Jim Connolly

Scottish Re Group Ltd. will acquire the U.S. individual life reinsurance business of ING Re.[@@]

The transaction includes ING’s transfer of $800 million in reserves and its payment of a $560 million ceding commission to Scottish Re.

The transaction consists of traditional mortality business, which in the life reinsurance industry requires collateral to satisfy the reserve requirements of the Valuation of Life Insurance model regulation, better known as Triple-X, and its successor Guideline, A-Triple X. Scottish Re is already in the traditional mortality business and the transaction will provide the company, based in Hamilton, Bermuda, with scale, says Melissa Daly, a Scottish Re spokesperson.

In a statement, Fred Hubbell, ING’s executive board member, said that the transaction fits ING’s strategy of allocating capital where it can generate the best returns. The transaction is expected to reduce the capital requirements of ING’s U.S. reinsurance business by $560 million, improve ING Group’s debt/equity ratio by .2% and increase the capital coverage ratio of ING Insurance by 19%.

Following the acquisition, Scottish Re will have approximately $1 trillion of face amount of life reinsurance in-force, $8 billion in assets, $2.1 billion in revenues; and a capital base of approximately $1.3 billion.

In addition to the assets transferred by ING Re, Scottish Re will raise an additional $230 million in new capital, which will satisfy the capital requirements for the new business. The new capital includes $180 million to be provided by the Cypress Group, a private equity firm based in New York, and, an additional $50 million of trust-preferred securities. The size of Cypress Group’s stake in Scottish Re in exchange for the investment is 9.9% of ordinary shares, according to Daly. If warrants and subdebt are exercised, the total would increase to 22% of Scottish Re’s ordinary shares, she adds.

But the size of Scottish Re following the close of the transaction, expected by year-end 2004, would make it the third largest life reinsurer and the tenth largest globally, she says.

Following the announcement, Fitch Ratings, New York, affirmed Scottish Re’s ‘BBB’ long-term issuer rating, as well as the ratings on all its outstanding debt, and affirmed the ‘A’ insurer financial strength ratings of all operating subsidiaries. Fitch says that its rating outlook is ?Stable.’

In affirming the ratings, Fitch concludes that the ratings strengths of the transaction outweighed certain ratings concerns. Because the books of business are complementary, with minimal overlap, the transaction will improve Scottish Re’s diversification, significantly enhance its overall scale and provide the opportunity to gain access to new clients, according to Fitch. Management anticipates that the acquisition will be highly accretive to earnings and that transition risk will be reduced because the business comes with certain systems, and a core group of reinsurance specialists will be retained from ING to administer the business, Fitch adds.

Moody’s Investors Service, New York, affirmed the ?A3′ insurance financial strength ratings of the company’s core insurance subsidiaries, Scottish Scottish Annuity & Life Insurance Company (Cayman) Ltd. and Scottish Re (U.S.), Inc.

The outlooks for the ratings of Scottish Re and its subsidiaries were changed to negative from stable, however.

According to Moody’s, the negative outlooks reflect a decline in risk-adjusted capital levels (as calculated by Moody’s) caused by this very large transaction and the integration risk associated with it, as well as the uncertainty regarding the future financial performance of the block of business being acquired. The rating agency added that this opinion also was based on the substantial and recent rapid growth at Scottish Re, including the non-organic acquisition expansion, which increases the risk profile and potential earnings volatility of the company.

Offsetting these weaknesses, Moody’s notes, is that the ING transaction remains consistent with the core strategy of Scottish Re to grow its traditional mortality-risk business. The rating agency added that benefits of the transaction include broader market presence and scale, additional life reinsurance expertise, and enhanced earnings capacity. In addition, Moody’s pointed out that Scottish Re has mitigated the rollover risk that is associated with letters of credit (LOCs) that are backing statutory-reserve requirements (e.g., Regulation XXX reserves) by means of the transaction structure.