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Insurers turn to securitisation for financing and risk transfer Back  
Europe is witnessing steady growth in the development of securitisation as a tool for financing and risk transfer, within the life insurance industry in Europe. A number of transactions have come to the market in recent years and according to Standard & Poor’s, further growth is expected in the number, type, and sophistication of transactions in the years to come, Fiona Reddan reports.
To date, three main types of transaction have been observed in Europe:
• Value-in-force (VIF) monetisation (closed books and existing business)
• Life insurance catastrophe-linked bond
• New business strain funding (premium securitisation)

Of these, the monetisation of VIF, sometimes referred to as embedded-value securitisation, has to date been the most prominent, with three large transactions completed in Europe. In essence, this type of securitisation allows life insurers to monetise the future profits associated with existing business. It can be seen as an alternative to other traditional funding sources, such as hybrid debt, both of which can qualify as regulatory solvency capital. These transactions also serve insurers as a tool for risk management and give certainty over the value of future surplus that can be attributed to an insurer’s shareholders at a particular point in time. The technology in these monetisations has been used by insurers operating an ongoing business (such as Friends Provident Life and Pensions Ltd.’s Box Hill Life Finance PLC transaction, detailed below) as well as those that have closed books of business (as with Gracechurch Life Finance PLC and Mutual Securitisation PLC). In this way the tool can be seen as providing an effective solution to both barriers to growth, as funding can be used to cover the new business strain associated with writing new business, as well as barriers to exit, where the securitisation of a closed book of business gives a degree of finality and certainty to the run-off of the book.

The use of catastrophe bonds within the life insurance industry is a relatively recent development, and follows the steady flow of catastrophe bond issuance in the non-life sector in the past 10 years. The Vita Capital Ltd. and Vita Capital II Ltd. transactions, issued by Swiss Reinsurance Co. (AA/Watch Neg/A-1+) and discussed below, serve to protect the insurer or reinsurer from catastrophic mortality risks (such as epidemics or large-scale terrorism) that are associated with writing term life insurance business. The transactions provide an alternative to reinsurance or retrocession of risks that would prove unavailable or prohibitively expensive in traditional markets.

Finally, new business strain transactions serve to provide a source of funding to life insurers that face large and immediate cash costs of writing new business, which will only be recovered from premium flows over time. The mechanism used to fund these cash costs (such as the commission paid to brokers bringing new business) involves securitising a loan to the insurer, which is fully contingent on the premiums being paid over time.

We consider that the potential for further development of life insurance securitisation remains high in Europe and the number of transactions is expected to increase. Key drivers of the market are regulatory changes, the availability and price of reinsurance, and the state of profitability in the sector as a whole.

Securitisation is increasingly being viewed as a useful tool for insurers, who are being faced with greater regulatory capital needs and tighter definitions of eligible regulatory capital. Much of the rationale for VIF monetisation transactions, such as Box Hill, is the need to raise eligible regulatory capital and unlock the intangible assets of future surplus, which will no longer get sufficient regulatory capital credit as implicit items on the insurer’s balance sheet. Securitisation technology can also be seen as benefiting the insurer’s desire for growth, and can help overcome the cash needs associated with new business strain, which often have to be met from existing shareholders’ funds. This can be done either by unlocking the VIF of exiting business or by securitising the premiums associated with the new business as it is written, as was achieved by Norwich Union Life & Pensions Ltd. through the Anglia Funding Ltd. Transaction.

Securitisation may also be of interest to the growing number of insurers who have pulled out of certain lines of business, such as with-profits plans, and placed the associated, long-term liabilities and their cash flow funds in an orderly run-off.

Catastrophe bond securitisations, such as the Vita Capital transactions, are already common in non-life insurance, and it is likely that with scarcity of reinsurance capacity other life insurers and reinsurers will look to this type of technology when managing catastrophic mortality and possibly also longevity risks.
Current indications are that insurers are starting to consider some very different types of securitisation. In all likelihood, the future development of the market for insurance securitisation in Europe will see a number of bespoke transactions as well as developments on the types of transaction seen to date. There is also considerable potential to harness the established concepts of structured finance and to apply them to new issuers, new classes of business, and new investor bases. The transactions being considered may also involve more complex financial engineering, with the prospect of tranched transactions and unwrapped securitisation increasing in likelihood. In December 2004, for example, the Queensgate Special Purpose Ltd. transaction in the U.S. ‒ which involved the monetisation of five books of exiting life insurance business acquired by Swiss Re ‒ was brought to the market as a tranched transaction (the lowest tranche being below investment grade) and without the benefit of a monoline bond wrap. Queensgate may well pave the way for similar transaction structures in Europe.

Regardless of how the market develops, certain industry-specific considerations will remain constant. In particular, as a regulated industry, insurance is subject to regulatory intervention of varying degrees of implicit or explicit severity should the authorities consider that the best long-term interests of policyholders are being compromised. In general, therefore, investors must always assume that they are subordinate to the policyholders, the protection of whose interests must always constitute the regulators’ primary concern. Transactions that attempt to monetise the future profits of a business are therefore unlikely to be able to achieve delinkage from the rating on the insurer itself.

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