Rating agency Moody’s says that the recent embedded value life securitisation deal completed by U.S. life reinsurer, Reinsurance Group of America Inc. (RGA) is credit negative, as it effectively discounts the future profits that could have been made from the closed-book.
Moody’s Investors Service actually raises a very good point about embedded value securitization transactions in a piece on the deal, saying that by realising profits from a closed-book of life reinsurance business now, by selling notes to investors, it has undercut the profit that could have been realised from the business had it held it within its portfolio.
Moody’s explains; “The transaction is credit negative because RGA will accelerate future income and cash flows totaling approximately $300 million on a present value basis, thereby weakening future capital generation capacity.”
Now, while Moody’s makes a good point it has to be noted that freeing up capital to put it back to work elsewhere is important and a big part of the motivation for this embedded value deal from RGA’s point of view. The reinsurer will be willing to take a discount on the profit it could have made, in order to realise the majority much more quickly, allowing it to re-deploy capital that could otherwise have been tied up for years.
Interestingly this is an issue that affects many types of insurance and reinsurance companies and we’ve even heard of insurance-linked securities (ILS) managers looking to offload parts of their portfolio to free up cash to put into new deals. So it’s not only an issue for life re/insurers with longer-tailed business, it can also be a strategy for short-tailed specialists too.
However, Moody’s opinion is based on its belief that RGA will struggle to find business that has a better credit profile than the closed-book that it has offloaded the profits from to investors and suggests that the closed-book involved in this deal may have been as good as it gets for RGA.
“In our view, it is unlikely that RGA will deploy the proceeds from this transaction (ceding commission of $256.5 million plus capital released) to a business that has the same or better credit profile as the subject business,” Moody’s said.
Moody’s also notes that it does not believe that RGA required the capital for its recent acquisitions, which could have explained the motivation to bring the embedded value securities to market.
Finally, Moody’s notes; “Because profits from the business are first used to repay noteholders, RGA essentially retains the majority of the risk in the business, but receives discounted profits earlier than it would have otherwise. The $300 million of proceeds and the pre-funded interest payments compose about 60% of the embedded value of the business ceded to Chesterfield Reinsurance (i.e., RGA retains 40% of the embedded value, but most of the downside risk).”
It’s an interesting viewpoint that Moody’s holds and it’s understandable that it feels this embedded value life insurance deal to be credit negative for RGA based on the points above. However it does raise an issue which is worth remembering when it comes to any type of insurance linked securitisation, it is not always possible to know the motivations of the sponsor and why they elected to undertake the deal.
This even goes for a catastrophe bond, which you’d imagine were purely transacted for risk transfer purposes. While they are a risk transfer instrument they have been used in the past as a way to up the competition between traditional and alternative markets, in order to achieve a better rate-on-line by some sponsors.
Insurance securitisation transactions have been undertaken as a way to manage capital as well, in fact this embedded value deal may well have that as one of the core motivations for transacting the deal. This is a use for insurance securitisation which is expected to become increasingly prevalent, especially as insurers find a use for capital markets capacity as a way to improve their own capital adequacy under new regulatory regimes such as Solvency II.
In fact, there have been securitisation deals in insurance and reinsurance markets purely as a way to begin building relationships with investors. In some cases this has actually resulted in sponsors paying more for a catastrophe bond than they might have for the equivalent traditional reinsurance or retrocessional cover, at least in the past when issuing cat bonds was more expensive. So the reasons a deal comes to market are often far from clear.
It is of course possible that Reinsurance Group America has a new acquisition lined up or a transaction which is much more attractive than Moody’s could possibly know. There has to be a sensible reason for entering into this transaction and we’d imagine it fits with a key strategic aim for the life reinsurer.
Sometimes holding the risk could be more profitable technically than securitising it, that is certain. However, the benefits of the process of securitisation and sharing that risk or reward with capital markets investors (building relationships with them) may outweigh any additional profits that could have been made.