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Concerns about firms' reserves draw attention

New York eyes carriers that securitize blocks of insurance

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By Darla Mercado

October 26, 2008 6:01 am ET

New York state regulators are looking into insurance carriers that securitize blocks of life insurance in order to alleviate strains on their capital reserves.

A locked-up credit market and a reinsurance industry that is hesitant to back up life carriers have raised new concerns that some carriers might run into problems meeting their statutory-reserve requirements, leading to higher costs on life insurance and, in the worst-case scenario, possible insolvency, analysts and actuaries said.

Transactions that face regulatory scrutiny include securitization under Regulation XXX, which involves a carrier's use of a special-purpose vehicle to issue non-recourse-debt securities to institutional investors in the capital markets. Proceeds from the investors then go toward funding excess statutory reserves — acting as reinsurance for a book of insurance policies.

AFFECTED COMPANIES

Insurers that may be affected include AEGON NV of The Hague, Netherlands, Genworth Financial Inc. of Richmond, Va., and Protective Life Corp. of Birmingham, Ala., according to filings with the Securities and Exchange Commission.

Carriers created these funding structures in order to comply with the Kansas City, Mo.-based National Association of Insurance Commissioners' Regulation XXX, which imposes higher required statutory reserves for carriers that issue guaranteed-level-premium term life insurance, universal life insurance and other whole-life plans.

But these structures have caught the regulators' attention as some of the transactions began to fail this year. "Our interest was piqued in the early spring of 2008, when we had heard that some of these securitizations were being put back," said Hampton Finer, a deputy superintendent and chief economist with the New York Department of Insurance.

The problem arose when ratings agencies downgraded bond insurers' triple-A ratings this spring, hurting the ratings on some bonds. XXX transactions were also insured, and when the downgrades came, investors began asking for their money back, Mr. Finer said.

If the carriers couldn't count on investors' contributions to fund reserves, they would have to secure other financing sources or go into their own capital to ensure that they met the XXX reserve requirements. Companies that fell below their required reserve requirements could also be considered insolvent.

Mr. Finer's department interceded with carriers who relied on these transactions, and is it reviewing possible funding alternatives, including searching for outside capital and other lines of credit.

The department declined to disclose the names of the carriers involved. Mr. Finer said he thinks that the insurers involved are safe but may be encountering trouble with their reserve levels.

However, more trouble could be ahead for the XXX transactions as the reinsurers become more selective about which carriers they back up, analysts said.

The still-tight credit markets have also exacerbated the situation as banks remain uneasy about providing direct funding or letters of credit to insurers.

"XXX securitizations are used to free up capital, and capital markets are very tight right now," said Marc Steinberg, senior financial analyst at Oldwick, N.J.-based A.M. Best Co. "Many direct writers are looking to reinsurance, but there's only so much capacity."

The cost of reinsurance will likely increase as more carriers seek backing from a small pool of reinsurers, Mr. Steinberg said.

When insurers encounter difficulty in securing XXX solutions, they are required to hold a higher level of reserves, decreasing the amount of excess capital available. If the carrier's capital position weakens, its ratings may also be affected, Mr. Steinberg said.

Although insurers remain reticent about whether they have reached out to regulators for funding help, "recent market conditions impacting securitization transactions create a need to pursue alternative approaches such as reinsurance and private-financing transactions," Genworth said in its second-quarter SEC filing.

In its 2007 SEC 20-F filing, which is an annual report for foreign private issuers, AEGON said that Regulation XXX could have "an adverse effect on our financial condition and results of operations by requiring us to increase our statutory reserves for term and universal life insurance or incur higher operating costs."

Jody M. Puffett, director of strategic planning and development at AEGON, wrote in an e-mail that market conditions are "challenging." The carrier now uses on- and offshore reinsurance solutions that require letters of credit but is looking at a diversified mix of solutions for the future.

Genworth said in a second-quarter filing with the SEC that it expects these conditions to continue, adding that its ability to finance the additional reserves could affect life insurance sales or new-business returns. The company declined to comment.

Protective Life said in its second-quarter filing that it has been "challenged by changes in the reinsurance market" that have affected its capital management, particularly in its traditional-life business, which requires reserves under Regulation XXX.

Neither company would comment on whether regulators are assisting them with securing additional sources of funding.

If carriers need to finance their reserves on their own, the consumer will feel the pinch in terms of a premium increase, said Steven I. Schreiber, a New York-based principal and consulting actuary with Milliman Inc. of Seattle.

Many challenges are in store for the insurance industry, but that may lead to greater innovation from reinsurers, including private transactions.

In one such transaction last January, Swiss Reinsurance Co. in Zurich said that it would provide The Savings Bank Life Insurance Company of Massachusetts in Woburn with up to $175 million in XXX reserve funding.

"Reinsurers are marketing more solutions on the XXX side," Mr. Schreiber said. "I'm aware that there are others willing to do transactions."

CAUTIOUS OPTIMISM

But reinsurers will be selective about with whom they do business, Mr. Steinberg said. "The reinsurers are prudent on what they write; the ability to raise capital right now is difficult and costly," he said.

Meanwhile, the New York Insurance Department regards the industry with cautious optimism.

"Our sense is that we can forbear on taking action that would be destabilizing. We're not going to do that until the market has a chance to fix the problem," Mr. Finer said.

"The companies will either have to put in a little more capital, which some are in a position to do, or access other sources for financing reserves," he said.

E-mail Darla Mercado at dmercado@investmentnews.com.

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