Triple X deal gets the market excited for more, but no, it's not porn

Two groundbreaking life insurance securitizations - done very quietly this summer - introduced a new asset class to eager investors and opened up exciting possibilities for future deals, sources said.

Although both contain life insurance-related receivables, the two hush-hush deals are significant for different reasons: One frees up the extra reserve companies are required to hold against term life policies under a new regulation known as Triple X. The other captures the arbitrage between annuities and long-term life insurance policies.

Both deals are believed to be the first of their kind.

Several more companies are said to be looking into similar transactions. So far, the would-be issuers have yet to overcome the daunting hurdles that kept life insurance from getting securitized before, observers said. But now that some innovators managed to crack the code, interest is expected to hit a crescendo.

The Triple X deal achieved a series of firsts, including being the only transaction so far to make use of new laws in South Carolina to facilitate insurance securitization.

Several sources said the Triple X regulation - which requires life insurance companies to hold substantially higher cash reserves on term life policies - looks particular promising as a spur for future deals. Many companies are feeling the pinch of constrained capital, and are looking for ways to free up that money. "That's really the hot area," one source said.

First Colony Life Insurance Co., a subsidiary of GE Financial, is behind the first Triple X-related securitization. It is expected to be back with similar deals, perhaps annually.

River Lake Insurance Co., a special purpose company that First Colony set up in South Carolina, issued the senior unsecured notes. The $300 million deal, sold under Rule 144A, was oversubscribed when it came to market via Lehman Brothers in mid-July, sources said. It was rated triple-A, due to an Ambac wrap.

The other innovative deal in the life insurance sector this summer captured the arbitrage between long-term life insurance policies and annuities - Patron's Legacy 2003-1. The $232 million deal, reportedly in the works for two years, came to market in late July via UBS Warburg. It also was rated triple-A rated, with a maturity of about 50 years.

The sponsor is said to be Blue Water Capital, a Tennessee limited liability company. Also involved in the deal were AIG Life and Berkshire Hathaway.

The idea behind the arbitrage deal is that an insurer securitizes a portfolio of life insurance policies and uses the proceeds to purchase annuities. The cash flow from the annuities would be used to pay the insurance premiums, plus interest to noteholders, with the issuer capturing the excess.

But one problem is that payouts on life insurance require proof of death and payouts on annuities require proof of life. So if a person goes missing, with no proof of death, the life insurance won't pay out for seven years. However, because there is also no proof of life, the annuity might stop paying - which would then cause the life insurance to lapse. That seven-year gap is a serious hurdle to securitization.

Typically, the life insurance policies that companies want to securitize are for high net worth individuals. The pool of policyholders might be comprised of 30 to 100 people, so one person represents a substantial part of the portfolio.

The solution is gap insurance, which Patron's Legacy has. One source said, however, "Gap insurance is rare and expensive." And that challenge alone has been enough to prompt some interested companies to give up on arbitrage deals in the past.

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