Barclays Capital’s rare £250m value in-force deal for Aegon Scottish Equitable proved there is a growing appetite for securitisations among insurers. Writer Edward Russell-Walling.
Securitisations aren’t exactly all the rage with investors right now, for obvious reasons. But occasionally a rare issue shines a light into surviving pockets of appetite and suggests a way forward for certain issuers. Such was Zest, Aegon Scottish Equitable’s recent £250m ($466m) value in-force (VIF) life securitisation, masterminded by Barclays Capital’s insurance capital markets team.
Left to right: Kory Sorenson, Jonathan Rourke, Jeff Wood, Yik Hui
Even before the debt capital markets soured, there had been relatively few VIF life securitisations, largely because insurance companies enjoyed cheaper and easier access to capital via other routes, such as hybrid securities. But those routes have become less easy and more expensive. Looking further down the track, the prospect of the EU’s Solvency II regime, which comes into force in 2012, makes securitisation look more attractive to insurers as a fund-raising tool.
Few issues
While the capital-generating attractions of securitisation already exist under the UK regulatory regime, there have been only five VIF life issues, including Zest, so far from UK insurers. BarCap has been involved with the four most recent – two public issues in 2003 and 2004, for Gracechurch (secured on Barclays Life assets) and Box Hill (Friends Provident), respectively, and two privately placed transactions for Aegon.
The first Aegon issue, in early 2007, raised £92m. It securitised closed blocks of business from Guardian Linked Life Assurance and Guardian Pensions Management in a transaction known as Portofinos. This was a toe in the water for the institution, according to Kory Sorenson, head of BarCap’s insurance capital markets team: “They were keen to add securitisation to their range of capital management tools and wanted to see how it worked, how it was perceived and how quickly it could be done.”
Common features
While Zest added various structural innovations, both it and Portofinos had certain basic features in common. Each qualified as core Tier 1 capital with the UK’s Financial Services Authority and received operational leverage treatment – so they did not count as debt for rating purposes. And, with BarCap providing contingent loans to the issuer, the transaction proceeds were not collateralised, freeing them to be used at Aegon’s discretion.
Aegon has declared its desire to manage capital more effectively and internationally across the group, reallocating it to higher-growth businesses – for example, in eastern Europe and Asia – and the securitisations have taken place against that backdrop.
Following the success of Portofinos, Aegon and Barcap began talks on the possibility of a follow-up. These discussions assumed more formal dimensions towards the end of 2007. Aegon made it clear that it would like to do something by mid-2008 and so, once its actuaries were clear of their year-end January workload (these deals tie up a lot of actuaries), work on Zest began in earnest.
The first of Zest’s innovations was that the defined book of business being securitised was within an open fund, not needing to be transferred to a separate legal entity. This was made possible by a ‘modelled definition of statutory surplus’, developed by BarCap. The way the deal is structured, investors only receive interest and principal repayments if the book generates a profit, or surplus. It’s this equity-like lack of guarantee that allows the proceeds to qualify as Tier 1 capital.
That surplus is easy enough to measure if the business block is closed, as in Portofinos. It is a line in the regulatory return. But measuring the surplus on a defined book within an open fund is rather more complex, hence the modelled definition of surplus.
“It’s a proxy for the regulatory return number,” says BarCap associate director Jeff Wood. “Aegon is required to track the profit emerging on these policies at the individual policy level. That’s common in the reinsurance industry, but new in the life business.”
The modelled definition removes the need for Aegon to set up a new vehicle to hold the policies. For investors, the effect is the same as if the policies had been transferred outside Aegon, while Aegon saves on time, money and complexity.
Another of Zest’s innovations is that Scottish Equitable may add new business to the defined book for the first three years, to maintain the £250m of outstanding financing and to maximise the duration of the benefits.
Revolving feature
“These transactions tend to pay down fairly quickly,” says Jonathan Rourke, a manager in the BarCap insurance capital markets team. “But the insurer wants maximum benefits, and the investors – who have had to do bespoke due diligence – want to see sufficient returns for their efforts. By adding a revolving feature, you enable the addition of new policies to the defined book, so maintaining the benefits while the investment risk remains unchanged.”
As long as the book is generating a surplus, investors receive fixed (though undisclosed) interest payments from year one. However, another difference between Zest and Portofinos is that, while the latter began amortising immediately, amortisation of Zest only starts after the termination of the revolving period. So, all things being equal, principal repayments will begin after three years.
Zest’s assets are a group of one million or so individual and group unit-linked pensions policies. As Mr Rourke notes, the most appropriate assets for this type of transaction are those where the risks are easy to identify and easy to stress test, and where cash flows are relatively stable. “The most suitable are unit-linked policies,” he says.
While it has a legal final maturity of 15 years, the deal is expected to mature within eight years. Rated A by Fitch, it took five months to put together and was finally launched in mid-July. BarCap, as sole structurer and lead manager, had been in touch with likely investors much earlier, however, familiarising them with the concept. The deal was eventually placed with “a handful” of investors from that specialised pool that understands the insurance sector and is capable of assessing its risks.
Growing interest
“It sends a good message,” says Ms Sorenson, “that, even in difficult market conditions, we could get a transaction done in considerable size. We are now seeing more interest from other insurers who may have done significant amounts of hybrid but are now getting close to their limits.”
The cost of hybrid issuance, she adds, has increased over the past year or so from 70 to 80 basis points (bps) over Libor to about 350bps. “Securitisations are more expensive too, but have not undergone the same swing, and are now slightly less expensive than hybrid.”
Securitisations certainly take much longer to assemble. Ms Sorenson believes that there are three requirements for an insurance company to execute a Zest-type transaction successfully.
“It must have the systems in place to show it can measure risks on a policy-by-policy basis,” she says. “It must have some other place to use the capital for a higher return. And it must have a management that embraces enterprise risk management and wants to go down that road.”
Securitisation may even have an indirect role to play in acquisition finance. Because of the lead times involved, it is not the ideal way to raise quick funding for acquisitions. When time is not of the essence, however, an insurer can securitise rather than raise hybrid capital, thereby leaving itself room for manoeuvre when an acquisition opportunity does arise.
“They can keep their powder dry on hybrid, retaining the ability to top up in a hurry,” says Ms Sorenso .
BarCap believes that Solvency II can only add to securitisation’s allure for insurers.
“As we head towards Solvency II, insurance companies are looking more closely at economic capital,” says Mr Wood. “And this type of transaction fits well into that framework, which recognises it as a risk mitigation tool in a pan-European context for the first time.”
