for the fees. Obviously we all say we do it for performance, but I’ll tell you how I think the model should be different.

Liz Hoffman:
I thought you all did it out of the goodness of your heart, Anant, to secure Americans’ future.

Anant Bhalla:
Well, we need to talk about that, because retirement security is a very important theme that needs to be dealt with. And I want to broaden that to personal financial advice and wealth management overall. But before I go there, to your question on fees and alignment, driving fee income, a lot of firms went public. The minute you go public, you can’t be a monoline. You can’t be a single business company. If you’re just a private equity firm without credit, it’s harder to be public. You’re not going to trade very well. Public markets value growth. Frankly, I would say they overvalue growth. And we see this always play out through cycles. So because these investment firms went public and they needed growth, they grow for size. Fees drive everything.

Liz Hoffman:
This is how Blackstone became a trillion-dollar asset manager.

Anant Bhalla:
Correct. But if you’re investing insurance money, you have permanent capital. And sometimes you have to be patient. Sit in cash, which means you don’t earn fees. So there’s the misalignment. You’re running a publicly-traded asset manager. You have to earn fees in order for your multiple. Every dollar you take back, if you’re running a trillion dollars and you sit 10% in cash, that’s a hundred billion dollars, and you are making 1% fees, and the market was giving you 20 times multiple, let’s do the math together. A trillion dollars, 100 billion in cash, 1% fees, that’s a billion dollars, 20 times multiple, or even if it was at, say, 60% margin, $600 million of EBITDA times 20 times, that’s a $12 billion haircut.

Liz Hoffman:
Right at my limits. That’s why we became journalists, but we follow you. The incentives are to manage ... increasingly the incentives in this business have been around how much you manage, not especially how well you manage it. Is that fair?

Anant Bhalla:
Correct.

Liz Hoffman:
Okay.

Anant Bhalla:
The incentive structure has flipped to size over performance.

Rohan Goswami:
You mentioned 1823 in passing. Can we for our audience explain what 1823 is? Because a lot of folks may not have heard of you guys.

Anant Bhalla:
I founded 1823 Partners as a firm that’s focused on three very simple things. The first, be patient. Be patient and look for how to deliver multiples of invested capital over a long-term period. So we look at how do we make 20 to 30x over a generation, not how to make 4x over 10 years, which is really hard. Second is good investors should not use financial leverage. You should look at all asset classes on an unlevered basis. And lastly, why buy the same asset over a generation five times just because the manager’s incentives required them to crystallize incentive every seven years in order to pay people?

Liz Hoffman:
This is what big institutional investors hate, which is that one private equity firm they’re invested in sells a company to the other private equity firm they’re invested in. They still own it and they have paid fees twice now.

Anant Bhalla:
Right. Absolutely. So think unlevered, look for the best ideas that you can own the entire capital structure and create alignment in your people. And so the genesis of 1823 was to create an at-scale private investment firm that only manages evergreen capital. So it doesn’t go into the market every two years, raises a drawdown fund, and invest that, has an investment period, and then people are watching the clock. In sports, watching the clock makes a lot of sense. In investing, watching the clock or being on the mic every quarter in an earnings call in a public company, they make you make silly mistakes if you’re a long-term investor or owner of an asset.

Liz Hoffman:
You have backing from the Reimann family in Europe. This is the old Reckitt fortune. You bought an insurance company late last year, had about, what, 20, $25 billion of assets, I think. What are you doing with it?

Anant Bhalla:
So I wear two hats. I’m the founder, co-founder and CEO of 1823 Partners, the investment business. And yes, I also spend my time as one of the partners running JAB Holdings, which is what you mentioned as the CIO of that firm. JAB bought Prosperity Life in the US and has done a number of other transactions. I’m the executive chairman of that insurance business, and it is the anchor client for 1823 Partners, with 1823 running the investments. But it’s a perfect example of driving alignment. While JAB grows its insurance business alongside its consumer businesses, effectively it’s a long-term investor in platforms. It needs an investor who’s aligned with it in certain strategies. It also allows the investment of the insurance company to be managed by others. It’s not about control it. Where 1823 does not specialize, others manage the assets. We have a very large global asset manager that manages core fixed income for that insurance company.

Liz Hoffman:
Because you don’t want to be in the bond business, in the plain vanilla bond business.

Anant Bhalla:
And nobody can be great at everything. That’s just reality. Tell me a sports player who can play every sports. Yes, there are a few gifted ones who can play two, three, but they don’t do it for a living. They do it as a hobby. We’re not hobbyists. We’re professionals.

Liz Hoffman:
I think your criticism of traditional insurers is that they were a bunch of guys in tweed suits sitting in Hartford, Connecticut, not working that hard, not thinking that hard, buying a lot of AAA public bonds and clipping coupons that left an opening for people who are better at investing. And I wonder where you think the natural ... Well, where are we on that journey? Because we’re going to get to some of the criticisms of some of the risks here. But the last time I looked at data, it’s a little out of date, but I doubt it’s changed that much, the average insurance company that was owned by an alternative asset manager owned stuff that yielded about two-thirds of a percentage point more than the traditional mutuals and guarantees. So they are invested in riskier stuff. And I’m curious where you think that ought to stop.

Anant Bhalla:
I go back to, if you look at the origin story of this industry, till 20 years ago, insurance companies understood their clients very well. They owned distribution. They were part of originating those promises and liabilities. And so the cost of funds was manageable, meaning the money that you paid out to people, the float that you managed over the lifetime before the claims came in, cost you three to 4%. Now that’s no longer the case. The cost of that float with the entry of newer players who have the asset-side expertise or alignment with players who have asset-side expertise has gone up 150 basis points. So now this cost of funds is, say, 5% or more.
So the traditional model of wearing tweed suits and buying bonds, to use your expression, doesn’t work anymore because the asset mix that is in the insurance industry has skewed towards being able to afford higher investment returns and pass that on to raise the funding to earn fees. So you have this virtuous cycle that’s actually no longer as virtuous for the benefit of policyholders because you have to own private assets. I tried to do it with 20% of assets 10 years ago and most recently I see it being a 30 to 40% business. Unfortunately, there are players who are doing it where they’re pricing it where it’s 100% of the asset mix.

Liz Hoffman:
Where they’re paying so much to raise that money that they have no choice but to go invest it in super risky stuff?

Anant Bhalla:
Correct. The question isn’t that can we go back to the good old days of having 100% plain vanilla bonds because that ship sailed 10 years ago? To me, the fundamental question is can we make it work with a healthy mix through matching those promises with some mix of the cocktail has got pretty high octane. Can we manage it with a lower octane mix of private assets? Can we do it with safer private assets? And those are 20 to 40% of sub-50% of the portfolio or are the newer entrants pushing it to 100%?

Rohan Goswami:
For the average person on the street, hearing what actually goes into their life insurance payouts or their annuity payouts might give them a little pause, right? Because these are kind of riskier assets than, say, the AAA bonds of General Electric or IBM. There’s not as much of a guarantee and there’s a little more self-dealing.

Anant Bhalla:
We’ve effectively got out of the investing business is what my point is. Insurers got lazy. We had a lazy CIO trade where we effectively outsourced that investing to traditional managers. And then the alt managers jumped in and just changed, they moved the cheese. They moved the cheese to the mix of alt investments that need to be in the portfolios.

Liz Hoffman:
Well, because you’ll be dead by the time it pays out, I think is the problem. But I know of no policy holder who wakes up in the morning and thinks, “Boy, I really hope my insurance company gets bought by a private equity firm today. Fingers crossed.” So what would you say to that person as a lot of those policies are getting sold and transferred and originated by firms that look very different than the mutuals and the guarantees of the kind of 20th century that we think about?

Anant Bhalla:
Personal financial wealth is where this goes back to. People need advice on wealth management and you have to save. We are a consumerist society. If you don’t save and you’re going to rely on someone else to bail you out, then you need to build up wealth. And when you want to de-accumulate it or when you want some guaranteed outcomes, back insurance companies that you know are going to be around for the next hundred years. Be picky about who your insurance company is. And more importantly, is there patient permanent capital behind it?

Liz Hoffman:
But where do you think this ends? There’s an old joke on Wall Street that you don’t worry about bad ideas because no one repeats them. You worry about good ideas because eventually someone will come along and do it badly. And this is so obviously a good idea on paper that someone is going to come along and do catastrophically badly. Do you worry about that?

Anant Bhalla:
That’s the one thing that keeps me up at night because what’ll happen is the pendulum could swing significantly the other way from a regulatory point of view. Regulation in the US enables the ability for effectively investors to have time to invest the liabilities or the float before claims are paid. That environment is very conducive in making guarantees and long-term promises. The US is one of the best markets to do that. However, if you have newer players who are just, there’s just too high octane fuel going onto these balance sheets in order to make the investments work, they will blow up. And there are zombie insurers hiding today in the marketplace. We know them, we see them, we whisper about them. We need to speak more openly about it. And the regulators are moving to a point where they’re saying, “Let’s make sure what’s happening today [inaudible 00:25:26] I simplify it.”
On the investment side, to justify the investments, there’s a lot of rating shopping. An insurance company, in order to put investments on its balance sheets, needs a rating. Otherwise, the capital charges are very high. There’s a lot of rating shopping happening on these esoteric assets. So first of all, you’ve got esoteric assets or just say anything that has a cashflow or even the hope of a cashflow getting rated. Then you have jurisdiction shopping. I could be in state A versus state B, or I could just fly over the ocean and some of my promises fall in the ocean. That doesn’t happen.
So jurisdiction shopping and rating shopping has resulted in the perception that the barriers for entry are very low. I jokingly call it, you should call it the asset management re-strategy. Asset managers, to your point, if they don’t have an insurance company, they have envy and they feel they’re going to go obsolete. So they add the word “re” behind their names and say, “Yes, I have a division. It’s called reinsurance. That’s how I get in.” Regulators need to put limits on reinsurance from newer players or limits on this rating shopping.

Rohan Goswami:
As you’re alluding to, insurance regulation right now in the US is a state-by-state thing and each state has their own regulator. Is there a worry then from where you sit, or maybe a good thing it might sound like, that in a different time and in a different administration, there might be a federal regulator of this space?

Anant Bhalla:
That experiment has been tried in the past and I think the state-by-state regulatory system works very well and it has evolved over time where it’s forward-thinking, it results in not group-think, but challenging different states. So the federal example obviously could always happen and would be constructive. I think in the state-by-state regulatory environment, the decision-making and reaction time cycle to the level of innovation going on needs to speed up. And that’s what the regulators are doing in the US, and I promise not to give acronyms, but there are new regulations being talked about, both in the US and the UK, that talk about this dynamic of reinsurance. If you are a policy holder, to Liz’s earlier question, and you bought a guarantee from me, you want to know that I will be there to back your guarantees. Not that through the back door, I sent it to a reinsurance company and that reinsurance company didn’t even know how to spell the word “insurance” five years ago.

Liz Hoffman:
And reinsurance for our listeners is insurance for insurers. It is the ultimate backstop. A lot of it is offshore. And actually, I don’t want to escape past it too quickly. You said that experiment’s been tried. I think you’re talking about MetLife post-financial crisis. That ended badly for the federal government. They lost at the Supreme Court. I think they were embarrassed by it. They have not tried again, but if we end up in a situation where a big life insurer goes belly-up and the industry has to step together and bail it out, that seems like very fertile ground for, again, perhaps a different administration to say, wait, why are we regulating this 50 different ways?

Anant Bhalla:
Yes, but there are all of other actors around it. I think there is the rating agencies and regulation of the rating agencies also which didn’t go very far, which creates an un-level playing field at times because standards are, they’re open to judgment. And the state-by-state regulation embracing its own view on ratings and not relying on insurance ratings or asset ratings from rating agencies is probably a more likely evolution. And we’re seeing that. It’s happening in the CLO world right now where the National Association of Insurance Commissioners, the NAIC, is doing that.

Rohan Goswami:
Let’s take a quick break there. We’ll be right back with more from Anant.

Liz Hoffman:
You’re relying on ratings agencies and we have been burned before by people shopping around for a AAA rating. And you’re talking about state regulators and we’ve been seeing that game of whack-a-mole before. It just seems pretty clear to me that there is at some point in the next couple years going to be a big blow up here and everyone’s going to ask, “Who was watching this?”

Anant Bhalla:
There are a group of technocrats that are running these associations that regulate insurance companies at the state by state level. Could you have a federal body that does it? Of course you could. I think the natural dynamic that comes though is the charters of insurance companies would have to dramatically change. And it’s not a federally-chartered ... It’s a choice. Would an insurance company in the state of Iowa or in the state of Texas move to a federal charter? There’s no incentive. Goes back to incentives. What is the incentive to do that? So I think that ship has sailed in terms of state by state regulation is there and it’s trillions in size. The total assets in insurance company balance sheets in the US is north of six or seven trillion dollars and it needs to be managed therefore appropriately.

Liz Hoffman:
You said earlier that the concern among asset managers is that if you don’t have an insurance company, you’re going to be obsolete. Do you think that’s true?

Anant Bhalla:
Yes. If you’re an asset manager and you need to go public in order to monetize and have an incentive compensation plan for your next generation, you need to be multi-strategy. So if you’re private equity, you want to have credit. If you’re private equity and credit, you may want to have real estate. The best way to have permanent pools of capital is have either retail investors in funds or insurance. Those are permanent [inaudible 00:31:05] of evergreen vehicles, especially when the largest investors ... How did private equity firms get created in the ’90s? They got created because pension funds were still accumulating assets with defined benefit plans in the US getting transferred to insurance companies now and those assets being in decline as people de-accumulate. The only way to manage investible assets over someone’s lifetime is to be part of accumulation and de-accumulation. And that’s what insurance provides.

Liz Hoffman:
And just to unpack that a little bit, you talking about de-accumulating, this is the baby boomers, this big generation starting to retire and dis-investing from the market so that they can spend and live their lives, and the generations coming up behind them are not investing as much, not saving as much, and have very different retirement plans, as you said.

Anant Bhalla:
Correct. I mean, let’s talk about markets a little bit. There is $60 trillion in US wealth, six-zero, 60 trillion. There is $13 trillion at the work site. This is people who are working and they have a 401 plan or a 403(b) plan, some regulatory-defined-therefore-these-acronyms plan that makes them be a forced saver at their work site, their employer. Ultimately, all of that wealth needs to be, if you have a million dollars and you go to a financial advisor, the financial advisor says you can take out 4% a year, so take out 40,000 of your million, and the rest, let me invest, because as I grow it, you’ll never outlive your money. But there’s no guarantee in that. Your advisor better be really good, but that 4% rule is the rule of thumb that most people live by. You have a huge industry in wealth management managing $60 trillion and insurance is not even five. So the penetration of insurance in the broader wealth ecosystem is tiny and people don’t have guarantees while they live, while they save, and also when they die. So the share of insurance can be very large and that’s what alt managers also see, the newer players also see. Insurance can be a big part of the large 70 to $80 trillion market in the US.

Liz Hoffman:
Let me see if I can channel a broader criticism, which is that Wall Street took big chunks of the economy private and are now selling it back to us, only this time it’s riskier and more expensive. They’re in our brokerage accounts through these semi-liquid retail funds you were talking about. They’re coming to our 401(k)s, presumably, and now they’re in our life insurance. And in the case of insurance, entirely without our consent. And a lot of this stuff has not been through an economic cycle. So can I ask you to respond to the broader criticism that as individuals we are being forced into a financial system that we didn’t choose?

Anant Bhalla:
The counterpoint to that is what is your option? Owning public markets?

Rohan Goswami:
Oh, that’s grim.

Anant Bhalla:
Owning public markets where the Magnificent Seven drive your entire future outcome, not to channel the CEO of another large firm, but effectively there is some truth to that story. The reality is equity markets don’t reward long-term investors. The alignment of incentives in equity markets rewards growth and that’s why you’re seeing what’s happening today. There is more risk in owning public equities than private companies. So private companies are a store of value, but incentives matter. How you put those private companies to back Main Street promises or investors, whether it’s retail investors, and what are the gates that get put up? We talked about in private credit, a lot of people bought evergreen private credit vehicles and didn’t realize the gates where you can only take 5% of your money out every quarter. It’ll take years to get all your money back. So I think it’s about disclosure of what people are buying, that’s a huge risk, and how they can get liquidity.

Rohan Goswami:
Can we come back to something you just said about private companies being better for long-term investors? The criticism that a lot of public market investors make is, “Well, we get marked tick by tick every single day that the market’s open,” whereas privately held assets or private assets generally are marked by their owners and are marked quarterly. And yes, there are rules around it, but there’s less rigor around marking. Is it really fair to say that private companies are better stores of value and are more valuable when the people who determine that value are returning to incentives, very incented to not re-mark at a lower level?

Anant Bhalla:
The incentives need to be around. The marks are real. Don’t extend and pretend, if I could use that expression, on your marks.

Liz Hoffman:
You may.

Anant Bhalla:
Be realistic on it. And money is made in investing on the way in. One of the misaligned incentives of drawdown fund structures where you raise money every couple of years because you get three years to invest it, five years to harvest it, and ultimately return it legally in 10 years. The criticism of that structure is that because the clock is ticking and you’re watching it, you are not in control of those private investment outcomes. So I agree with you, private investing needs an evergreen vehicle in order to be able to have patience and prudence. Patience and prudence in investing requires you not to watch the clock and have incentives that make you realistically mark them. The devil’s in the details.

Rohan Goswami:
We’ve danced around private credit, but I think, Liz, this is one of Liz’s sort of bugbears, her favorite subjects. And sitting here relatively uninformed about both, it does seem to me that the growth of private credit, growth of insurance in this space, go hand in hand and have sort of pushed each other up over the last 15 years. And I guess a question for you is, do you think that these massive positive insurance money are kind of the only thing propping up this parallel lending system that’s evolved since the GFC, since 2008?

Anant Bhalla:
Yes. Not the only, but a significant driver, to give you a short answer to your very thoughtful question. Look, it is definitely distorting it. It is definitely distorting the markets because, again, a trillion-four flowing into structured products since COVID, by the way, which wasn’t that long ago. In the last five years, a trillion-four of insurance money in the US going into structured products. More than half of corporate borrowing or debt issuance in the US being to fund the AI boom, where potentially winner takes in the LLM models, whether it’s ChatGPT or Anthropic or whoever, if the winner takes all and you’re building the infrastructure for that, that’s a binary outcome. You can’t have insurance money support a binary outcome where a winner takes all.

Liz Hoffman:
But there’s a big loan right now that I think Apollo and Blackstone are putting together for Anthropic, $36 billion for Anthropic to buy a bunch of AI chips. And I don’t know this for a fact, but I suspect a chunk of it is going to end up inside Apollo’s insurance business and Blackstone’s insurance business. They’re a little bit different, but it is going to be rated and backed by insurance money. And I was joking with someone the other day that at some point in all of this, some AI company is going to take down a life insurer and we’re all going to say, “What were we even doing here?” Do you think people sort of understand where the money is?

Anant Bhalla:
Yeah, you have to pick spots where you believe the, I don’t know about the specific transaction you’re talking about, but the spots where you invest insurance money or, frankly, any long-term investor’s money, which investor wants the risk of losing principle? We built 1823 saying we’re built around the old rules of investing, which is have curiosity to go in new spaces for sure, but never lose money. Make money when your investors ... People need to worry about the return off their capital, not just chase return on their capital right now. When markets go through late cycles, the mentality has to shift to return off, not return on capital. Because if you get envy or you have the fear of missing out, the two Fs you cannot do in the investing business are FOMO, fear of missing out, and fraud, risk underwriting, which is binary.
So there’s a theme over here, the virtuous cycle of investing permanent capital, if you never want to lose money, sidestep certain sectors. I’m not sure if funding AI chips ... This is the bet people are making in this space right now. There’s performance risk. Deliver me a data center that is 99% uptime with 95% efficiency of cooling, cooling, and I’m going to put hotter and hotter chips in there, and you have a 10-year lease. But if I overbuild, if I’m Magnificent Seven, whichever, and I overbuilt and I need to cut back on your 10-year lease, I can. Because can you really guarantee me performance 99% of the time with cooling that’s 95% efficient? So there’s a lot of performance risk that’s been underwritten of the providers of these infrastructure assets that is then getting rated. I can bet a serious dollar that the rating methodology does not reflect that. And that’s where, as a curious investor, you have to ask yourself, “What do I have to believe to get my principle back, to get my money back?” Not just look at the return on my money assuming everything goes right.

Rohan Goswami:
What trades are there out there that yield anything close and are immune to the AI disruption right now from where you sit?

Anant Bhalla:
Trash collection.

Rohan Goswami:
Okay.

Anant Bhalla:
I mean, jokes apart, heavy assets, heavy asset intensity and low obsolescence risk. You got to look at investing. And there’s this phrase called HALO. How do you invest in durable returns? And durable return comes from things that are irreplaceable.

Liz Hoffman:
Why do you think that Wall Street investors encroached on insurers’ turf and not the other way around? You can imagine a world where the old mutuals decided to get good at investing before the high finance crowd decided that insurance was cool.

Anant Bhalla:
Insurance companies are complex machines that are run by effectively semi-bureaucratic firms that end up being a renter. If you’re the CEO of an insurance company, you’re not looking how I’m going to be running this thing 20 years from now, especially if you’ve taken it public. You’re trying to get through the next three years and hope there’s no one pushing you out in five years. You need to be able to run these businesses for decades if you make promises for decades. So a founder-led mentality creates an owner’s mindset. It creates an insurgency on behalf of a customer. And so I think insurers blew it because they forgot their customers, the insurance policyholders, and what they needed to do for them. The raw materials for them were investing. Founder-led alt firms saw the opportunity. They’re more entrepreneurial and they stepped in.

Liz Hoffman:
Yeah. Sort of a bit of a dig though, that Wall Street is seemingly so much better at insurer’s business than insurers are at Wall Street’s business. Maybe we were right about the guys in Connecticut.

Anant Bhalla:
The thing I would say though is Wall Street’s very good at investing. Alignment is what can glue the two better, the two industries better. That doesn’t exist too much right now in the marketplace. We could definitely do a better job in driving alignment between managing insurance money and the Wall Street mindset of growth. And lastly, insurers needed to get back into knowing their customers. In which industry do you not know your customers? None. If you don’t know your customers in any industry, you’re going to eventually fail.

Liz Hoffman:
How are you raising money?

Anant Bhalla:
At 1823, we’re raising money by delivering performance. We’ve got $20 billion from our anchor clients at JAB Insurance. We’ve also got other family offices and long-term investors, whether it’s pension funds and others who value compounding returns and not having to buy the asset again. It’s refreshing when you say we’re going to go buy X, Y, Z asset. I’ll give you a live example. We just bought Ghirardelli in San Francisco.

Rohan Goswami:
Very nice.

Anant Bhalla:
Thank you. It is a great asset in need of ... Its cashflows are going to go down a bit and then come back up. If you’re a traditional firm owning it in a fund, we bought it from a very responsible investor, but they owned it in a fund. We brought it on. And this is our business case for it. Today we make around a 7% unlevered return on it. Unlevered. We could put three-year debt on it and think that levered return is higher, but it really needs seven to eight years of debt, 10 year of debt. Why? Because we are going to release the asset, improve its experience for its customers, for our tenants over there, and eventually it’ll be a great double-digit returning asset for us.

Liz Hoffman:
And you are staying off the fee treadmill. You have no plans to take this thing public in five years?

Anant Bhalla:
No.

Liz Hoffman:
Okay.

Anant Bhalla:
The plan is to build an institution that gives enduring returns. By the way, performance fees is enough to attract talent. You’re a talent, we say, “You never have to fundraise. We’re at scale. And by the way, what you could do at two to five billion of size, you cannot do at 20. So pick, I have investment pods. Go do what you do very well and think as one firm,” because the incentive structure is across the firm. If your asset strategy does not make sense, sit down. Don’t be desperate for class participation. You can avoid, this is not high school that you need to put your hand up every time you need to give an answer at an investment committee. Sit down if your asset class isn’t making sense.

Liz Hoffman:
You were talking earlier about the promise to individuals of not outliving your money. And I’m curious what you think GLP-1s do here. Are we all going to live forever and that annuity trade that I booked today starts to look like an awfully bad bet for the company that promised me $10,000 a year until I die?

Anant Bhalla:
GLP-1s are a disruptor for sure. Now, what does that do in terms of what it creates risk on one side? I wouldn’t be in business and I’d be more of worrying about the world if I didn’t think of it both ways. The opportunity though is with GLP-1s, the musculoskeletal lifespan of people shrinks. So there is a downside to them as well, which means critical illness protection may become more important. If you’re an insurance company, you may want to sell people critical illness alongside a longevity protection annuity.

Liz Hoffman:
So we’re going to live longer, need more annuities, less life insurance, but more disability. This is great.

Rohan Goswami:
Everything’s priced in, Liz.

Liz Hoffman:
This is great.

Anant Bhalla:
Yeah. It’s a portfolio effect. Have the portfolio right, get the directional right, don’t try and second-guess it, but that’s where long-term money needs to be in the business.

Liz Hoffman:
And remember to eat protein. This is where I think people go wrong. They get on this stuff and then they turn into skeletons.

Rohan Goswami:
They get gaunt and haggard. Protein is critical.

Liz Hoffman:
Yes.

Anant Bhalla:
So maybe the annuity companies can buy a protein company on their balance sheet.

Liz Hoffman:
That is synergy. I love it. Well, that feels like a great place to leave it. Anant, thank you so much for coming. This was a lot of fun. And Rohan learned a lot about insurance today, I think.

Rohan Goswami:
I did. This is the most quiet I’ve ever been on a podcast.

Liz Hoffman:
Can confirm.

Anant Bhalla:
Well, it was a pleasure. Pleasure was mine. Thank you both.

Rohan Goswami:
Thanks, Anant.

Liz Hoffman:
Thanks, Anant. Take care.

Rohan Goswami:
Look, Liz, I will admit it sucks working with you because I don’t have to learn that much about insurance or private credit. It’s wonderful otherwise, but it’s like a vacuum of knowledge that I just don’t even need to touch. And it was incredible. I really enjoyed Anant. I’m curious what you made of, he kept on coming out with this idea that the two sides of the equation weren’t aligned and that the incentives were skewed. And do you agree with that? How do you fix that? What’s the solution?

Liz Hoffman:
Yeah. When I came to the story a couple of years ago, I didn’t totally understand what was going on. And the thing that clicked for me is, oh, for Wall Street, this is just a big pot of money that they get today and they have to give back way later, maybe never, who knows, and can have a lot of fun with in the meantime. And so when he talks about incentives, that’s what he means, that traditional insurers, think of them what you want, the MassMutual and Pacific Life and MetLife that came up in the 19th and 20th centuries truly as stewards, they are liability-first. They go out and they sell this promise to people and then they do the bare minimum to deliver it. They don’t try to get too cute. And the shift that we were talking about is that people who invest money for a living came to this and said, “Oh, this looks fun.” And that’s the incentive that he’s talking about.
This is the same way that banks have gotten into trouble forever, by taking their depositors’ money and going and doing stupid things with it. This is a very similar kind of longer-term, slower-moving outcome, but the exact same dynamic. And I think as pernicious, honestly.

Rohan Goswami:
I was going to say it really feels like things ... Shit’s just going to blow up at some point. It just has to your point.

Liz Hoffman:
I’m happy to be proven wrong on this, but it’s so obvious to me that this is where the next big crisis comes from is this collision of non-bank lending, non-deposit funding through insurance. He has a pretty high opinion of state regulators and there are certainly some very good ones.

Rohan Goswami:
Do you share that high ... Well, there’s some good ones, but-

Liz Hoffman:
I don’t operate a state-based insurance company, so I couldn’t speak to it. There’s certainly some good ones, but having covered a few of these situations where you see insurers just pick up and move and then it’s 18 months or two years before they really get really poked and prodded, that seems obviously like a problem to me. I don’t often say this, but I don’t think anything but a giant blowup is going to change much of anything because he said totally unequivocally, did not hesitate, that if you don’t have an insurance company, if you’re a big asset manager, you will be obsolete.

Rohan Goswami:
You’re screwed. Which of the big players does not have an insurance company right now?

Liz Hoffman:
There’s really two different models. There’s a company like Apollo or KKR that own insurance companies, have big insurance company balance sheets. Apollo owns Athene. It is $350 billion of actual balance sheet stuff that they own that risk. There’s a more kind of a plug and play model like a Blackstone that manages money for insurance companies, but doesn’t itself own one.
But the real loser here, and we didn’t really get into it, is that insurance really needs credit. It doesn’t work that well with private equity, which is he was-

Rohan Goswami:
Why not?

Liz Hoffman:
Because it’s very lumpy. You buy these companies and you’ll get money later when you sell them or take them public if you can. Whereas credit, you lend money and you start getting money right back, which matches how insurance companies have to pay out claims as people retire and die.

Rohan Goswami:
Contractual in, contractual out.

Liz Hoffman:
Correct. And so the place where this doesn’t work at all is these LBO shops, places like Hellman & Friedman, Advent, Warburg Pincus that have really stuck to their knitting and don’t have credit arms. They also didn’t go public, and so they avoided that treadmill that he is talking about. But I think you’re going to see what we used to talk about as the private equity industry really bifurcate into giant, mostly publicly-traded asset managers that have big lending businesses and big insurance businesses, and then these really specialists still doing like Henry Kravis’s LBOs.

Rohan Goswami:
Which model do you think is vindicated then? The smaller Hellmann & Friedman style thing or the massive Apollo-Athene combinations?

Liz Hoffman:
I think there’s room for both, but I do think as reporters who cover this space, we need to actually understand that when we say private equity, what are we even talking about? Because increasingly it is not that. But I do think there is going to be some kind of blow up here. And I do think ultimately it probably ends with a heap of new regulation looking back at what happened in 2008, completely changed the financial landscape through the Dodd-Frank Act. So I don’t know.

Rohan Goswami:
I’m glad you just turned to Dodd-Frank, because obviously as we said when we were with Anant, this space exists the way it does today because banks can’t lend the way they used to and they can’t directly invest the way they used to. People have complained about Dodd-Frank for basically since inception, people at the banks. Do you think that we should roll back those limitations and let banks start to step in?

Liz Hoffman:
I do think that if you asked Ben Bernanke, who was running the Fed back after 2008, if this is what he had in mind, or actually Barney Frank, who just died, if you asked him, “Is this really what you had in mind?” A huge life insurance business sitting inside-

Rohan Goswami:
Black box world.

Liz Hoffman:
But sitting inside a firm that wakes up in the morning trying to think, “What cool things can I invest in?” I don’t think that’s what anybody had in mind, but that is what we have and not talked about, you have to make sure people are educated and understand what they’re buying. There is no way for me as a life insurance policy holder, I have no control over who ends up owning that asset and what they do with my money. And I just hope that they have it when I need it. And I think we are going to see a bunch of situations over the next five or 10 years where they in fact do not.

Rohan Goswami:
Well, on that lovely sunny note, that’ll do it for us this week. Thanks for listening to Compound Interest from Semafor Business. Our show is produced by the incredibly kind and patient Josh Billinson.

Liz Hoffman:
With special thanks to Anna Pizzino, Katherine Bilgore, Claire Einstein, Rachel Oppenheim, Ben Smith, Tori Kuhr, Vilanna Wang, Garett Wiley, Stephanie Chang, and Daniel Hoeft.

Rohan Goswami:
Our engineer is Bob Mallory. Our theme music is by Steve Bone.

Liz Hoffman:
If you like Compound Interest, sign up wherever you get your podcasts. And if you want more from Semafor Business, you can sign up for our email newsletters in your inbox at semafor.com.