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Strong, Continuing Need Seen For Insurance-Linked Securitizations

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The need for life insurance securitizations will continue in the long-term, although in 2008 and possibly in 2009, the vibrancy of the market may be temporarily curtailed, according to speakers at a recent Investment Symposium sponsored by the Society of Actuaries, Schaumburg, Ill.

Of a total insurance-linked securities capacity of approximately $60 billion, roughly $25 billion-$30 billion is non-life and $35 billion-$40 billion is life insurance related, said Chris Brockwell, director of insurance linked securities with Swiss Re Capital Markets, New York.

Since 1997, approximately $47 billion in worldwide insurance and reinsurance capacity has been created through the issuance of insurance-linked securities, he said during the session, ‘Securitization: Issuer, Investor, Regulator & Administrator.’

New issuance in 2007 exceeded that of 2006 by 50%, Brockwell noted.

However, there may be a pause in the ILS market because of current problems with monoline insurers who guarantee securities, he told Symposium attendees.

Most ILS’s have relied on monoline companies’ credit enhancements to complete deals by bringing securities into the ‘AAA/Aaa’-rated category, he explained.

To date, he said, this model has worked, although now investors are concerned about monolines’ exposure to subprime problems.

But it is possible that the current dislocation in the credit markets may also increase the flow of transactions where there are non-financial risks such as mortality or morbidity risks, he added. The reason, according to Brockwell, is that there is a limited correlation with financial risks that could be appealing to investors who want diversification.

Securitizing embedded value in these insurance products is done by determining the embedded value of future profits, Brockwell’s presentation showed. With the embedded value financing model there can typically be more debt and higher leverage than with the traditional financing model because of the securitization, he noted. Leverage can increase return on equity, he added.

For life companies, securitizations both leverage returns and can be used to minimize higher than expected mortality risks, the risk of pandemics or terrorism and the risk of lapsation, he added.

Jeffrey Bamundo, who is in the advisory services area of PriceWaterhouseCoopers, New York, discussed how managing a securitization after the transaction has been completed is critical for the deal to be successful.

Unless preparations are taken, there can be unwanted difficulties in managing the business associated with such transactions, he said.

Care must be taken, Bamundo said, to avoid unneeded complexity, communication weaknesses and lack of accountability, as well as proper handling of accounting for the business.

Failure to properly manage the business behind the securitization after the deal closes, he continued, such as the settling inter-company accounts across business units, increases the chance of errors in classification or financial reporting and, consequently, the risk that there will not be a credit for reinsurance ceded.

Therefore, responsibilities should be defined, communicated and monitored by management, Bamundo said.


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