How to Raise Capital from Insurance Companies' CNY2 Trillion in Assets?

As insurers turn to alternative investments and regulators relax policy limitations, Chinese private equity (PE) and venture capital (VC) firms are all itching to raise capital from insurers and exercise their fund management skills.
Aug. 02, 2021 15:19
How to Raise Capital from Insurance Companies' CNY2 Trillion in Assets?

By Pan Jin and Ou Yu

 

As insurers turn to alternative investments and regulators relax policy limitations, Chinese private equity (PE) and venture capital (VC) firms are all itching to raise capital from insurers and exercise their fund management skills. But let us get one thing clear: how much money can insurers actually invest?

 

On July 17, 2020, the China Banking and Insurance Regulatory Commission instituted revisions allowing insurers to invest as much as 45% of their preceding quarter's total assets in equity products. That is up from 30%.

 

But no one is even close to the upper limit in practice, as bonds, bank deposits and financial products still dominate insurers' asset allocation.

 

The public data of large life and non-life insurance companies in China reveals that by the end of 2020, Chinese insurers still needed to invest CNY11.9015 trillion in equity assets to reach the 45% ceiling. If 20% of that - as most of the case in practice - were deployed into equity investment funds (outside the insurance system), it would amount to a large CNY2.38 trillion.

 

The Insurance Asset Management Association of China (IAMAC) reported in May 2021 that by the end of 2020, Chinese insurers actually invested CNY20.1286 trillion. Among that, just 8% is equity investments, 23% of which is equity investment funds (outside insurance system), amounting to CNY37.3 billion. Compared with the CNY2.38 trillion ceiling we just figured out, there is a huge gap of up to CNY2 trillion.

 

Again, let us get one thing right: insurance assets are not monolithic – there are life and property insurance companies, insurance groups and reinsurance companies. Each has different natures and preferences.



Source: IAMAC

 

Of life insurance companies' equity assets, 33% are equity investment funds (outside the insurance system). For property insurance companies, it is 19%. Among all the peers, the winner is obvious: life insurance companies are backing equity investment funds the most.

 

This is common sense – both life insurances and equity investment funds are long term, and they suit each other. But Nebula Advisors has advanced a different opinion: property insurance companies might have been significantly overlooked.

 

Currently, China has very limited options for insurance the permanent capital. Life insurance products, featuring high debt cost, long duration, low tolerance to losses and strong demand for rapid return, are unsuitable for growth-stage PE investments because the return comes too slowly.


In contrast, property insurance is less "debt-like" than life insurance. Insurers do not have to return the fee if the property remains safe. But insurers do need to pay life insurance customers money throughout their lives, so that capital is more like a liability.

 

Thus, property insurance companies have little cost of debt, allow for slower investment returns, and are willing to perform more long-dated equity investments. Start a conversation with property insurance companies, and fund managers raising new funds will be pleasantly surprised.

 

"Can I have insurance investors? Do insurers really have the so-called 'white list' for fund managers?" Fundraising managers ask these questions often. Well, first, there are must-haves for fund managers to ask insurers for investments:

 

1.     Requirements for PE firms

  • Sound corporate governance and management system, decision-making process and internal control mechanism;

     

  • Registered or subscribed capital no less than CNY100 million, and an established risk reserve system;


  • Investment and management activities governed by Chinese laws, regulations and relevant policies;

     

  • Each GP team comprising over 10 members experienced in PE investments (above 3 successful exits), of which at least 2 have over 5 years of relevant experience and at least 3 over 3 years. Among the senior management, at least 1 member shall have more than 8 years of experience. Also, at least 3 should be good at business operation, financial management and business financing.


  • Excellent track record and reputation with assets under management (AUM) no less than CNY3 billion (excluding AUM of other managers in which holds shares);

     

  • Mature systems in terms of investment target reservoir, asset custody and isolation for risk control;

     

  • Established, scientific and well-implemented systems of incentives, restraints and follow-up investments;

     

  • Answerable to China Banking and Insurance Regulatory Commission's (CBIRC's) questions concerning the investment of insurers' funds and able to report on the relevant situations;

     

  • Itself and its key staff have no major violations of laws and regulations in the last 3 years;

     

  • Other conditions set by the CBIRC for prudential purposes.

     

  • Each raised fund larger than CNY500 million and following certain directions in selecting sectors and targets. As we can see, most small and medium-sized PE firms cannot meet the threshold requirements.

 

2.     Requirements for VC firms

  • Sound corporate governance and management system, decision-making process and internal control mechanism;

     

  • Over 5 years of excellent track records, with accumulative AUM no less than CNY1 billion;

     

  • Each GP team comprising over 5 members experienced in venture investments (above 10 successful exits), of which at least 3 having over 5 years of relevant experience and at least 3 having worked together for 5 years. The investment decision-making staff should have more than 5 years of venture investment experience, at least of which 2 having over 3 years in business operation.

     

  • Mature mechanisms of incentive and restraint, follow-up investment, asset custody and isolation for risk control;

     

  • Answerable to the questions of CBIRC concerning the investment of insurers' funds and able to report on the relevant situation;

     

  • No major law violations in the last 3 years.


  • Each raised fund not over CNY500 million, discouraging VC giants from raising capital from insurance companies.

 

Besides these application conditions for PE and VC managers, CBIRC will further conduct regular scrutiny on fund managers who have raised funds from insurance investors.

 


 

Even when PE and VC firms meet these basic application requirements, they must pay attention to many other practical issues.

 

1. Special terms of contract

In practice, most insurance companies have additional provisions in the fund contracts concerning capital contribution and default, investment direction and restriction, management fees, return distribution, equity transfer, conflicts of interest and related party transactions. The GP may decide whether to modify the fund contract or sign side letters with the insurance investor.

 

2. Cornerstone investor

An insurance company shall subscribe no more than 30% fund shares in one single equity investment fund according to provisions. An insurance group (holding) and its insurance subsidiaries altogether shall not contribute more than 60% fund shares to the same equity investment fund.

 

These percentages register high, but in practice insurance investors rarely play the role of cornerstone investors. Thus, when raising capital from insurers, fund managers should have found their anchoring investors in advance.

 

3. Risk reserve

Risk reserve is common for publicly placed funds, and it is calculated as no less than 10% of management fees. No more risk reserves need to be drawn when the risk reserve balance reaches 1% of the net fund assets.

 

PE funds can decide the volume of their risk reserves, but once that is set, the CBIRC will have the right to check and confirm.

 

4. Management team

The management team is undoubtedly the focal point for due diligence research. First, insurance investors will ask the fund managers for the list of their successful exits, and of potential exits. Required information will include the invested company's profile, the industry to which it belongs, an investment analysis summary, the investment amount and equity proportion, investment stage (round of financing), investment return rate, post-investment management, etc.

 

Moreover, the team member composition, the division of labor and everyone's resume will be carefully examined during due diligence research.

 

5. Investment advisory committee

In terms of organizational structure, insurance investors usually require the fund managers establish an investment advisory committee to deal with the conflicts of interest, related party transactions and major decisions of fund operation.

 

6. Synergy and co-investment

Insurers attach great importance to synergy with GPs. Insurance investors usually hold a large proportion of equity in unlisted enterprises (non-insurance), and they even eagerly co-invest with the most performing GPs in verticals because this way they can increase investment returns.

 

7. Current income

With insurance companies paying more and more attention to the current income and solvency ratio, GPs must prove their ability in actively managing IRR and DPI to the insurance investors, to let the insurance LPs see the expected income.

 

Furthermore, GPs can also help insurers with liquidity management through secondary transactions.

 

8. The "white list"

The long-lasting rumor goes that insurance companies have a "white list" of GPs. But the reality is there is no such thing at all, except that in 2019 IAMAC released a rating report of 143 fund managers with whom insurers have cooperated. The 143 managers fall into 4 categories from A to D. Nevertheless, the ranking only covers a limited number of 143 fund managers, less than 1% of all Chinese PE and VC firms. And the ranks are not determined once for all – PE/VC firms can still make efforts to improve their grades. Not to mention that the rating is only for insurers' reference, not for investment decision-making.

 

About the authors

Pan Jin: Researcher of Wuhan Donghu Guolong Equity Investment Fund Management Co., Ltd., one of the new practitioners in the equity investment industry, has experience in full lifecycle of PE funds.

 

Ou Yu: Researcher of Wuhan Donghu Guolong Equity Investment Fund Management Co., Ltd., once a fund-focused lawyer in a well-known law firm specializing in PE funds, has assisted more than 10 PE/VC firms to partner with insurance LPs.

Topics:
private equity, venture capital, China, insurance, fofweekly, fundraising