Regulation Triple-X, the ruling that mandates how much cash reserve insurance companies must keep against their term life portfolios, has insurance carriers seeking reserve relief in the securitization market. At least two such transactions are seen funding before the year is through.
"Securitization has emerged as an important tool for managing various aspects of the insurance business," said Scott Willkomm, president of Scottish Re Group Ltd., during a panel discussion at Standard & Poor's conference dedicated to new assets in held last wee New York. "The funding of noneconomic reserves from the capital markets is the most important element."
Scottish Re has completed one $200 million transaction funded through an HSBC Securities conduit, and is working on another longer-term transaction with another firm, Willkomm said.
The much maligned regulation Triple-X took effect in January 2000, and has since resulted in a substantial increase in gross statutory reserve requirements for insurance underwriters. Meanwhile, the calculated economic reserves - based on what companies are actually experiencing in mortality rates - continue to decline. This is due largely to the fact that statutory reserves are figured using mortality rates on policies issued prior to 1970.
"[Regulators] are concerned about underreserving, and so they use a conservative mortality table that doesn't recognize that mortality rates have declined significantly," said analyst S&P's James Doona. "The statutory reserves according to this table are roughly three times what the economics would suggest, so the statutory reserves and economic reserves are out of whack."
Furthermore, life insurance companies have created their own underwriting classes - such as superpreferred nonsmoker as opposed to select nonsmoker - that are not accounted for in the statutory constructions. Thus, the disparity between the economic and statutory reserves grows ever wider, creating a substantial reserve redundancy and putting pressure on the price of insurance products, ratings analysts maintain.
The conventional solution has been to reinsure the excess mortality represented by that difference, or to secure a letter of credit from a bank. However, as banks are unwilling to extend letters of credit beyond one year, there is a mismatch for polices that can extend as far as 30 years. "If you use a letter of credit that expires in one year, the mismatch subjects you to price risk," S&P's Doona said. "The [industry wide] shortfall for letters of credit is somewhere in the vicinity of $100 billion, and could grow to be as large as $140 billion."
Moreover, capacity on letters of credit is constrained by banks seeking to limit their overall exposure to the insurance sector, Doona added. Securitization is one of the most attractive alternatives, industry sources said. The blueprint structure has insurance companies setting up a special purpose reinsurance company and entering into a reinsurance agreement with that company to hedge the excess mortality.
"The special purpose company issues notes to the capital markets and hold, the proceeds in a Regulation 114 trust, and those notes underlie the reinsurance agreement. Investors earn Libor plus a spread, and the spread is the premium being paid for the reinsurance," Doona explained.
So far, the River Lake transaction from First Colony, a GE Financial Company, is the only such public transaction to date. That transaction is essentially a long-term vehicle being funded through the short-term market. The special purpose reinsurance company issues a note to a money market trust, and that trust then issues money market securities to the public. Investors see the 28-day Dutch auction securities, Doona said.
While the mortality table is in the process of being updated, most in the industry do not think the remodeling will be sufficient to alleviate the reserve stress on insurance carriers. The new table is based on data from 1990 to 1995 with projected improvements to 2001, according to a S&P report.
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