#381 | End Game: Brookfield and American National
Quick Take
In quick succession, Brookfield has executed four key elements of what appears to be the end game strategy for American National. First, reinsuring the entire fixed and indexed annuity block to an affiliated offshore reinsurer. Second, stripping out nearly $3.5 billion of surplus related to subsidiary companies that now sit under the holding company and plugging the capital gap in part with a permitted accounting practice from Texas to allow $560M of stop-loss reinsurance to count as surplus. Third, reallocating some $4.8 billion of American National’s $20 billion of investments into Brookfield-sponsored or affiliated vehicles, including whole securitized loans, real estate equity and joint venture debt and equity. And fourth, dramatically growing annuity sales and buying American Equity for over $4 billion. What’s the end game? Brookfield is clearly in it for the assets and, in particular, the annuity assets. Where does that leave life insurance policyholders? In a bit of an awkward spot as an afterthought in the grand plan. And increasingly, that’s more likely now to happen to life policyholders who get caught up in annuity-oriented transactions.
Full Article
10/27/23 Update – We found a filing for an update to American National’s FIA products showing that they’ll be adding a Brookfield index – Brookfield Value Architect – in partnership with HSBC. This is the first time we’ve seen an index branded with the name of the owner of the life insurance company on it. We’ll do a quick write up of the index once it goes live.
A few months ago, I made a passing comment in an article about the fact that although PE firms are generally executing on the same playbook with the prime example being Ohio National, it seemed as though Brookfield was leaving American National largely untouched since it acquired the company for $5.1 billion in May of 2022. Unlike Ohio National, which was almost immediately systematically dismantled, stripped and then duct-taped back together after being purchased by Constellation, American National’s balance sheet remained largely unchanged after the acquisition by Brookfield. I thought, maybe, Brookfield had a different playbook and that American National would be a different story. As it turns out, they just needed a bit more time to make the plays.
Since the company was acquired in May of 2022, Brookfield has made three substantive changes. First, the company executed a reinsurance transaction with Freestone Re, a newly formed captive reinsurer in Bermuda, for 95%+ of American National’s fixed and indexed annuity business. This was low-hanging fruit. The majority of large fixed annuity writers, even blue chips such as Mass Mutual and Lincoln, use offshore reinsurance for annuities either with their own captives or through a third-party reinsurer. Statutory reserving for fixed annuities, particularly those with guaranteed rates, is more punitive than it needs to be. Offshore reinsurance allows companies to hold reserves that are more aligned with their actual earned rates, not the statutory valuation rate.
But offshore reinsurance can also allow for significantly more investment flexibility without high capital charges, allowing insurers to invest riskier offshore than they would in the US. American National arguably would have reinsured their fixed and indexed annuity block whether Brookfield had purchased them or not just to stay competitive with their peers, for better or worse. It’s harder and harder for life insurers to be competitive these days without offshore reinsurance. The tie-up with Brookfield just gave them a ready vehicle to do it.
Second, Brookfield reorganized American National Insurance Company. As recently as 2019, American National Insurance Company (ANICO) was a publicly traded insurer. In 2020, American National Group was created as the publicly traded holding company for ANICO. Brookfield arguably finished the transition in 2023 by extracting the P&C entities (under American National Insurance Holdings) and the mysterious ANTAC LLC, which owns a bunch of entities with cryptic names like ANH20 and ANICO Eagle, from ANICO and moving them up to American National Group. What’s left in ANICO is, primarily, life insurance and group annuities.
At a Group level, which drives ratings from the major agencies, not much has changed. But at the statutory entity level, it’s a completely different story. ANICO is a shell of what it used to be. Total adjusted capital at the end of 2022 was $3.5B. Now, it’s just $1.4B – and it actually should be quite a bit less than that. American National received a permitted practice from Texas to book “the notional value of coverage defined in an excess loss reinsurance agreement…associated with a closed block of level premium term life policies and universal life policies with secondary guarantees” as an admitted asset to the tune of $563,609,182, which results “in an undiminished, equivalent increase in statutory surplus.”
In other words, American National did a deal with a reinsurer to cover the losses on a block of business beyond a certain point and booked the benefit of that reinsurance agreement as surplus. One way to interpret the $563M is that it increases surplus because, effectively, those are losses that would have been incurred had the reinsurance not been in place. Unfortunately, there’s not a lot of detail in the filing. But regardless of how Texas categorizes it, stop-loss reinsurance is not high quality, readily available surplus. It’s financial engineering.
Third, Brookfield has moved a significant portion of the assets invested by ANICO into Brookfield-affiliated vehicles. A third-party group, UNITE HERE, penned a scathing report about Brookfield’s repositioning of American National’s assets that you can read here. The gist is, basically, that Brookfield got an exception from Texas to allow for Brookfield Asset Management and American National to be considered unaffiliated for the purposes of statutory reporting. Like the other permitted practice from Texas, this Disclaimer of Affiliation feels like a technicality that gives Brookfield Re the ability to allocate more than the usual amount to affiliated investments managed by Brookfield Asset Management without providing transparency about the affiliation.
According to the report by UNITE HERE, Brookfield has repositioned $4.8 billion of American National’s $20B in assets into Brookfield-affiliated investments as of YE 2022, regardless of whether they’re classified as affiliated or not in the statutory filing. The list is pretty interesting. Of the $4.8 billion in affiliated investments, about $1.2B is standard debt. The quirk is that virtually all of the debt is related to real estate, which is Brookfield’s specialty. The UNITE HERE report makes much of the fact that, like many other commercial real estate investors, Brookfield has had a tough time recently with some of its office and retail holdings. That’s obviously not unique to Brookfield. But UNITE HERE points out that American National may end up holding the bag on some of Brookfield’s distressed assets. We’ll see.
Far more significant and interesting, however, is the $2.2B in structured credit. And not just any kind of structured credit, but commercial real estate structured credit. As I’ve written before, life insurers are industrial consumers of structured credit, which is a way to package loans and other receivables into debt-like structures that are tranched by quality. The tranche at the top of the stack receives the first claim on cash flows and is the last to be exposed to losses, which is why it gets an AAA rating. Lower-rated tranches are subordinate to the higher-rated tranches for cash flows and are exposed first to losses. And all the way at the bottom is the equity tranche, which is the first to miss out on cash flows and the first to be exposed to losses.
Life insurers generally only invest at the top end of the stack when they buy structured credit for the simple reason that they have clear liabilities that need to be backed by assets that aren’t going to default. Equity in structured credit is extremely risky and requires a huge capital charge to hold at a life insurer. As a result, it’s pretty rare to see equity positions in structured credit with any real magnitude on the balance sheet of a life insurer. Not so for American National. The $2.2B in structured credit that Brookfield put on American National’s balance sheet is whole – as in, American National took all of the tranches, including the equity position. All in, just the equity portion of the holdings amounts for around $220M of the total $2.2B in structured credit.
Why would Brookfield structure the investments this way? Why not just put the debt directly on the balance sheet of American National, especially considering that it looks like some of these structured credit tools are linked to a single underlying real estate loan? Because it’s more optimal, from a capital standpoint, to securitize it first. It’s basically RBC arbitrage, even though the NAIC has recently released more punitive capital requirements for equity tranches of securitized credit.
On top of all of this securitized credit equity, Brookfield also loaded American National up with around $1.1B in affiliated short-term lending facilities for real estate and a $450 equity position in a joint venture with Primary Wave, a music label. And I actually think UNITE HERE didn’t quite catch everything. There were a few more private placements on the schedule that, as I dug into them, showed a Brookfield affiliation, including debt from one firm that Brookfield recently salvaged out of bankruptcy.
Brookfield has clearly taken the helm of the investment strategy for American National and is steering it towards a friendly port. The UNITE HERE paper points out that Brookfield “acknowledges that related party transactions involving its insurance companies means ‘Conflicts of interest will arise directly or indirectly.’ In particular, Brookfield Asset Management Insurance Advisor LLC’s Form ADV Part 2A Brochure states:
‘BAM Insurance Advisor will therefore have an incentive to cause Client Accounts to make investments in current or future Brookfield Accounts that (i) are otherwise difficult to raise, including without limitation, because predecessor vehicles have had poor investment performance, the strategy is new or out of favor or turnover of the investment professionals responsible for performance or (ii) have a possibility of generating higher fees or carried interest than another potential Brookfield Account. Correspondingly, BAM Insurance Adviser will have a disincentive to cause Client Accounts to make investments in (a) Underlying Accounts that are otherwise in high demand or (b) are expected to generate relative lower fees or carried interest than other potential Brookfield Accounts…Additionally, given BAM Insurance Adviser’s discretionary authority over Brookfield Reinsurance’s assets, Brookfield may seek to utilize such authority and influence to cause accounts of the Brookfield Reinsurance Related Account Group to enter into transactions that benefit Brookfield more directly.”’
This is a pretty profound disclosure. What it says, as far as I read it, is that Brookfield doesn’t have the same fiduciary responsibility to American National, as an affiliated entity, as it does to other investors in its funds. The buyers of annuities and life insurance at American National aren’t investors in Brookfield funds – they just own an insurance contract, which isn’t a fiduciary relationship. As a result, Brookfield has the “discretionary authority…to enter into transactions that benefit Brookfield more directly.” In other words, Brookfield can take the economics of the overall enterprise into account, not just the economics to American National. That seems like good news for Brookfield shareholders and bad news for American National policyholders.
I would argue that we’re already potentially seeing this play out at American National. Prior to Brookfield buying the company in 2022, American National didn’t have (from what I can tell) hardly any equity tranches for securitized credit, didn’t own a lot of real estate equity and didn’t do a lot of short-term lending, certainly not against old office buildings in New York City. Brookfield has clearly changed the strategy at American National. Who benefits from the change, however, is something of an open question. Some of these investments, just from eyeballing them, are not exactly top-drawer stuff. Instead, it kind of looks like Brookfield is using American National as a place to already do what the disclosure says it could do – park distressed, hard to sell assets that need to be held to maturity to realize what Brookfield perceives as market value, particularly given the current challenges in the commercial real estate market.
The end game for Brookfield with American National is becoming increasingly apparent. Step one is to dump the liabilities to an affiliated offshore reinsurance company. Step two is to slim down the capital structure and backfill with financial engineering courtesy of a Texas permitted practice for the reinsurance deal. Step three is to reshuffle the assets into Brookfield sourced and affiliated investments that may, according to the disclosure, be more about Brookfield’s economics than American National’s.
Step four is to go pedal to the metal in the annuity market to get more deposits both organically and inorganically. Now that all of the pieces are in place, American National has dramatically grown its annuity sales by offering some of the most attractive Multi-Year Guarantee Annuity rates on the market. Take a look at historical sales for ANICO up to Q2 of 2023, which show a huge spike in the most recent quarter. Since then, ANICO has backed off of the rate and sales have likely slowed significantly. Yellow is MYGA sales, blue is everything else (for annuities).
Brookfield also recently ponied up over $4 billion to buy American Equity Life (AEL). American Equity has one the best and most enduring reputations in the fixed annuity market, building up a loyal following of agents who put a disproportionate amount of their business with AEL. It’s an extremely powerful and trustworthy brand in annuities. Over the past couple of years, AEL embarked on a much-needed modernization process in an attempt to blend the old-school service that defines AEL with new-school techniques to deliver better products and rates. It was working and Brookfield invested in the new AEL, but – to make a long story short – Brookfield decided that it didn’t want to share the prize with anyone else and decided to buy AEL outright at an absurd price. Why? Because AEL holds another $60B or so in assets to manage on favorable terms.
However, I think it would be a mistake to assume that life insurance is simply a means to an end for all institutional investors. The history of these sorts of acquisitions is that, most of the time, the institutional investor is willing to actually support the new business franchise. What they find out in short order is that supporting the new business franchise involves giving back no small bit of the overall economics. Otherwise, the company can’t be competitive and can’t attract premium. That’s why I’m not particularly concerned about institutional investors, as a category, getting into the annuity space. They have to fight for the business, in doing so, the policyholders reap the benefits – as long as the company is well capitalized.
That, I think, is the real risk with institutional ownership of insurance companies. Aggressive investment strategies require strong capital backing – real capital backing, not permitted practices or deferred reinsurance gains, as in the case of American National and Ohio National (respectively). Institutional investors aren’t a threat to the life insurance industry as long as they play by the established rules that keep life insurance companies safe. They’re only a problem if they start doing things that they shouldn’t be doing.
As a result, I don’t think it’s fair to paint all institutional activity in our space with the same broad brush. Instead, we should ask questions – are they hollowing out the capital structure of the insurers? Are they taking undue investment risk? Are they treating clients fairly? Are they committed to supporting their business? Are they taking steps to improve their credibility and ratings? In other words, these are the exact same questions we should be asking of every insurance company, regardless of ownership. Institutional investors may prove to be just as problematic, or not, as other types of ownership.
With one exception – timelines. Institutional investors have often been characterized as having a short-term time horizon that is mismatched to long insurance liabilities. I don’t think that’s necessarily the case, based on my experience with these firms, but it’s also certainly the case that some of them are in it for the exit. That is not much of a concern for accumulation annuities because the timelines are short or even for guaranteed payout annuities because the guarantees will be unaffected.
But short timelines are fundamentally incompatible with life insurance. There are far more non-guaranteed elements at play in life insurance over a far longer time horizon with fewer potential options for exiting an underperforming contract. An owner of a company selling life insurance should be in it for the long haul. Anyone – institutional investor or not – who is in life insurance for the short-run is setting agents and their policyholders up for disappointment. The problem is that life insurance policyholders caught up in annuity transactions don’t get a choice. And increasingly, as more and more companies change hands, they may not like where they land.
