U.K. life insurer, Friends Provident is the latest insurer to tap the market with a GBP380 million ($726 million) embedded-value securitization. The deal follows the Norwich Union Life & Pensions Limited GBP200 million securitization of future new business profits completed in October.

Regulatory challenges imposed over the last four years in the U.K. insurance industry have sent companies to seek funding beyond the traditional reinsurance borders and into the securitization realm (see ASR 6/17/02). The FSA in the last year worked to implement what's coined as the prudential directive, which aims to bring more clarity to the "realistic" position of insurance companies.

Life insurers are now faced with the task of tiding up balance sheets and finding hard capital and one key option is through securitization. "Now, with the dust settled, companies can better understand their financing position," explained one source. "Insurance companies need to finance themselves and the FSA says you can't rely on equity like you used to, so these companies have to consider alternative methods of funding."

Looking at the embedded value of life insurance profits has become a point of focus, especially in last year, as companies face these more stringent balance-sheet reporting regulations. When general levels of capitalization fall towards the regulatory solvency minimum, there is a risk of active regulatory intervention in the insurer's operations, which can cause the company to cease writing profitable new business, explain analysts at Standard & Poor's in a recent research report on the industry.

Insurance companies may elect to securitize a part of their business, such as a block or portfolio of existing policies, or in some circumstances, a whole business that has been put into runoff. Regulators in some jurisdictions may view the SPEs, created to hold insurance assets and execute securitizations, as performing insurance business. "On all of these deals, the regulator must provide a no-objection stance and, in the sense that we are beginning to see more of these deals, we at least know that the regulator is at least not objecting to the use of securitization," said one analyst.

Structurally, the aforementioned deals are different. Norwich Union was seeking to deal with a new business strain doing a securitization of premiums and creating something that is more akin to a financial reinsurance. From an insurance viewpoint, it was the first time a company used the securitization market to fund new business activity. As a result of this securitization, Norwich Union will be able to diversify its funding sources away from traditional reinsurance.

The program involves a loan to by an SPV called Anglia Funding, which funds the loan by borrowing from the Royal Bank of Scotland's $15 billion commercial paper conduit, TAGS. The loan is secured by the premium cashflows and commission clawbacks due on a diversified portfolio of term life and mortgage protection policies originated by Norwich Union Linked Life Assurance Limited. The proceeds of the secured loan will be used to fund the commission and set up costs incurred by Norwich Union when writing new protection policies.

The Friends Provident deal, Box Hill Life Finance, falls more in line with the embedded-value securitization structures featured in the Gracechurch Life deal - both transactions managed by Barclays Capital - and the National Provident Institution deal.

Under the Box Hill Life Finance transaction, the insurer securitized the value-in-force surplus from a defined book of life insurance policies originated by Friends Provident. The majority of the policies are unit-linked where the investment risk is passed directly to policyholders. A large portion of the book of business is unit-linked pensions contracts that typically experience low lapse rates and are further protected by U.K. legislation restricting access to pension funds prior to retirement age. The notes are also backed by an Ambac wrap.

Friends Provident is seeking to improve the quality of the solvency capital through providing finance to Friends Provident Reinsurance Services as reinsurer (a wholly owned special purpose reinsurer), which will provide reinsurance to Friends Provident on the defined book. The proceeds of the notes will be held in the form of qualifying assets by the reinsurer to back the reserves required in respect of its reinsurance obligations towards Friends Provident - thereby improving the regulatory solvency position of Friends Provident.

The deal has sparked renewed interest from a number of insurance companies with closed funds and industry players say that if the Friends Provident deal prices favorably, the market is likely to see a number of these deals come to fruition next year. "The structure is largely similar to the Gracechurch transaction and now that we have seen it twice, certain aspects of these deals are clearly adaptable," said one market source. "The driver for these deals is regulatory in nature and now that more transactions have happened, more companies are going to want it available as a potential form of restructuring in the future."

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