LONDON (Reuters) — Tough regulation, arcane accounting and complex risks have made insurers a tricky target for private equity investors.But, under increased pressure to put their growing capital piles to work and facing stiffer competition for attractive targets, private equity funds are taking a fresh look at insurance, a sector expected to see a wave of consolidation and where new niches offer the potential for high returns, analysts say.

Insurance is more complex than the traditional private equity hunting grounds. Insurers deal in often obscure risks and work under rules that oblige them to hold plenty of cash on their balance sheets to protect policyholders.

Leveraging up balance sheets, for example — a typical private equity strategy in retail, telecoms or manufacturing — is all but impossible in insurance, due to strict solvency requirements from both regulators and credit ratings agencies.

Yet insurance deals are also less hotly contested and they can be highly lucrative.

Barclays Private Equity made a 19 times return on its investment in UK insurer Admiral, which floated in 2004.

“Insurance is one area where we are very keen to do more deals,” said Owen Clarke, a managing director at Barclays Private Equity. “It is a little bit easier to find good value, attractive opportunities that are not so widely marketed.”

So far this year, private equity accounts for just under 9 percent of all insurance M&A deals by value, up from 7.6 percent last year, according to research firm Dealogic.

To hit profitable return targets, private equity investors have so far targeted either Bermudian reinsurers, taking advantage of high rates and lighter regulation, or the less capital intensive insurance-fringe businesses at home: distribution, claims management or broking.

“All those kinds of deals are easy for the venture capital community to do. They are not very capital intensive, they are in areas of the market that are consolidating — there is a very easy buy-and-build growth strategy that can be seen,” said Ian Clark, a partner with Deloitte.

Clark cited private equity firm Alchemy Partner’s investment in UK car insurer Footman James as a good example of the kind of deals private equity firms can do in the sector.

So far, private equity investors have targeted Bermuda-based reinsurers, set up to take advantage of soaring rates after events like hurricane Katrina last year.

“A natural catastrophe creates a dislocation in the market, new capacity comes in, rates harden and reinsurers can make high returns on capital employed,” said Mark Thornton, who co-heads the Asia business of private equity firm 3i. “Top reinsurers can make 20 to 25 percent on capital employed and such businesses are valued at a multiple of book value of say 1.4 to 1.5 times. So you can do the maths and see why these types of businesses can generate attractive returns.”

But the lack of leverage means the catastrophe reinsurance business will remain a cyclical investment for private equity.

“The point is you have to be leaning towards a highly profitable point in the cycle, otherwise you’re just not going to get the returns,” said Dominic Slade, a partner at Alchemy. Insurers closer to home are tougher targets, and investors have to skirt around the regulatory capital problem.

The success of the Admiral deal was due in large part to its business model, in which it passes most of the risks it underwrites straight to reinsurers such as Munich Re, meaning it can have a leaner balance sheet than many rivals.

In life insurance, the angle for private equity is narrower.

Barclays’ Clarke said investors could pick high-growth areas where having a less efficient capital structure is less problematic <\m> impaired life annuities, for example <\m> or simply consolidate insurers to extract value, taking a leaf out of the book of closed life players like Resolution.

“The time scales for life insurance are very long and the amount of capital you need to have in a life insurance business is very large, so making an attractive return in a 3-5 year period is tough,” he said. “Nevertheless, I think there will be the occasional deal done.”

Private equity investors attracted to reinsurance