the convergence of capital markets and insurance - … · session 177 of, the convergence of...
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Session 177 OF, The Convergence of Capital Markets and Insurance
Moderator:
Erik J. Thoren, FSA, CERA, MAAA
Presenters: Prannoy Chaudhury, FSA, MAAA
Jean-Francois Lemay, FSA Erik J. Thoren, FSA, CERA, MAAA
SOA Antitrust Disclaimer SOA Presentation Disclaimer
Capital Markets• Capital Markets have used many different ways to
enter the life insurance space• Capital Markets may look at the insurance industry to:
• Access a risk that that is not correlated to other markets like mortality/longevity
• Access assets to manage• Or simply invest in an area where returns are thought to be
attractive• The ideal structure to enter the market will depend on
the goal and the specific situation of the capital provider
3
Direct Investment in an Onshore Insurer
4
Onshore Life Co
Capital Market$
• Requires onshore regulatory approval• Assets will be subject to onshore admitted asset
rules and RBC requirements• Arm’s length asset management contract
Asset Manager
OwnershipIMAReinsurance
Direct investment in an Offshore Reinsurer
5
Offshore Reinsurer Co
Capital Market$
• No onshore regulatory approval• Reinsurance will be done on a funds
Withhled / Modlco / Assets in trust basis.• Assets will be subject to onshore
admitted asset rules but Offshore Capital requirements
• Investment Management Agreement will be between the Onshore Life co and the Asset Manager.
Asset Manager
Onshore Life Co
OwnershipIMAReinsurance
Direct investment in an Offshore Reinsurer using a Sidecar
6
Offshore Sidecar
Capital Market$
• Added benefit of not having to manage the reinsurer and ability to select slice of risk
Asset Manager
Onshore Life Co
Offshore Reinsurer Co
OwnershipIMAReinsuranceManagement Agreement
Direct investment in an Offshore Reinsurer And Onshore Life Co
7
Offshore Reinsurer Co
Capital Market$
• Onshore regulatory approval, but reinsurance to offshore company allows to get the capital benefits.
• Onshore company becomes a source of new business to offshore reinsurer
Asset Manager
Onshore Life Co
OwnershipIMAReinsurance
Direct investment in an Offshore Reinsurer And Onshore Life Co - stacked
8
Offshore Reinsurer Co
Capital Market$
• Offshore reinsurer can be used for third party reinsurance.
• Stacked structure allows offshore reinsurer to have a greater capital base.
Asset Manager
Onshore Life Co
Onshore Life Co
OwnershipIMAReinsurance
Some Tax Efficiencies…
9
Offshore Re (Cayman/BDA)
Capital Market$
• Benefit from have multiple jurisdictions:
• Irish/953(d) will have no FET
• Cayman may have more flexible capital rules and no FIT.
Asset Manager
Onshore Life Co
Onshore Life Co
Offshore Re (Ireland/953d)
OwnershipIMAReinsuranceManagement Agreement
Some More Capital Efficiencies
10
Offshore Re (Cayman)
Capital Market$
• Solvency II friendly jurisdictions for European business.
Asset Manager
Onshore Life Co
Onshore Life Co (US)
Offshore Re (Ireland/953d)
Onshore Life Co (Europe)
Offshore Re(Bermuda/Ilse
of Man/PR)
OwnershipIMAReinsurance
Cell Company Structure
11
Offshore Re (Cayman)
Capital Market$
• Each deal is collateralized and immune to default of other cells
Asset Manager
Onshore Life Co
Offshore Re (Ireland/953d)
Onshore Life Co (Europe)
Offshore Re(Bermuda/Ilse
of Man)
Cell/PIC
Cell/PIC
Cell/PIC
Onshore Life Co (US)
Onshore Life Co (US)
Onshore Life Co (US)
OwnershipIMAReinsurance
Complete the circle and reinvest in the capital markets
12
Offshore Re (Cayman)
Capital Market$
Asset Manager
Onshore Life Co
Offshore Re (Ireland/953d)
Onshore Life Co (Europe)
Offshore Re(Bermuda/Ilse
of Man)
Cell/PIC
Cell/PIC
Cell/PIC
Onshore Life Co (US)
Onshore Life Co (US)
Onshore Life Co (US)
Presented by:
Prannoy Chaudhury, FSA, MAAA Consulting Actuary, Milliman Inc.
Society of Actuaries - Annual Meeting (Session 177)
October 26, 2016
XXX / AXXX Reserve Financing
2
Agenda
Introduction to XXX / AXXX reserve financing
Common solutions to financing XXX / AXXX strain
Hot topic: AG 48
Role of actuaries in reserve financing transactions
3
Introduction to XXX / AXXX Reserve Financing
Many banks and reinsurers are willing to finance the excess of statutory over ‘economic’ reserves
The definition of economic reserves has historically been a negotiated deal term that for XXX/AXXX financing deals has often been GPV determined with best estimate assumptions. The graph below shows how XXX economic and excess reserves can vary over time.
0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
120.0%
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Statutory
Excess
Economic
4
Why do most large stock life insurers and reinsurers use reserve financing?
Most competitors price term life and universal life assuming debt-like financing costs for excess reserveso Results in better pricing for consumers
Reserve financing frees up surplus that can be used to improve RBC ratios, finance sales growth, or invest in acquisitions
The nature and structure of reserve financing utilized can impact rating agency views of an insurer’s capital adequacy, financial flexibility or enterprise risk management
5
Key steps in a XXX/AXXX transaction
Insurer identifies a particular block of XXX/AXXX business for reserve financing
Insurer receives proposals from financing providers (and selects one)
Insurer creates a Captive Reinsurer to which the chosen block of XXX/AXXX business will be ceded
Insurer works with its state of domicile and the Captive’s state of domicile regulator to receive approval (e.g., the transaction structure is presented along with the Captive’s pro-forma)
6
Common Solutions to Financing XXX / AXXX Strain
Structured reinsurance (3rd party)
Funded solutions (involving captive surplus note issuance)
Letters of credit (“LOC”)
Credit Linked Notes (“CLN”)
Other forms of collateral acceptable to the cedant’s regulator
7
Financing Structure: Non-recourse LOC
Popular since 2010
Some banks have additional features (with extra boxes and arrows) to differentiate their solutions
Most non-recourse LOCs to date have been “conditional”, whereby a draw is only permitted after economic reserve assets, and the Captive’s surplus assets are depleted
Bank
Captive Reinsurer
Reinsurance Premiums
Reinsurance Claims
Cash Drawn on LOC if needed
Life Insurer or Professional
Reinsurer
LOC Fees
8
Financing Structure: Credit Linked Note (“CLN”)
SPV
Captive Reinsurer
Reinsurance Premiums
`CLN
interest & principalLife Insurer or
Professional Reinsurer
Surplus Note interest & principal
Financing Provider
Fee=Surplus Note interest – CLN interest
SPV’s CF shortfall
Popular since 2012
Captive issues a Surplus Note bought by the SPV, and Captive buys the credit linked note (“CLN”) with a lower coupon
In good times, the coupon difference is paid to financing provider as a fee
In bad times, financing provider covers SPV’s CF shortfall
Reinsurance Claims
9
Key reserve financing market development: AG 48
Applicable for new transactions effective after 12/31/2014
One must determine Actuarial Method Reserves (“AMR”) that now replaces the ‘Economic Reserve’
o AMR is based on VM-20 (PBR) guidelines
o Interesting insights gained from AG 48 transactions regarding a PBR world.
AMR must be backed by ‘Primary Securities’ (cash, bonds etc.)
Excess of AMR, up to Statutory Reserve, can be backed by ‘Other Securities’ (LOC, CLN asset, etc.)
XXX/AXXX Statutory Reserves
AMR Economic Reserves
Mezzanine Layer = (AMR - Economic Reserves)
Excess of XXX/AXX Statutory Reserves over
AMR
10
Role of Actuaries in Reserve Financing Transactions
Develop actuarial projectionso Review experience studies to determine best estimate assumptions
o If working for a bank or other provider of financing, advise on key risk factors for the block of business.
Analyze financing proposalso Quantitative: for e.g., impact of the different transactions on the distributable
earnings of the Insurer
o Qualitative: regulatory approval, rating agency view of the transaction
Develop deal modelo Based on the terms of the chosen transaction structure (documented across a
number of legal documents), develop a deal model that incorporates items such as the Captive’s priority of payments
o Help determine the Captive’s capitalization and dividend thresholds.
THIS DOCUMENT SHOULD NOT BE REPRODUCED IN ANY FORM WITHOUT PRIOR WRITTEN APPROVAL
The convergence of capital markets and insurance –secured financeErik Thoren, CFA, FSAOctober 26, 2016
USP0221
Agenda
• Capital markets overview
• Why secured finance?
• What is secured finance?
• What else do I need to consider?
• Summary
USP0221
Capital markets overviewInsurers have been living in a tough environment
Source: Bloomberg, as of October 2016.
Chart 1: 10-year global government yields Chart 2: Spread between 2- and 10-year yields
Chart 3: US credit spreads• Tough environment yield over the past decade
• Can you find higher returns using alternatives to debt?– Move into alternative investments (i.e., PE, hedge
funds, real estate equity) is not a panacea
• Where else can you search for yield?– Extend duration– Lower credit quality– Less liquidity
USP0221
Capital markets overviewCredit and liquidity risks in the marketplace
For illustrative purposes only.
Cre
dit r
isk
Liquidity
Mid-market private debtMezzanine, second lien
Distressed debt
High yield bondsBroadly syndicated bank loans
Residential and consumerCommercial real estate loans
Secured corporatesInvestment grade bonds
Lower Higher
Higher
Lower
Securedfinance
USP0221
High yieldInvestment grade
+340bp
Why secured finance?Complexity and illiquidity premium creates a potential attractiverisk-adjusted return
As of June 30, 2016. The spreads shown are for illustrative purposes only.
0
50
100
150
200
250
300
350
400
450
500
550
600
650
700
750
AAA A BBB BB
Spre
ad o
ver 3
mon
th L
ibor
(bp)
Representative secured finance universe Investment grade corporate bonds
USP0221
Why secured finance?Regulation has created opportunities to extract illiquidity/complexity
• Increasing regulation has reduced bank lending
• Leading to wider secured credit spreads
• Long term investors (insurers) can provide an alternative source of finance to borrowers
• Illiquid secured finance provides an interesting opportunity for insurers
– Risk/reward opportunities are compelling – no need to sacrifice credit quality while seeking additional return
Source: Bloomberg, TRACE and Morgan Stanley, as of June 30, 2014.
Analysis of bank balance sheet asset base
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
2006 2008 2009 2011 2012 2014
Yoy
Cha
nge
Assets
USP0221
• Secured finance refers to lending that is secured against a single asset or portfolio of assets
• Typically, investors provide capital in return for interest and principal payments
• Investments can be structured with different credit and cash flow timing characteristics– e.g., senior investment grade tranches (e.g., AAA, AA or A) with a
supporting junior ranking tranche (e.g., BB), where principal of most senior tranches paid off first
What is secured finance?Introduction
For illustrative purposes only.
Examples of collateral include:• Residential mortgages• Commercial real estate
loans• Corporate loans• Auto loans• Credit card debt
Senior loan
Junior loan/equity
Collateral pool (e.g., mortgage
loans)
Interest and principal from
mortgages
Interest frommortgages
Principal frommortgages
Losses
Debt (e.g., 60%)
Equity (e.g., 40%)
Priority of payments
USP0221
What is secured finance?Collateral and liquidity characteristics
For illustrative purposes only.
• Prime residential mortgage backed securities (RMBS)
• Auto loans (ABS)
• Credit card debt (ABS)
Residential and consumer
• Mortgage warehouse
• Bridge lending
• Auto/credit card warehouse
Commercial real estate Secured corporate
Liqu
id
• Office
• Retail
• Hotel
• Corporate loan warehouse
• SME warehouse
• Collateralized loan obligations (CLO)
• Whole business securitizations (WBS)
• Collateralized mortgage backed securities (CMBS)
Illiq
uid
USP0221
What is secured finance?The trade-off between ‘liquid’ and illiquid
For illustrative purposes only.
Securities Loans
Origination Public market Proprietary channels
Underwriting and valuation
PublicLoan-level underwriting
Private informationLoan-level underwriting
Structuring None (structuring is already done so your decision is “take it or leave it”)
Negotiate deal terms and security package
Trading Public tradable market Limited liquidity, hold to maturity ore.g., sell to syndicate/ club member
More Liquid Less Liquid
USP0221
• Are we able to?
– What are our ALM considerations?
– How much liquidity can we sell?
– Are they permitted?
• Do we want to?
– What is my risk appetite?
– What are my collateral and structure preferences?
– How much will we allocate?
• How can we?
– How familiar are we with investing in these assets?
– What are we able to access?
– Should we do this in-house or hire an external manager?
What else do I need to consider?
USP0221
• More opportunity exists now for insurers as a result of bank deleveraging
• Reach for yield does not have to come at the cost of increased credit risk
• Secured finance provides an interesting opportunity for insurers:
– Enhanced yield vs. investment grade corporate bonds by extracting illiquidity and complexity premium
– Most insurers familiar with or already invest in ‘liquid’ secured finance types
– Illiquid assets may be particularly attractive due to increase yield and protection
• There are a lot of decisions to make along the way
Summary
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