2011 Orlando Valact 39

2011 Valuation Actuary Symposium
Sept. 12- 13, 2011

Session #39 PD: Whats New in Reserve Financing
for Life Insurance Products?

Scott Avitabile, Esq.
Robert Meehan, FIA
Ann G. Perry

Moderator
Alan J. Routhenstein, FSA, MAAA

Primary Competency
Results-Oriented Solutions
1
Whats New in Reserve Financing
Presented by: Scott D. Avitabile, Partner
Dewey & LeBoeuf LLP
Session 39PD
September 13, 2011
Dewey & LeBoeuf | 1
Table of Contents
I. Bank Funding Solutions to XXX/AXXX Reserves
II. Structure Overviews and Schematics
III. Regulatory Issues
IV. Limited Purpose Subsidiary
2
Dewey & LeBoeuf | 2
Bank Funding Solutions to XXX Reserves
Dewey & LeBoeuf | 3
Bank Funding Solutions to XXX/AXXX Reserves
Structured financial transaction designed to access bank funding to
alleviate the reserve strain from Regulation XXX/AXXX reserve
requirements on level premium term life and universal life insurance
products
Permits ceding insurer to retain economic benefits of experience on the
ceded policies
3
Dewey & LeBoeuf | 4
Structure Overviews and Schematics
Dewey & LeBoeuf | 5
Structure Overview
Transaction structure combines (a) ceding of level premium term life
or universal life risks subject to Regulation XXX/AXXX to a newly
formed special purpose captive reinsurer (usually domiciled in
Vermont), (b) credit for reinsurance trust or funds withheld account,
and (c) long-term surplus notes or a letter of credit
Transaction structure by steps:
(a) Ceding insurer forms and provides equity capital to special purpose captive insurer,
(b) Ceding insurer and captive enter into reinsurance agreement whereby policies subject to
Regulation XXX/AXXX are ceded to the captive. An independent actuarial study is
performed on the reinsured book of business. Book of policies is usually closed and
identified, although transactions with open reinsurance agreements that permit new
business over time are possible.
(c) Captive issues surplus notes to the bank or the bank issues a letter of credit for the
benefit of the ceding insurer.
(d) Proceeds from the sale of surplus notes or the letter of credit are then deposited in a
credit for reinsurance trust to secure the captive's reinsurance obligations or the letter of
credit is held by the ceding insurer.
(e) In a recourse transaction, the ultimate parent company or a well-capitalized affiliate of the
captive guarantees payment on surplus notes (sometimes through a total return swap,
which some banks prefer) and guarantees payment of fees to the bank and
reimbursement of draws on the letter of credit. In a non-recourse transaction, the
obligation to reimburse the bank on a letter of credit draw is solely that of the captive.
4
Dewey & LeBoeuf | 6
1. Ceding Insurer cedes its XXX/AXXX business to
Captive Re through a reinsurance contract
2. Captive Re issues Surplus Notes to the bank or
bank issues letter of credit to Ceding Insurer
3. Captive Re accounts for Surplus Notes or Letter of
Credit as statutory capital
4. Captive Re deposits proceeds from Surplus Notes
or the Letter of Credit equal to the reserves into the
Reserve Credit Trust or the Ceding Insurer holds
the Letter of Credit as beneficiary
5. The Reserve Credit Trust is pledged to Ceding
Insurer, or Letter of Credit is held by Ceding
Insurer in each case to secure reinsurance
reserve credit for the Ceding Insurer
6. Parent Company provides guaranty of
obligations of Captive Re
Capitve Re
Structure Schematic Recourse Transaction
Ceding Insurer
Surplus Notes
Assets
Reinsurance
Contract
Reserve
Credit Trust
Parent
For the
Benefit of
LOC
Bank
LOC
Guaranty
LOCfor the
Benefit of
CedingInsurer
Dewey & LeBoeuf | 7
1. Ceding Insurer cedes its XXX/AXXX business to
Captive Re through a reinsurance contract
2. Captive Re issues Surplus Notes to the bank or
bank issues letter of credit to Ceding Insurer
3. Captive Re accounts for Surplus Notes or Letter of
Credit as statutory capital
4. Captive Re deposits proceeds from Surplus Notes
or the Letter of Credit equal to the reserves into the
Reserve Credit Trust or the Ceding Insurer holds
the Letter of Credit as beneficiary
5. The Reserve Credit Trust is pledged to Ceding
Insurer, or Letter of Credit is held by Ceding
Insurer in each case to secure reinsurance
reserve credit for the Ceding Insurer
6. Obligation to reimburse the bank on a Letter of
Credit Draw is solely that of the Captive
Capitve Re
Structure Schematic Non-Recourse Transaction
Ceding Insurer
Surplus Notes
Assets
Reinsurance
Contract
Reserve
Credit Trust
For the
Benefit of
LOC
Bank
LOC
LOCfor the
Benefit of
CedingInsurer
5
Dewey & LeBoeuf | 8
Regulatory Issues
Dewey & LeBoeuf | 9
Regulatory Issues
Formation of Special Purpose Captive Reinsurance Company
Choice of domicile (South Carolina, Vermont, offshore)
Domiciliary Approvals
Organization and licensure of captive
Affiliate reinsurance arrangement
Issuance of surplus notes
Execution and delivery of related transaction documents
Ongoing approval of payments on surplus notes
Reinsurance Arrangement
Terms of reinsurance agreement between ceding insurer and captive must be approved by
ceding insurer's domiciliary state
Reinsurance trust must be established and must comply with ceding insurer's domiciliary
requirements
Investment guidelines must be established to manage funds inside and outside Reinsurance
trust
Letter of Credit must comply with ceding insurers domiciliary requirements, although a
recent trend in Non-recourse letter of credit transactions has been to utilize conditional
letters of credit, which do not necessarily comply with such requirements
6
Dewey & LeBoeuf | 10
Regulatory Issues
Order of Draws on Letters of Credit
Conditions to Draws on Letters of Credit
Primary/Joint Liability of the Captive Reinsurer
Pledge of Assets of the Captive or the Cedant
Physical Segregation of Funds Withheld
Mark-to-Model Collateral Posting
Permitted Practices
Letters of Credit as Capital of the Captive
Trust Assets as Capital of the Captive
Parental Guarantees as Capital of the Captive
Limited Purpose Subsidiary Laws
7
Limited Purpose Subsidiary
Limited Purpose Subsidiary Laws adopted in Iowa (12/22/10), Georgia
(7/1/11), Indiana (4/6/11) and Texas (6/17/11). All are very similar and
based on the original Iowa model
An LPS is similar to a captive insurance company in most ways, and is
organized via an application, which includes, among other items, a
plan of operation, pro forma financial statements and a model of the
proposed book of business to be reinsured, the same as would be
required to form a special purpose financial captive in Vermont or
South Carolina
An LPS must be wholly-owned by the organizing life insurer
An LPS is required to maintain a minimum amount of capital ($2.5
million in Iowa, plus any additional amount of capital as prescribed by
the Commissioner)
Limited Purpose Subsidiary (contd)
An LPS may:
i. Reinsure life risks of a parent or affiliate (except in Georgia, where it
may reinsurer only the risks of the direct parent)
ii. Issue debt securities (like surplus notes) and access financial markets
to support its capital
iii. Count as admitted assets on its statutory financial statements
proceeds from a securitization, letters of credit, parental guaranties and
other assets approved by the state insurance department
iv. Retrocede its risks to third-party reinsurers if permitted by the
Commissioner
v. Pay dividends to its parent so long as its prescribed minimum capital
and surplus amounts are not breached
8
Limited Purpose Subsidiary (contd)
The statutory right to count letters of credit and parental guaranties as
capital is a major development in the ability to finance Triple X reserves
The laws expressly provide that a debt security issued by an LPS will
not be considered an insurance product and that investors holding such
securities will not be deemed to be engaging in the business of
insurance, which clarifies a long-running concern in the insurance-
linked securities market
Offices Worldwide
Dewey & LeBoeuf LLP
1
Whats New
in Reserve Financing for Life Products
Robert Meehan
Hannover Life Re
SOA Valuation Actuary Symposium
September 2011
Reserve Financing
Introduction
1
Financial Solutions Landscape
Structured Reinsurance vs. Capital Markets
Whats New? Current Structured Reinsurance Solutions
Agenda
2
Bank Loan:
Payback - Guaranteed
Cost - Credit Rating
Monetization:
Payback - Secured
Cost - <Full Sale
RBC Support:
Payback - Heavily Secured
Cost - Credit Rating+/-
Trust Preferred:
Payback - Unsecured
Cost - Credit Rating++
Debt Issuance:
Payback - Unsecured
Cost - Credit Rating +
XXX Securitization:
Payback-Heavily Secured
Cost - Min Size of 250M
collateral need
Surplus Note:
Payback - Contingent on
Regulatory Approval
Cost - Credit Rating
Surplus Relief:
Payback - Secured
Cost - Credit Rating+
DEBT EQUITY
Coinsurance:
Payback - Underwritten
cash flows
Cost - Full Sale +/-
Equity Issue:
Payback - Unsecured
Cost - Full Sale
Financial Solutions Landscape
Examples
Mortality Hedge:
Payback - Extremely Secured
Cost - <<Credit Rating
Reserve Financing 2
Reserve Financing
Modified coinsurance or coinsurance structure on newly
written business
New Business Cash
Financing
Often modified coinsurance or funds withheld coinsurance
where assets reside with original cedant
Inforce Block Cash
Financing
Structured reinsurance using both coinsurance and modified
coinsurance or yearly renewable term (YRT) to reduce /
eliminate cash transfer at inception
New Business Non-
cash Financing
Often referred to as Surplus Relief or EV Securitizations.
Takes many forms structurally but in most cases accelerates a
portion of the future statutory cash flow
Inforce Block Non-cash
Financing
Modified coinsurance or funds held coinsurance generally
placed without an explicit up-front ceding commission
Solvency Capital Relief
Bank structured financing combined with reinsurance
protections in a tax-advantaged solution for the ceding
company
Hybrid Reinsurance
3
Structured Reinsurance
Transaction Types
3
Reserve Financing
Structured
Reinsurance
Capital
Markets
Larger Sizes
Capped Exposure
Tax Advantaged
Capital
Advantaged
Operating
Leverage
Non-Recourse
Bias
No 3
rd
Party
Actuarial Review
Licensing =
Rogue Draws
4
Life / Health Financing Market
Reinsurance vs. Capital Markets
Structured
Reinsurance
Capital
Markets
Reserve Financing 5
4
Reserve Financing
Structured
Reinsurance
Capital
Markets
Larger Sizes
Capped Exposure
Tax Advantaged
Capital
Advantaged
Operating
Leverage
Non-Recourse
Bias
New Business
Long Tenors
6
Reserve Financing
Traditional stop-loss wrapped with collateralization allowing for capital credit
Most easily compared with SPV-issued senior debt funding
Collateralized Stop-Loss
Notional principal contracts used to transfer remaining mortality risk in XXX
and structured credit facilities for life issuers
Matched basis risk provides hedge treatment and capital efficiency
Mortality Hedges
Combined with novation rights to a licensed reinsurer, hedges allow for non-
contingent LC issuance with mitigated rogue regulator risk
Mortality Hedges with Novation Protection
Next generation in reserve financing
Maximum efficiency in financing cost and risk transfer
Swap-Backed Synthetic LCs
Post-Crisis Developments
7
5
Reserve Financing
Ceding Company
3
rd
Party Reinsurer
STOP-LOSS STRUCTURE
Coinsurance Agreement
Easy to execute
Can be used on either new business or existing business
Collateralization of notional protection can provide capital
benefit in certain situations
Experience Refund
Captive Reinsurer
Stop-Loss Approach
8
Reserve Financing
Ceding Company
3
rd
Party Reinsurer
BANK FINANCING SUPPORT
Bank agreement can be new or existing
Generally limited by credit provider to inforce business only
Swap contract protects credit provider and provides capital relief
Experience Refund
Captive Reinsurer
C
o
l
l
a
t
e
r
a
l
F
e
e
s
Credit Provider
Swap Premium
Hedge Protection
Reinsurance Hedge Protection
9
6
Reserve Financing
Ceding Company
3
rd
Party Reinsurer
Novation Protection can be added to enhance credit provider risk
protection against rogue draws
Much more complicated structure with higher capitalization needed
Allows financing to be non-contingent
Experience Refund
Captive Reinsurer
C
o
l
l
a
t
e
r
a
l
F
e
e
s
Credit Provider
Swap Premium
Hedge Protection
10
Reserve Financing
Ceding Company
3
rd
Party Reinsurer
Upon an uncured breach, business novates to reinsurer
Bank is made whole and exits structure
Bank and Captive make payment of required assets to
Reinsurer and converts agreement to traditional reinsurance
Captive Reinsurer
Make-Whole
Payment
Credit Provider
Make-Whole
Payment
11
7
u Longer tenors (durations)
12+ years for XXX
20 years for AXXX
u AXXX
No-lapse guarantee rider approach
Traditional coinsurance
u New business financing
Reinsurance support to credit providers allowing for inclusion of new
business into existing XXX/AXXX facilities
u Will funded solutions come back?
Rate environment issues
Spreads
Market liquidity
u Reinsurers / Banks / ILS Funds
Value added = f(size, tenor, risk appetite)
Reserve Financing
On the Horizon ... Whats New?
Discussion Topics
12
Thank you!
1
EVALUATING OPERATING DEBT
USED BY LIFE INSURANCE
COMPANIES
SEPTEMBER 13, 2011 ANN PERRY, VICE PRESIDENT SENIOR CREDIT OFFICER
Session 39PD
2 EVALUATING OPERATING DEBT, SEPTEMBER-2011
Agenda
1. Operating Debt Framework - Criteria
2. Financing XXX/AXXX Reserves
3. Letters of Credit
4. Financial Metrics
2
OPERATING DEBT FRAMEWORK -
CRITERIA
1
Operating Debt Framework
Operating debt not part of capital structure
Self supporting repayments not dependent on
enterprises other resources
Self liquidating
As a result, operating debt imposes lower burden
on enterprise than financial debt
3
Asset Liability Management
Assets and liabilities well matched
Duration mismatch limited to +/- 6 months
More cash matched as maturity approaches
Minimal refinance risk/ pricing step-up risk small
(<100bp)
FINANCING XXX/AXXX RESERVES
2
4
Financing XXX/AXXX Reserves
Term of debt should be matched to trust assets
The term of debt may be less than peak level and/or runoff of
reserves
Longer term financing solution may be required when debt
matures
If debt matures within 3 years analysis includes stress scenarios
Impact on capital adequacy and financial flexibility
Reserves back onto ceding companys balance sheet
Asset Quality
Asset risk must be low
Investment grade with average A3
Well diversified - no material concentration in any sector
No security >1% of assets (excluding Aaa-rated government
securities)
10 largest securities not > 5% of total assets
Liquid 144a or publicly traded
Stable cash flows
Minimal market volatility
5
Operating Debt Forms a Closed System
Debt, assets and related capital segregated from other
enterprise activities
For XXX/AXXX transactions, legal segregation
Stable and predictable cash flows
Substantial capital cushion based on conservative
assumptions
Support from rest of enterprise not needed or expected
Capital
Operating debt should not leverage enterprises overall
capital
Extremely unlikely possibility of losses
Adequate capital must be established upfront even for
stress scenarios
If capital is underestimated by 10% or more operating
debt reclassified to financial debt
6
Collateral Posting
If collateral posting required, debt may not be eligible for
operating debt treatment
Evaluations made at transaction inception
CDS spread triggers problematic
Collateral posting requirements incorporated into
companys liquidity analysis
Other Considerations
Operating debt must be issued closely (within 6
months) to acquisition of associated assets
Policyholder obligations not generally classified as
debt
Recourse transactions only (analytically
determined)
7
LETTERS OF CREDIT
3
Letters of Credit
LOCs funding capital are treated as financial debt
However,
LOCs associated with remote risks (including
XXX/AXXX) analyzed for liquidity and capital
adequacy not leverage and coverage
8
FINANCIAL METRICS
4
Financial Metrics
Leverage Ratios
Total leverage all debt included
Operating debt excluded from financial leverage ratio - benefit
capped at 10 percentage points
Equity supporting operating debt deducted for financial leverage
Coverage Ratios
Operating debt interest excluded from earnings coverage earnings
related to operating debt also excluded from EBIT
Analytically we may look at total coverage
9
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OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK,
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HISTORICAL FACT. CREDIT RATINGS DO NOT CONSTITUTE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS ARE NOT RECOMMENDATIONS TO
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1 September 21, 2011 [Enter presentation title in footer] Copyright 2007
Whats New in Reserve Financing
Session 39PD
Presented by
Alan Routhenstein, FSA, MAAA
(Alan.Routhenstein@Milliman.com)
September 13, 2011
2
First, lets meet the panelists
Ann Perry, Vice President Senior Credit Officer
Moodys Investor Service
Scott Avitabile, Esq, Partner
Dewey & LeBoeuf LLP
Rob Meehan, FIA, VP, Pricing - Financial Solutions
Hannover Life Re
3
Our organizational plan for this session is:
1. Consulting Actuary Perspective (Alan)
2. Rating Agency Perspective (Ann)
3. Law Firm Perspective (Scott)
4. Reinsurer Perspective (Rob)
5. Questions & Answers (Audience)
4
Consulting Actuary Perspective
Why do many insurers and reinsurers use reserve financing?
Financing transactions publicized in the last 18 months
Common forms of life reserve financing transactions
Recent developments in life reserve financing
5
Why do most large stock life insurers and
reinsurers use reserve financing?
Most competitors price term life and universal life assuming
debt-like financing costs for excess reserves
Reserve financing frees up surplus that can be reinvested in
other products or used to improve RBC ratios
Reserve financing, when properly structured, can improve a
companys financial flexibility
6
Insurers have considered reserve & capital
financing in a broad variety of forms
Structured reinsurance
Letters of credit (LOCs)
Funded solutions involving captive surplus note issuance
Other forms of collateral acceptable to the cedants regulator
7
8
At least 13 reserve or EV financing deals have
been disclosed in the last 18 months
Disclosure
or Announce-
ment Date
Protection Buyer or
Insurance Group
Issuer of Financing
Disclosed Description
of Subject Business
Disclosed
Maturity of
Transaction LOC Funding
Unclear or
Other
Forms of
Collateral
Lead Financing
Provider or Risk
Taker
6/6/2011 Atlanticlux unit linked life EV 10y EUR 60 PartnerRe
5/24/2011 Lincoln XXX 12y $925 Credit Suisse
4/19/2011 Ohio National XXX & AXXX 20y $250 sr. debt investors
4/6/2011 Old Mutual XXX &/or AXXX N / A N / A Nomura
3/30/2011 MetLife XXX & AXXX 10y $350 Credit Agricole
1/24/2011 ING XXX 8y $615 CS, HLR
12/21/2010 RGA XXX 10y ext to 20y $300 Nomura
12/10/2010 Protective XXX 12y $790 UBS
7/13/2010 Aviva XXX & AXXX "long term" $325 Credit Agricole
6/15/2010 Lincoln AXXX 30y $500 sr. debt investors
5/4/2010 Mutual of Omaha XXX 7y $150 Credit Agricole
4/29/2010 Protective XXX 8y $610 UBS
3/1/2010 Hannover Re life & health 30y $500 Deutsche Bank
9
10
Non-recourse LOC financing has only a few
boxes and arrows. It became popular in 2010
Some banks have additional features (with extra boxes an
arrows) to provide a parent guarantee relating to the payment of
LOC Fees, investment performance and/or non-guaranteed
elements (for AXXX transactions)
Bank
Captive
Reinsurer
Reinsurance
Premiums
Reinsurance
Claims
Life Insurer
or
Professional
Reinsurer
LOC Fees
Cash Drawn on
LOC if needed
11
Deal model based recourse LOC financing
requires a comprehensive parent guarantee
In addition to an obligation to reimburse amounts drawn, the
guarantor might be required upon certain adverse events to post
collateral or contribute additional capital to the captive
Bank
Captive
Reinsurer
Reinsurance
Premiums
Reinsurance
Claims
Cash Drawn on
LOC if needed
Holding
company
Reimbursement
obligation
Life Insurer
or
Professional
Reinsurer
LOC Fees
12
An internal funded solution usually involves
a reserve credit trust holding invested assets
Senior Debt
Investors
Captive
Reinsurer
Reinsurance
Premiums
Reinsurance
Claims
Surplus Note
proceeds
Reserve
Credit Trust
Ceding
company is
beneficiary
Life Insurer
or
Professional
Reinsurer
Holding
company
Senior debt
interest & principal
Sr debt proceeds
Surplus Note interest
& principal
Surplus Note
proceeds
Investment
income
13
A recourse funded solution is usually
guaranteed by the holding company
In a diagram
for a non-
recourse
funded
solution, the
Holding
Company box
and arrow
would be
deleted
Surplus Note
Investor(s)
Captive
Reinsurer
Reinsurance
Premiums
Reinsurance
Claims
Surplus Note
proceeds
Reserve
Credit Trust
Ceding
company is
beneficiary
Life Insurer
or
Professional
Reinsurer
Holding
company
Guarantee
Surplus Note interest
& principal
Surplus Note
proceeds
Investment
income
14
A wrapped funded solution usually involves
an SPV and a financial guarantor
SPV
Captive
Reinsurer
Reinsurance
Premiums
Reinsurance
Claims
`
Surplus
Note
proceeds
Reserve
Credit Trust
Ceding
company is
beneficiary
Life Insurer
or
Professional
Reinsurer
Financial
Guarantor
Guarantee
of interest
& principal
Surplus
Note
interest &
principal
Surplus Note
proceeds
Investment
income
Debt
Investor(s)
Debt interest & principal
Pro-
ceeds
Guarantor
Fee
15
16
We have seen key rating agency & regulatory
developments over the last 18 months
Moodys issued operating debt guidance in May 2011.
Fitch issued Insurance-Linked Securities (ILS) criteria in
August 2011.
Dodd-Frank Act is a 2010 federal statute that restricts
extra-territorial state reinsurance regulation.
Limited Purpose Subsidiary (LPS) laws in IA, IN, GA and TX
permit a parent guarantee as a form of financing.
17
There have been of other ILS market
developments over the last 18 months
Mutual insurers: Mutual of Omaha became the first mutual for
which LOC financing has been publicized.
Financing providers: More banks offer solutions. Some banks
prefer non-recourse solutions. More banks offer AXXX LOCs.
Other forms of collateral: Many LOCs have provisions that dont
meet the strict NAIC definition of LOC. Other innovative
structures are being marketed.
Reinsurer participation: Professional reinsurers are involved in
many non-recourse transactions.

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2011 Valuation Actuary Symposium

Sept. 12- 13, 2011

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