The increasing pressure on life insurers to diversify their portfolio risk, coupled with their efforts to improve earnings, is heightening interest in the securitization of insurance policies as an alternative to boost liquidity, said analysts with Standard & Poor’s, New York, in a teleconference.
The securitization of life insurance policies is a transaction that is similar to a loan. The investor gives the insurer a lump sum and receives, in return, future earnings on a specific block of insurance business in the same way a lender receives payments on a loan, while accepting the associated payout risks. Meanwhile, the life insurer is free to use the cash it has raised in the transaction.
“In the past, insurers have both created insurance products and kept them on their balance sheets, rather like being a manufacturer and a warehouser of the same product,” said Jayan Dhru, director with S&P. By freeing up capital and liquidity, securitization will make much-needed resources available for life insurers and allow them to concentrate on what they know best. “Securitization allows life insurers to concentrate their key talent of underwriting by realizing income flows more quickly,” he noted.
Despite the benefits securitizations will bring to them, life insurers, in the past, had little mechanism or incentive to securitize insurance policies. However, with demutualization in full swing in the industry, a new market for securitization is surfacing, according to Dhru.
After demutualization, life insurers will have to act more like fund managers for their policyholders and shareholders than security guards for the vault of policyholder’s money. “[Demutualized] life insurance companies now have to consider shareholders and their demand for competitive returns on equity,” he noted. “Once risk has been transferred through securitization, insurers can earn higher returns without impairing their ratings.”
At least in an accounting sense, according to Dhru, securitization helps improve the debt/equity ratio of an insurance company because the amount raised from a securitization is not considered debt but rather the sale of an asset. The cash received from the securitization reduces the need of raising capital through debt offerings.
Dhru said the two largest risks involving securitization will stem from reinsurance and expenses associated with the transaction of securitization.
Reinsurance that may be included in the securitized block will benefit potential investors as it reduces the yearly volatility of income, he noted, but its value to the holders of financial instruments will depends on the insurer’s ability to recoup payments when reinsured events occurs. “If the reinsurance treaty [on a secured block] contains something more than protection,” said Mark Puccia, an analyst with S&P, “we will not consider it as a meaningful transfer of risk from an insurer to a reinsurer.” He noted, “we will take into account the financial security rating of the reinsurer and examine the financial instrument’s resilience to defaults on payments by the life insurer.”
Another risk insurers have to take into consideration is expense related to securitization. “It would be customary to link securitization-related expenses to customer inflation plus a margin,” said Dhru. “The major risk in this context is a period of high consumer inflation, especially if it coincides with a period of low investment returns.” Expenses would increase as the ability to earn attractive returns was lowered.
Additionally, in the early days of life insurance securitization, insurers will have to accept less attractive terms to access the capital market, he noted. “The capital market has not generally been enthusiastic about investing in transactions that are not wholly separate from the financial strength rating on the underlying insurer,” added Dhru. “Greater separation between the sponsoring insurer and the securitized block of business will be needed for the life insurance securitization market to develop,” he concluded.
Reproduced from National Underwriter Life & Health/Financial Services Edition, November 5, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.