A.M. Best Rating Methodology: Rating Funding Agreement-Backed Securities.

OLDWICK, N.J. -- A number of large U.S. life insurance companies have increased the volume of their institutional spread business by issuing funding agreement-backed securities (FABS) through private placement securitization vehicles, such as European Medium Term-Note and Global Medium Term-Note programs, as well as the new Securities and Exchange Commission-registered programs.

A new methodology describes A.M. Best Co.'s the approach to rating the securities and related programs where the notes to be rated are secured by funding agreement contracts issued by U.S. life insurers.

A.M. Best views funding agreements as an alternative form of long-term financing for highly rated companies with considerable expertise in asset/liability and investment management. As such, A.M. Best will assign ratings to each FABS issuance under these programs.

A.M. Best believes that funding agreement providers must employ sophisticated asset/liability management techniques and possess expertise in fixed-income and portfolio management, as well as proficiency in the structuring and management of the FABS program--similar to the skill set necessary for managing a profitable GIC issue.

In broad terms, funding agreements are nonqualified annuities or annuity-like instruments that are designed specifically to generate regular cash flows to service the debt on short-term or medium-term notes issued through a securitization vehicle--a trust and/or special-purpose vehicle. The structure transfers the credit quality of a policyholder claim at the insurance company to the notes of the special-purpose vehicle. Funding agreements are governed by laws of the underwriting insurer's home state, whereas the notes, like most U.S. corporate securities, ordinarily are governed by New York law.

FABS are targeted to the institutional market--banks, pension funds and other insurers. The notes offer investors access to high-quality issuers at a level higher than senior bondholders, with attractive relative spreads. Although the core group of funding agreement providers has been stable, new issuers have entered the market through both the institutional and retail avenues. The FABS market has grown to more than $150 billion issued, providing a complement to a life insurer's existing business lines.

Recently, some FABS issuers have established SEC-registered medium-term note programs. These enable an insurer to sell notes to U.S. retail buyers and to a broader range of U.S. institutional buyers than the predecessor programs, thus diversifying the investor base. Additionally, registered programs are priced more attractively compared with the private placement market, and retail funding helps to smooth out the uneven inflows and outflows of institutional note transactions. Although SEC-registered programs currently have onerous reporting requirements and a lengthy approval process, A.M. Best expects the process to gain efficiency in the future.

For more information on A.M. Best's rating methodologies or to download a copy of this full methodology report, visit, http://www.ambest.com/ratings/methodology.html.

For a list of A.M. Best's debt ratings, please visit http://www.ambest.com/debt.

A.M. Best Co., established in 1899, is the world's oldest and most authoritative insurance rating and information source. For more information, visit A.M. Best's Web site at http://www.ambest.com.