Securitization's big bang: leaders of North American life insurers say they are considering securitization as never before.

Key Points

* The growth of securitization in life insurance is likely to be more robust than the equivalent catastrophe bonds on the P/C side.

* The increased interest is evidence of higher reinsurance pricing and the growing popularity of insurance securitizations among investors.

* Concerns about the availability of capital are driving nearly a third of respondents to actively explore alternatives for raising capital.

Not only is securitization on the verge of becoming main stream, the life industry is poised to outpace the property/casualty industry in the volume of securitizations.

According to a survey of 70 North American life-insurance company chief financial officers, 50% said they'd consider using securitization to address their capital needs in the next two to three years. Currently, only 4% of respondents use securitization.

The increased interest is evidence of a couple of trends: higher reinsurance pricing and the growing popularity of insurance securitizations among investors, said John Nigh, managing principal of the Tillinghast business of Towers Perrin, and author of the survey.

"On one hand, reinsurance pricing has not so much hardened as it's gotten more rational, vs. a few years ago. On the other hand, offshore solutions, such as letters of credit, are not viewed as permanent solutions, whereas securitization is" Nigh said.

In addition, "the Street, the market, is really understanding insurance and looking through the products becoming more transparent, more understandable. They are willing to make investments in [insurance] products that are securitized," Nigh said. "That's what is leading, or pushing, the insurance industry toward securitization."

Today, 57% of the CFOs surveyed said authorized reinsurance is the most popular means of addressing capital needs, while offshore reinsurance, at 44%, is a close second. Securitization, however, is showing a dramatic increase in popularity as an attractive and viable alternative.

Tillinghast found that 66% of respondents are using or exploring securitization for managing statutory surplus strain on universal life business associated with Actuarial Guideline 38, a standard adopted in 2002 by the U.S. National Association of Insurance Commissioners governing reserve adequacy for universal life. Another 55% are using or considering securitization in association with term life business related to Regulation Triple X, another NAIC standard that uses reserve calculations that significantly exceed economic reserves based on the insurer's realistic actuarial assumptions.

A Boost From Triple X

Over the past two years, four Triple X securitizations have been completed: two by First Colony Life Insurance Co., one by Banner Life Insurance Co. and William Penn Life Insurance Company of New York, and one by Scottish Re Group Ltd.

The growth of securitization in life insurance is likely to be more robust than the equivalent catastrophe bonds on the property/casualty side, said Nigh, because the capital needs in life insurance are much greater, given the reserving needs driven by Triple X and other requirements.

A.M. Best Co. has been monitoring securitization efforts in catastrophe risk, Regulation Triple X, surplus notes and insurance trust-preferred collateralized debt obligations, closed/defined blocks of business, life settlements and annuities. A.M. Best also sees potential securitization strategies for reinsurance recoverables and consumer insurance policy premiums.

Third-party pressures are also driving life insurers toward securitization. As the Tillinghast survey shows, among the reasons for pursuing securitization, 50% of respondents cited mitigating letter-of-credit exposure and 33% cited limiting reinsurer credit exposure. Also, securitization is seen as less expensive than funding capital needs independently.

Obtaining letters of credit from banks to secure their reserves is becoming more costly and difficult for life insurers, said Nigh, a factor that encourages insurers to avoid the problems associated with third-party deals and seek out securitization.

While the majority of life insurance-related securitizations are related to Regulation Triple X, which requires companies to put up more reserves than they once had to for term-life insurance policies, Nigh said he expects to see a second wave related to Regulation AXXX, which requires companies to put up additional reserves for annuities.

"Between Triple X and AXXX, we will see a big bang in the next few years in the number of securitizations," Nigh said. "And then, we'll see a leveling off, what I call a warehousing of that risk, with companies repeating the processes periodically as they get the business."

The survey found that 70% of life insurance company CFOs consider capital management to be a key concern for them today, and expect that to continue over the next three to five years. Concerns about the current and future availability of capital are driving nearly a third of respondents to actively explore one or more alternatives for raising capital.

Seventy-three percent of respondents said they're considering surplus notes; 40% said they're considering trust preferreds, and 13% cited funding agreements as other sources for obtaining capital in the next two to three years.

Survey: Life Insurers Turning to Securitization

Why Life Insurers
Need Capital

Maintaining/growing new business   93%
Rating agency demands              59%
Facilitating nonorgaic growth      56%
Regulatory issues                  44%
Funding existing obligations       26%
Pricing                            22%

How Companies Address
Capital Needs Today

Cede to authorized reinsurers    57%
Cede to offshore reinsurers      44%
Slow or control growth           41%
Unsecured debt issuance          40%
Surplus notes                    33%
Letters of credit                32%
Equity issuance                  31%
Sale of block of business        11%
Securitized debt issuance         4%
Securitization                    4%

Why Insurers
Pursue Securitization

Enhance GAAP return on equity        50%
Mitigate letter-of-credit exposure   50%
Limit reinsurer credit exposure      33%
Avoid high reinsurance cost          33%
Raise capital                        33%

How Companies Plan to Address
Capital Needs in 2 to 3 Years

Cede to authorized reinsurers   65%
Securitization                  50%
Cede to offshore reinsurers     46%
Surplus notes                   39%
Equity issuance                 35%
Letters of credit               31%
Slow or control growth          27%
Sale of block of business       27%
Securitized debt issuance       27%

Source: The Tillinghast Business of Tower Perrin Life Insurance
CFO Survey