#323 | The Real New Ohio National

Q2 Update – In Ohio National’s Q2 statutory statement, they disclosed a $279 million dividend paid to the holding company owned by Constellation and undoubtedly fueled in part by Ohio National’s increase in surplus after the sale of the participating Whole Life block to Hannover Re, as discussed in this article. This is the final chapter of the PE playbook and exactly what I refer to in this article when I write about “hollowing out” a life insurance company. That capital should have stayed at Ohio National. Instead, it went upstream, repaying the majority of the $500 million that was used to purchase the company.

Quick Take

With the Q1 2022 statutory filing, the playbook for Constellation’s purchase of Ohio National is becoming increasingly clear. Not only did Ohio National lay off a meaningful number of distribution and underwriting, but they also executed a massive reinsurance transaction that effectively sells their entire Whole Life block to Hannover Re in exchange for $880 million, with some strings attached. They also shunted more FIA reserves off to their Cayman-domiciled Sycamore Re and took an enormous capital withdrawal from their primary captive reinsurer. The net result is that Ohio National is being hollowed out and the capital is likely going to be sent upstream to the consortium of owners, providing a quick return of and on investment. What should producers do? Unfortunately, moving the business is probably the best solution. Where to go? To companies that aren’t doing the same thing that Ohio National did – selling cheap guarantees, relying on captives to prop up capital, making short-term money grabs that imperil the long-term franchise and just generally making imprudent decisions that other companies question. And the good news is that there are plenty of companies that still fit the bill, but not all of them.

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When it comes to private equity buying distressed life insurers, there seems to be a very clear playbook – get it relatively cheap, modify policyholder benefits where possible, cut operating expenses and hollow out the company with reinsurance deals.

As I’ve written in two prior articles (#268 and #308), the first two steps have already been completed. Ohio National was sold for $500 million with an additional commitment of $500 million in capital contributed in $125 million increments in years 2-5. As the prospectus makes abundantly clear, the sale was triggered by anticipated financial distress. Ohio National needed a buyer and Constellation stepped up when it seems that no one else would. As a condition of the sale, Ohio National agreed to a new dividend framework that I covered in detail in #308 that essentially ensures that Ohio National policyholders will not get a dividend for 15 years after next year unless 10 Year Treasuries continue to climb and stay elevated. That covers the first two steps.

Now, Constellation is executing on the remaining two parts of the playbook. I heard at the beginning of last week that there was a significant layoff at Ohio National, primarily in sales and underwriting positions. That was later confirmed by Life Annuity Specialist, a news publication for life insurers, and it seems as though there was also a second round of layoffs later in the week. From what it looks like, the life and disability new business franchise at Ohio National has been thoroughly gutted, including some senior leaders.

That’s interesting news, but not nearly as interesting as what Ohio National is doing behind the scenes. In #308 I wrote that “the transaction [between Ohio National and Constellation] will also very likely entail block sales, reinsurance transactions and other plays to release capital.” That’s exactly what has happened, which is a testament not to any clairvoyance on my part but, rather, the incredibly predictable nature of these sorts of transactions. Buyers of distressed life insurers stick to the script. It works. For them, at least.

I got a tip that Ohio National had executed a huge reinsurance transaction in conjunction with the sale, so I pulled the Q1 statutory filing and, sure enough, it made for some fun reading. First, it details the tangled web of ownership for the new Ohio National. The general story to the public was that Ohio National was being purchased by Constellation, which is the insurance vehicle for two Canadian pension plans, CDPQ and Ontario Teacher’s Pension Plan (OTPP). According to the filing, CDPQ has the larger of the two stakes in Constellation – 49.5% compared to OTPP’s 29.9%. However, Constellation itself only owns 60% of Ohio National. If you run the math, plus Constellation CEO Anurag Chandra’s 1% stake, that tallies up to just 48.2% of Ohio National. So who owns the rest?

CDPQ, as it turns out, is a direct investor in Ohio National to the tune of 20%, bringing its overall direct and indirect stake in Ohio National to 49.7%. The remaining 20% of Ohio National is owned by 11004883 Canada Inc, which itself is owned by one Jean Turmel. Mr. Turmel appears to be something of a legend amongst banking circles in Canada and is a board member for OTPP. 11004883 Canada Inc owns 20% of Ohio National directly and an additional 11.76% indirectly through a 19.6% stake in Constellation Group. Tally it all up and CDPQ owns 49.7% of Ohio National, Jean Turmel (through 11004883 Canada Inc) owns 31.76% and OTPP owns 17.94%. The remaining 0.6% is Anurag Chandra’s courtesy of his 1% stake in Constellation. That’s quite a bit different than the narrative that Ohio National is now owned by “two Canadian pensions.” Here’s how the organizational chart looks in the Q1 statutory filing:

Now, for the more interesting part. Ohio National’s Q1 filing also makes mention of the fact that the company executed a reinsurance deal with Hannover Re on 3/31 that “includes all open block Whole Life…issued from August 1, 1998 thru December 31, 2021, including all whole life riders.” In return, “ONLI [Ohio National Life Insurance] recorded a deferred gain obligation of $880,471,095…which will be amortized into income as profits emerge on the block reinsured. As of March 31, 2022, $0 of the deferred gain has been amortized into income.” Although it doesn’t flow through to income, the deferred gain – which is one of the more bizarre statutory accounting constructs I’ve ever seen – shows up as “deferred coinsurance gain” on the balance sheet added to capital, which bolsters Ohio National’s surplus from $1.45 billion at the end of last year to $2.29 billion at the end of Q1.

Let me put this in plain English. As soon as the transaction with Constellation closed, Ohio National sold its Whole Life block to Hannover Re in exchange for $880 million, although it appears that $880 million has some strings attached to it. It’s also a coinsurance funds withheld structure, which means that Ohio National / Constellation still gets to manage the money even though Hannover Re gets all of the product economics. My view is that the only way this sort of deal is really possible is if you have a contractual dividend formula because that’s what would allow Hannover to put a value on the block. This transaction surely was contemplated as a part of the sales process, although in my reading of the prospectus there was no mention of it. Ohio National is, for all intents and purposes, no longer in the participating Whole Life business.

Over the past couple of years, Ohio National has been getting more juice out of its captive reinsurance structures. Captives can seem complex, but let me explain them for the purposes of this article with a simple analogy. In North Carolina, we have a lot of hogs. Hogs make a lot of hog poop. That hog poop goes into massive hog lagoons. Let’s say that an industrial-scale hog farm drains its hog lagoon into a lagoon owned by a subsidiary that then drains it into a lagoon owned by a different subsidiary just across the county line, where the regulations are more lenient and where the lagoon is well out of sight. Now imagine that hog farm then tells people that because there’s no lagoon on the farm and no stench in the air, its hogs miraculously don’t poop. That’s more or less what life insurers do with captives.

Ohio National has more than a few hog lagoons laying around a whole network of structures to move the mess. Ohio National has isolated all of its VA risk into one entity, Sunrise Re, which is wholly owned by Ohio National. From there, Sunrise Re retrocedes the risk primarily to Sycamore Re, a Cayman reinsurer that is also owned by Ohio National. Ohio National received a permitted practice from Ohio in 2020 to use non-statutory accounting for Sunrise Re, which has allowed it to suck several hundred million dollars of capital out of Sunrise Re without taking a balance sheet hit.

That’s real money that has been transformed from reserves into free capital. The biggest distribution occurred, not surprisingly, in March of 2022 to the tune of $200 million. Not long afterwards, Ohio National reinsured its entire in-force and new business FIA block tallying up to $625 million in reserves to Cayman-domiciled Sycamore Re, the final resting place of Ohio National’s toxic GMIB sludge. Presumably, the capital and earnings from that FIA block will serve as a ballast against the VA liabilities without requiring capital contributions from the parent company, in addition to getting some nice Cayman tax benefits, which has no corporate tax.

This is what I mean when I talk about a life insurance company being hollowed out. All of these maneuvers are for one end – to release capital that can be pushed upstream to the owners of Ohio National. Very rough math shows me that Ohio National was purchased for $500 million, but $1 billion (more or less, depending on taxes) was released and will eventually make its way upstream. It looks like the consortium that purchased Ohio National doubled their money overnight, although it’ll take time to actually get the earnings out of the company. All of this financial engineering, in addition to rates increasing, means that the consortium who bought Ohio National is very likely patting themselves on the back for a very timely and very savvy purchase. They essentially got it for nothing, from the looks of things.

A lot of folks have asked me what they should do about clients who own Ohio National. I’ve had more than a few producers ask me what they should do with their own Ohio National policies. The answer, I think, depends. If the client is uninsurable, then they should keep the policy. If the policy guarantees are incredibly rich and the client is fine receiving no dividends, then the client should weigh the credit risk of the insurer, but most likely they should stay. But short of those two scenarios, there is no reason that I see for anyone to keep an Ohio National – now really a Hannover Re – Whole Life policy. Take the profits and go. Heck, take the losses and go. It’s as simple as that.

A lot of folks have also asked some variation of “who’s next?” Hopefully no one, but we can’t guarantee that. In my mind, all we can see are warning signs and they were lit up like Times Square for Ohio National. If a company is heavily reliant on captives, that’s a warning sign. If the company makes drastic moves that imperil its new business franchise just to save a few bucks – which is what Ohio National did when it cut VA trail commissions – then that’s a warning sign. If a company is selling products that illustrate the best and have the best guarantees, then that’s a warning sign. If a company is doing things that no other company seems to want to do, then that’s a warning sign.

All of these were present with Ohio National. I don’t know of any other company where all of these are present, but the groundwork has been laid at a few. The bad news is that we don’t know with certainty what will happen. The good news, though, is that all of those warning signs are easily observable by laymen like us and, unlike agency ratings, they are leading indicators. If you see a life insurer doing things that seem imprudent, even if those things are imprudent in favor of your clients, then pause to consider the future repercussions. Listen to your gut and ask tough questions. Long-term financial strength is built on prudence and common sense, not brilliant financial engineering.

Where does this leave Ohio National? What will likely emerge is a moderately-rated player in the independent fixed annuity space, trading on the legacy of its name. And it would hardly be the first time that’s happened. Lincoln Benefit Life was a hot commodity amongst PE-backed insurers trying to make inroads into the independent market for the sole reason that it has a brand name, despite the fact that the company today has nothing in common with what it was 10 years ago. In the fixed annuity space, aggressive reinsurance deals and tenuous capital stacks are the norm, if not a competitive advantage.

Ohio National as you knew it is gone, both literally and figuratively. The only thing left is the name. That and the lagoons of GMIB hog poop sitting over the county line.