XXX/AXXX Market in Slow Thaw
Participants at the recent Life Insurance-Linked Investment Conference sponsored by Marcus Evans agreed that deal activity will remain tight for the reminder of 2009 and limited to bank lines of credit (LOC).
However, issuers have begun testing the funding waters after a long layoff, and there are hopes that capital markets solutions will regain favor by next year.
“A year ago a lot of issuers were saying let’s see how bad it can it get and let’s not do anything,” said Jorge Fries, managing director of Calyon. “Today the market is saying it can get a lot worse so let’s do something.”
The National Association of Insurance Commissioners (NAIC) passed Regulation XXX in 1999 requiring life insurance companies to hold additional reserves for term policies. In 2002, NAIC passed Regulation AXXX, which expanded the reserve requirements to universal life polices, especially those that carried guaranteed minimum life benefits.
Following passage of the regulations, securitization of XXX/AXXX ballooned to $9.5 billion by 2007 and was expected to more than triple over the next several years. But the credit crisis that began in 2008 halted market growth and no deals have been completed for the past several months.
The key problem for completing new securitizations are high credit spreads that are proving too costly, said Chris Brockwell, senior vice president of insurance-linked securities for Swiss Re.
“We do see funding availability but it’s at very high prices that drain the profitability out of these deals over an extended period of time,” Brockwell said. “Private deals are available at a very high price.”
LOCs currently are the sole source of funding for Reg XXX deals, but banks are being very picky about which companies they will underwrite because of concern over the life insurance sector. Currently, Fries said $300 to $500 million would be the “sweet spot” for a Reg XXX LOC that could attract a bank syndication.
Some banks are experimenting with ways to hedge their risk in Reg XXX LOCs by purchasing credit default swaps (CDS) on the life insurance holding company.
Using this method, Fries said a deal of up to $1 billion could get done, but with the price of a CDS on a double “A” rated life insurer currently at 600 basis points, few issuers are willing to absorb that cost.
When the Reg XXX securitization market does come back it will look markedly different, said Otto Lowe, managing director of liquidity and capital management for Transamerica Re.
He added that the collapse of the monoline insurers that offered credit “wraps” on the deals’ captive structures means the market will need to find an alternative that will gain investor confidence
“These are living, breathing captives that need surveillance for up to 20 years,” Lowe said. “Some party is going to need to step up, preferably with skin in the game, that can monitor the deals.”
Brockwell agreed, adding that getting investors comfortable with the securitization process will be the easy part.
“People need to get comfortable with the insurance sector again,” he said.