#268 | Constellation Buys Ohio National
A few days ago, Ohio National announced that it has agreed to be acquired by Constellation Insurance Holdings, a de-novo insurance holding company without even a website that is owned by two Canadian pension plans. The transaction is styled as a “sponsored” demutualization. Constellation will provide $1 billion of capital to acquire Ohio National, with half going to policyholders in exchange for their ownership interest in Ohio National and the remainder being contributed as capital over 4 years. Going forward, Ohio National will serve as the “platform” for Constellation to execute other reinsurance transactions, M&A activity and new business growth. The spin from Ohio National is that this transaction is the result of the success of the company and provides the fuel for future growth.
The reality, of course, is likely something rather different. Ohio National has been in a precarious financial position for years. It has eliminated business lines, reduced headcount and famously stopped paying trail commissions to agents on certain annuity contracts. The primary source of Ohio National’s financial pain is readily apparent – Variable Annuities with Living Benefits. For years, Ohio National offered some of the richest variable annuities available in the market, sporting complete investment flexibility, 6% GMIB roll-up rates and enhanced Death Benefits for (in some cases) less than 2% in all-in fees. Beyond VALB, Ohio National has also sold a fair bit of Guaranteed UL. To mitigate the damage from these toxic liabilities, Ohio National has relied on a numerous captive reinsurance to shore up its capital position. But those types of transactions only mask rather than eliminate the risk. Eventually the economics always shine through.
Enter Constellation. The CEO of the firm is the former CEO of Prosperity Life, another institutionally-backed acquirer of distressed life insurance companies (most notably Shenandoah Life). Ohio National will likely maintain a new business franchise that looks somewhat similar to what it is today, but the real appeal of the transaction is what happens financially behind the scenes at Ohio National and in acquiring more distressed blocks so that the cycle can continue. We’ve seen this movie before. Forget the spin, this transaction is about giving Ohio National what it needs – a way out of its financial quagmire – and Constellation a platform for more acquisitions.
What makes the Ohio National transaction different from others we’ve seen is that Ohio National is a mutual company. More accurately, Ohio National Mutual Holding, Inc, is a mutual company. The primary life insurance entities, Ohio National Life Insurance Company and Ohio National Life Assurance Corporation, are stock companies owned by the holding company which, in turn, is owned by the participating policyholders of the insurance companies. It’s a middle-ground corporate structure that theoretically blends the capital and business flexibility of a stock insurer and the commitment to customers of a mutual company. But the structure also has downsides – it lacks the external visibility and accountability of a stock company and the institutional focus of a mutual on paying dividends to participating policyholders. This is the first time in a very long time that a company has demutualized, let alone a “sponsored” demutualization with a single buyer.
In order for Constellation to purchase Ohio National, the Board of Ohio National had to agree (which it “unanimously” did) and, ultimately, its participating policyholders (“members”) have to approve the transaction. In exchange for approving it, participating policyholders will receive $500 million in payouts. I’m not sure how Ohio National categorizes “members,” but looking just at the participating Whole Life block at the company from the statutory filings, the $500 million translates to somewhere in the neighborhood of $5,000 on average per participating policy or about 12% of the current Whole Life reserves at Ohio National Life. There is little doubt that they will approve it. From the vantage point of a policyholder, Ohio National is giving them a significant payout (or policy benefit) to execute a transaction that Ohio National is positioning as the next great phase of the company and a benefit to the company and to policyholders alike. Why wouldn’t they approve it?
Ohio National participating policyholders were already in a precarious position. Ohio National once had one of the most competitive Whole Life products in the market, at least from an illustration standpoint and agents sold the daylights out of it as an alternative to the mainline mutual companies. But over the past few years, both the Dividend Scale Interest Rate and total dividends at Ohio National have been falling like a stone. Just last year, Ohio National slashed its DSIR from 5.2% to 4.7% and its dividend from $113 million to $105 million to somewhere around $100 million for 2021. Agents and policyholders were rightfully concerned about Ohio National even prior to this announcement. It’s hard to imagine that a new buyer with deep pockets is actually going to make things worse.
That might be hard to imagine, but it’s a distinct possibility. If Constellation follows the usual playbook, then Ohio National will be gradually but systematically stripped of hard capital and bloated instead with soft, statutory capital. This strategy of statutory arbitrage releases hard capital to the new owners of the life insurer without impacting the headline financial condition of the life insurer. But make no mistake about it – swapping hard capital for soft capital is a subtle but real degradation in the financial strength of the life insurer. Soft capital costs less than hard capital precisely because it is worth less. Funneling hard capital to investors and using soft capital to plug the difference at the life insurer tells you exactly what the real priorities are. And policyholders ain’t one of them.
On top of that, the participating dividends paid by Ohio National will be somewhat up for grabs. In a typical demutualization, the Whole Life policies are placed in a “closed block” that is required by regulators to be essentially run as a little mutual company within the stock company and only a minimal amount of capital and earnings can by siphoned off to the stock company. However, Ohio National Life Insurance Company already demutualized in 1998 when it converted to a stock company owned by a mutual holding company, which means that Ohio National has both closed and open blocks of Whole Life. The closed blocks are still protected. The open blocks, however, are not. What protects these policyholders? If the answer is just the “goodwill” of Constellation, then that’s a thin hope.
The unfortunate reality is that Ohio National policyholders are stuck between a rock and a hard place. Staying independent would presumably have been difficult for Ohio National – why else would they sell to an unknown new entity in exchange for a measly $500 million in capital contributions? They wouldn’t. CEO Barbara Turner essentially said as much in her press release by stating that “this transaction will significantly strengthen Ohio National’s financial position and ability to fulfill our obligations.” The inference is that without Constellation’s $500 million, things wouldn’t have gone well for the company. Policyholders don’t really have a choice anymore. They have to vote in favor, regardless of the cost and the risk. There doesn’t appear to be a viable alternative.
From my vantage point, I see one big lesson and one big question arising from this transaction. The lesson is that in life insurance, it’s easy to jeopardize a century-old company with a few years of mispriced business. Ohio National sold too many Variable Annuities with too rich benefits at too low of a cost. That’s the long and short of it. Ohio National is a classic example of why looking at ratings or even statutory filings isn’t sufficient to understand the future condition of the life insurer. Ratings and statutory filings look backwards. How then can you see the future state? Look at what products that company is selling. If a company is loading up on risky products that other companies aren’t willing to sell at the same price, then you know that the company is leveraging its future for today’s sales. The future may be kind and the company will survive, perhaps even thrive. Or the future will be cruel and the company will be crushed. The only thing we can measure today is risk – who is taking it and who isn’t.
I think a lot of producers really struggle with looking at life insurer financial strength this way. Everyone wants to believe that a highly-rated life insurer can sell risky products at cheap prices forever but, unfortunately, that’s not how our industry works. Life insurance products are long-duration obligations. The current financial strength of the company is the result of prudent risk and capital management over the preceding decades. The future financial strength of the company is dependent on what is happening right now. That’s why it’s so important for life insurance producers to really know and understand the risk that carriers are taking across the entire enterprise and not just in the life insurance business line. That’s a high bar. How can you clear it? Work with a distribution partner that knows the carriers better than you do and be selective where you place your business. Chase future stability, not current pricing.
Now, to the big question – will this happen again? Yes, of course, but probably not exactly how things played out at Ohio National. In the case of Ohio National, the company needed a suitor with deep pockets. It was looking to be purchased. It needed to demutualize to shore up its capital position, even if that meant turning away from its 111-year history as a mutual company. But what about mutual companies of a similar size that aren’t looking to be purchased? Imagine a scenario where a firm approaches the board of a mutual company with a buyout offer and demands that the board present the offer to the policyholders of the company, something like a proxy-fight in a publicly traded company. Is that possible? Yes, it is. Beyond that – it’s probable. In fact, I know of a group that has already raised hundreds of millions of dollars and secured billions in financing to do just that.
Long ago, there was the age of the mutual company. Then the mutual companies demutualized, ushering in the age of the publicly traded life insurer. Now, we are in the rising of the era of the institutionally-owned life insurer. Athene – now formally a part of Apollo – is the juggernaut of the new era, the model on which every other institutionally-owned life insurer is based. And Athene, by almost all accounts, has been phenomenally successful. The company reinsures tens of billions of dollars of annuity reserves coming from more traditional, mainline life insurers. It is one of if not the top FIA seller in the business. They’re in contention to buy or buy into almost every deal in the market. The guys at Apollo and Athene have made untold millions for themselves and their investors.
Detractors will rightly point out that Athene’s success is predicated, at least in part, on statutory arbitrage (its reinsurer is based in Bermuda) and aggressive and exotic investment strategies that other life insurers wouldn’t use in the same magnitude as Athene does. Both of these arguments have merit. We will find out, to paraphrase Warren Buffet, when the tide rolls out whether or not Athene is swimming naked.
But there’s a substantive difference between Athene and Constellation. Athene mints money because it has figured out how to generate investment spread on generally defined-duration, low-risk, accumulation-oriented annuity products. These are transactional, relatively short-term products. Smart annuity agents and buyers know exactly what they’re getting – a better rate with a bit more risk than a traditional insurer – and they’ve judged the extra risk to be worth the return. I can’t blame them for that, especially given Athene’s sterling track record and billions of dollars in hard capital on hand.
With Ohio National, however, Constellation is making a bet of a different sort. Ohio National has long-term liabilities on its balance sheet in the form of VALB, Guaranteed UL and even Whole Life. These are lifetime products, not short-term, time-bound products. Their risk profile is highly complex and tail-heavy. Athene is picking up pennies. Constellation is playing roulette. Athene is the first generation of institutional life insurance investors where the play was to leverage investment prowess to scrape a vig on the excess return. Constellation is the next generation – institutionally backed firms looking to buy massively risky life and annuity blocks believing that they can understand and manage the risk better than the life insurer or, at least, make a run at it and stick the policyholders with the bill if things don’t work out. Constellation isn’t the first and it will hardly be the last.
