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The Actuary The magazine of the Institute & Faculty of Actuaries

Innovative financing

Securitisation has often been viewed as a remote and esoteric method of financing. The truth is that it involves nothing more than segregating a portfolio of assets or rights to a set of cashflows and then repackaging this into securities that can be traded in the capital markets.
Securitisation has traditionally centred on mortgages and credit card receivables but now that the UK, the US and, increasingly, Europe have well-developed securitised debt markets, an ever-expanding range of alternative assets has come onto the securitisation radar. Having been met with a frosty reception and suffering from a lack of precedent, market participants across the board are now warming to the idea of life insurance securitisation.

Almost any assets or liabilities and their underlying cash flows can be marketed for securitisation, including premiums, charges, commissions and reserves. This allows insurers to accelerate the release of the capital element of the embedded value locked in blocks of business. Such securitisations are also known as a value-of-in-force (VIF) monetisation. Through securitisation companies can benefit from improved liquidity, a higher return on equity and a potentially lower cost of capital.
A number of recent transactions have been propelled by the attractive rates offered in comparison to issuing equity, subordinated debt, or hybrid products. As well as offering an innovative method of diversified funding, securitisation can provide an attractive alternative to reinsurance, the traditional hedging tool. Financial reinsurance is becoming increasingly fraught with obstacles such as limited capacity and relatively high expense.
A carefully structured securitisation can provide relief from onerous regulatory capital requirements. Funds raised can potentially be treated as core Tier I solvency capital in the regulatory peak, giving a boost to an insurer’s financial health.
Recent transactions demonstrate the range of uses for securitisation, from financing new business to hedging extreme mortality risk. Table 1 highlights some of these securitisation transactions.
The originators of a securitisation must be able to provide potential guarantors and investors with credible in-depth projections of the risk/reward profile of the business being placed. Therefore, preparing for placement has the spin-off benefit of helping companies to improve their understanding of the value drivers within their business. In turn, securitisation can enhance market credibility. Securitisation may carry favour with analysts, rating agencies and investors by elucidating certain balance sheet assets and liabilities that have traditionally suffered from being informationally opaque.

The difficulties
Planning a life insurance securitisation is a lengthy process and its success relies on commitment of time and resource from management. The placement itself requires commitment from a range of parties including bankers, lawyers, actuaries, accountants, tax advisers, regulators, and rating agencies. Therefore it is important that insurers are sure that securitisation is the appropriate solution for their strategic objectives and capital profile needs rather than assuming that securitisation is the solution and working backwards.
The success of securitisation relies on being able to deliver clearly defined and reliably quantifiable cashflows to the market. This can pose a challenge when securitising open portfolios, though recent placements have demonstrated that it is possible to overcome this with careful planning.
The potentially highest hurdle that must be cleared is that of winning regulatory backing. Consideration must be given to whether policyholders are being treated fairly and their interests protected. To date in the UK, the FSA has been supportive of securitisation and early issuers have been able to take advantage of the lack of standardisation or consensus around how such transactions should be structured. It is unlikely that the FSA would raise serious objections in the future. Why would it when the risk of failure is being passed from policyholders and shareholders into the financial markets?
Securitisation in life insurance may still be in its adolescence, but at a time when the industry is increasingly capital-constrained, insurers will have to innovate to move forward. Securitisation could rapidly grow into a fundamental component of an insurer’s financing strategy.