Reinsurance Group of America in embedded value life securitisation

Life reinsurer Reinsurance Group of America Inc. is marketing a life reinsurance embedded value securitisation transaction, through an issuer named Chesterfield Financial Holdings LLC, as it seeks to recognise some of the profitability of a defined book of life business.

Chesterfield Financial Holdings LLC, a Delaware domiciled company, is proposing to issue $200m of Class A notes with a term of 20 years (maturity due in December 2034). The notes will be sold to investors to allow Reinsurance Group of America (RGA Re) to realise some of the profits embedded in a defined portfolio of life reinsurance business.

Investors will receive regular quarterly interest payments and return of principal as long as the expected performance and mortality experience of the book of life reinsurance is as modelled and expected. The ceded business underlying the deal is in-force yearly renewable life reinsurance business that RGA Re has assumed between 2006 and 2010.

The life reinsurance block is, given RGA Re’s scale, considered large and diverse by ratings agency Standard & Poor’s, with an amount at risk of $266.2 billion and approximately 2.65 million policies included in it.

The deal structure sees a reinsurer established, Chesterfield Re, which will enter into a quota share retrocession agreement with RGA Re. Chesterfield Financial issues the embedded value securitization notes to investors, the proceeds of which will allow RGA Re to realise a portion of the profits of the book of life reinsurance.

The notes are at risk of significant increases in mortality experience within the defined book of life reinsurance. Standard & Poor’s believes that pandemic is the major risk that could impact the notes. Major pandemics, such as a repeat of the 1918 Spanish flu, could cause a default for the notes such as a missed interest payment, but the risk is generally considered to be relatively low with this securitization.

When rating the notes, S&P applied 17 stress scenarios to establish when Chesterfield Financial would require assistance from the parent, RGA Re, to keep up payments to investors. S&P found;

“In certain scenarios, to make timely payments of principal and interest, Chesterfield Financial depended on the support of RGA Inc. In the event of a mortality event that caused an (approximately) additional 0.83 deaths per thousand in a year, Chesterfield Reinsurance Co. (Chesterfield Re) would need to issue a surplus note to RGA Inc. that would allow Chesterfield Financial to continue to make timely payments of interest and ultimate payment of principal. At 1.32 deaths per thousand, the note would depend on the liquidity support of RGA under the affiliate note purchase agreement to continue to make timely payments of interest.”

“We view the probability of this event occurring as less likely than RGA not meeting its obligations at the current rating level. The preliminary rating is based on a 4.75% interest rate on the notes. If the interest rate is higher than that, the final rating could change. A lower final interest rate would likely have a positive impact on the cash flows but likely would not result in an upgrade because we are linking the rating on the EV notes to RGA Inc.”

The transaction was found to be relatively insensitive to assumptions about how universal life policies were funded, according to S&O, which it said was consistent with its expectations given the subject book of business’s relatively small exposure to this line.

S&P also examined the asset returns of the portfolio, as well as looking at lapse assumptions for policies, but said that this did not have a significant impact on the results of its stress tests either.

The stress tests that were material were particularly those involving both short-term and long-term mortality increases and recapture, which suggests that the main risk to investors in these embedded value life reinsurance securitisation notes is a large increase in mortality rates of the underlying life reinsurance portfolio.

So Reinsurance Group of America, through this embedded value securitisation, can realise in advance some of the profits of a portfolio of life reinsurance that it has underwritten. This allows the reinsurer to unlock value in advance, with the help of investors buying the notes, while the investors get a quarterly interest payment in return for holding some exposure to the mortality experience of the book.

Deal’s like this will likely be appealing to many ILS investors and fund managers, particularly those with a focus on life deals. These transactions are not common anymore, so demand from investors could be quite high.

Embedded value life insurance or reinsurance securitizations are complicated deals. Much more information can be found in S&P’s presale report here.