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Bond wrappers for life insurance securitization?


There is some good commentary on the Standard & Poor’s website about their recent insurance linked securities conference which discusses the state of the life insurance securitization market.

Highlights of the release below:

Will Life Insurance Securitizations Wither Without Bond Wrappers?

Issuance of traditional life ILS, where long-term risk is typically packaged and backed up with bond insurance, has been in existence since 2003. Activity has dropped meaningfully since last summer, as ratings were lowered on asset-backed securities, collateralized primarily by subprime and Alt-A mortgage loans, and ratings on several bond insurers fell below ‘AAA’. The underlying securities were generally in the ‘AA’ and ‘A’ categories.

A bright spot for the issuance market is that there is still investor demand for life ILS. Since mid 2007, private placements have accounted for a good portion of the market. Indeed, if private placements were counted, 2007’s ILS activity would have outpaced that of 2006 and will likely exceed issuance for 2008. However, lower investor acceptance of wrapped transactions has prevented any public deals from going to market so far in the first quarter of 2008, so the ILS market remains crimped.

There is still growth potential for securitizations. Said conference panelist Alex Cowley, managing director at Lehman Brothers, life insurance continues to be “an ideal asset to be securitized and wrapped. There’s a huge amount of historical data, which can be used to predict business going forward.”

Both Mr. Cowley and conference panelist Shiv Kumar, a managing director with Goldman, Sachs & Co., believe an unwrapped life ILS market could develop. We would likely rate unwrapped ILS paper in the speculative-grade range or close to it, which, Mr. Kumar said, would change how these instruments are priced, marketed, and sold. Alternative wrapper-based structures could also emerge, Mr. Kumar said, which could produce even higher yields.

For a successful unwrapped market to develop, however, more seasoning of lapse experience would have to emerge in the underlying blocks of universal term life (known as AXXX) business. Companies would also have to disclose more information to investors about the underlying block’s lapsation performance and about mortality experience, Mr. Cowley said.

The trick would be getting life companies to provide this information publicly, as most insurers consider it proprietary information. “A balance would have to be found,” said panelist Wayne Stuenkel, senior vice president of Protective Life Corp.

The impact of the auction rate market’s collapse in August 2007, stemming from reduced liquidity following the housing market’s disruptions, has been a kettle of trouble for issuers of what are known as XXX and AXXX transactions. The industry developed these securitizations–which are for long-tail term life and universal term life funding needs, respectively–to lower the cost of funding the excess reserves required by Regulations XXX and AXXX for the 15-50 years of risks the two blocks of business present to their underwriting companies.

The failed auctions of the past seven months have forced issuers of ILS paper to assume higher interest rates, typically between LIBOR plus 1.25% to LIBOR plus 2%, depending on the rating on the paper’s bond insurer. This was much higher than the LIBOR-plus-10-basis-point rate paid when the auction rate market was functioning normally. This substantially raised issuers’ costs of funding the excess reserve requirements and killed off the Dutch auction market for future issuances.

The full text of this release can be read here on the Standard & Poor’s website (registration required).

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