31 Jul 2008, Mark Pengelly, Risk magazine
“With the credit crunch, the market isn’t really open for people to raise capital. This is a private placement, and at the moment I think it would be very difficult for people to raise money publicly,” said Harish Gohil, senior director in the insurance team at Fitch Ratings in London.
Annual life insurance securitisation volumes grew consistently from 2002 to 2007. Last year, they reached $7.14 billion, according to Goldman Sachs. Embedded value or VIF deals among European insurers have long been thought of as a potential area for growth – due to both their merits as a capital management tool and the imminent demands of Solvency II, which will require European insurers to adhere to a risk-weighted capital framework by 2012.
However, recent market activity in the US and Europe has been reduced by the imperilled state of monoline insurers, which wrapped many life insurance securitisations. The situation is even worse in the US, as some regulatory capital transactions embedded troubled subprime mortgages within their collateral pools.
As well as being the first deal in some time, BarCap’s transaction – called Zest – is innovative in a number of ways. It is structured as a contingent loan referenced to an open block of Aegon Scottish Equitable’s life portfolio, meaning there is no need for a legally-segregated special purpose vehicle – a feature common to other insurance-linked securitisations.
The loan is linked to the statutory surplus of the policies contained in the referenced block of business. This means investor losses will be suffered if insufficient surpluses arise over the full length of the transaction, which matures in 2023.
It also incorporates a revolving feature, which allows Aegon Scottish Equitable to replace realised surpluses with new business for the first three years of the deal. The inclusion of a revolver makes it similar to another €400 million embedded value securitisation backed by part of Bank of Ireland’s life insurance portfolio in October last year. Dubbed Avondale, it was jointly placed by Goldman Sachs and Lehman Brothers.
More importantly, Zest does not make use of a monoline wrap – and is rated A by Fitch.
“People have to have a certain level of sophistication in insurance to really understand the structure and the risks in this transaction before participating in it,” explained Kory Sorenson, London-based director in insurance capital markets at BarCap. “A structure with a monoline wrap is more widely marketable because the due diligence has already been done by a central counterparty: the monoline. In this kind of transaction each investor has to do their own detailed due diligence.”
The underlying actuarial assumptions behind the deal are based on a model developed by Aegon Scottish Equitable and verified by New York-based insurance consultancy Tillinghast. It follows another £92 million unwrapped VIF deal for Dutch parent company Aegon in January 2007, which was also arranged by BarCap.
Most banks agree re-energising the sector will involve cultivating a new investor base prepared to get closer to the underlying actuarial risks in life insurance deals. But there is some question whether Zest actually achieves this, as the recent deal was syndicated by a handful of large financial institutions.
Existing life insurance deals remain at distressed prices in the secondary market. According to market participants, some US ‘triple-X’ regulatory capital transactions are trading at as little as 50% of par.
Some players hope to take advantage of this market dislocation. Switzerland-based asset manager and advisory Secquaero set up a €50 million fund in May to trade and invest in insurance securitisations. Chairman and managing partner Dirk Lohmann, who has over 27 years of experience in insurance and reinsurance, said he viewed the current situation as an opportunity.
“The issue with life insurance securitisations is they’re very complex: you’re often looking at portfolios of 50,000-70,000 lives. You need to understand mortality risk, lapse risk and interest rate exposure, and you need to build models individually for every portfolio that you invest in. Most funds are not built to do that but that’s one of the things we’re focusing on,” he said.
Although he isn’t optimistic about the immediate prospects for new issuance, he believes the market will come back in the long run. “In the long-term, the securitisation of life insurance risk will grow under a new business model without credit wraps from monoline insurers. There are other people who want to do these deals – you just need a broader and more informed investment market.”
Secquaero is among a growing constituency of specialist insurance-linked boutiques in the market – a welcome development for arrangers. “There are enough investors around now who have a decent enough insurance background to be able to understand the risk,” said Ian Carey, director of insurance structuring at Société Générale Corporate and Investment Banking in London.
The problem, he suggested, was one of scalability. “A lot of dedicated funds have been set up in the past year with an investment pot of €50-100 million. Most of these investors are only willing to make a maximum investment of €10-20 million in any particular deal. It means to get a €200 million deal done you’ve got to convince at least 10 investors of the merits of the deal.”