Actuarial Notes

Capital Markets Bureau Primer: Private Equity

By Jennifer Johnson · National Association of Insurance Commissioners · 2021 · CP341-101-25

Study guide: Exam CP-341

A primer from the NAIC Capital Markets Bureau, whose role is to monitor developments in the capital markets globally and analyze their potential impact on the investment portfolios of U.S. insurance companies. It explains what private equity firms and funds are, how funds are structured, the investment strategies and risks, how U.S. insurers value private equity investments, and the background to private equity firms acquiring U.S. insurers.

On the syllabus

Executive Summary

  • A private equity (PE) firm is an investment management company that uses its own funds, as well as capital from additional investors, to enhance or increase the value of a company; PE firms generate a profit for their investors, measured using an internal rate of return (IRR).
  • PE funds are the most common type of PE investment, generally formed as partnerships between a general partner (GP) and limited partners (LPs).
  • PE funds are generally illiquid, typically have a fixed term of 10 years, and generate high relative returns.

What are Private Equity Firms?

  • A PE firm is an investment management company, and PE funds are the most common type of PE investment.
  • Investors in a PE fund include institutions such as insurance companies and pension funds, as well as high net worth individuals; the GP is most often the PE firm.

Goals of a Private Equity Firm

  • A PE firm's primary mission is to bring about positive change in a company that increases its value, and its goal is to generate a profit for its investors, usually within a four- to seven-year timeframe.

How are Private Equity Funds Structured?

  • General Partners and Limited Partners
  • Capital Commitment, Lock-Up and Fees

Types of Private Equity Investments

  • The most common are PE funds, or primary funds; others include secondary market fund investments, fund of funds, exchange-traded funds and open-end mutual funds.

Who are the Private Equity Fund Investors and What are Their Returns?

  • To invest in PE, an investor must meet the definition of an accredited investor or qualified purchaser.
  • Investors receive returns through distributions when the GP exits an investment, and an IRR that varies over the life of the fund.

What are the Different Private Equity Fund Strategies?

  • Venture capital, growth capital, leveraged buyout and, to a lesser extent, mezzanine debt; others include infrastructure, natural resources, real estate and private debt.

Valuation of Private Equity Investments by U.S. Insurers

  • PE investments are subject to SSAP No. 48, Joint Ventures, Partnerships and Limited Liability Companies, which requires measurement based on an equity method, with admittance contingent on audited support.

What Are the Risks with Investing in Private Equity?

  • PE funds carry liquidity risk, as they are not readily exchangeable for cash and typically have lockout periods, and they lack price transparency as they are not publicly traded.

Background on Private Equity Firms Acquiring U.S. Insurers

  • The trend has been due in part to the low interest rate environment, with PE firms gaining a steady source of premium income and insurers potentially achieving higher investment returns and improved access to capital and asset sourcing.
  • The primer notes that investments could shift towards higher returning, and therefore higher risk, assets that are also less liquid, and that some state insurance regulators view the PE business model as short-term in focus.

Key Terminology

  • Accredited Investor
  • Additional Commitment/Unfunded Commitment
  • Capital Calls/Draw-Downs
  • Commitment Amount/Committed Capital
  • Commitment Period/Lock-Up Period
  • Distributions (Returns)
  • Exchange Traded Funds (ETFs)
  • General Partner (GP)
  • Growth Capital
  • Internal Rate of Return (IRR)
  • Leveraged Buyout
  • Limited Partners
  • Mezzanine Debt
  • Private Equity Funds
  • Qualified Purchaser
  • Venture Capital (VC)

Useful Links

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