[This page is a series of focused write-ups on applications in securitisation. For other applications, see the Securitisation Applications section on the Securitisation home page.]

Links on Risk Securitisation

Securitisation of embedded value in Life Insurance policies

Insurance linked securities – general



Late breaking news: 4th Dec., 2000

At a Forum on Alternative Risk Transfer, insurance was propounded as a source of contingent capital and as a building block of the capital structure of a company – click here for a report.

Late breaking news:

Added on 8th April, 2000:

Index-based risk-transfer device is a new innovation in the insurance market and claims several advantages over a traditional cat bond issue – click here for a news report.

Added on 17th Jan., 2000:

Hanover Re is continuing with securitisation of non-catastrophe insurance contracts as well – see our News page for a recent news addition – click here.

Other additions

Two very important articles on Alternative Insurance/ Alternative Risk Transfer have been added on 13th August and 17th August, 1999. Go to the Securitisation articles page to read.


Added on 28th June, 1999: The use of securitisation as a device of alternative risk transfer is growing among non-insurance companies. See this detailed report.

Added on 17th June, 1999: Not only are insurance companies making use of the cat bonds methodology, even non-insurance companies are buying insurance cover directly by issuing cat bonds. Read about one such issue by a Japanese company – click here.

Market is ripe for more of insurance risk securitisation – click for a news report on our Securitisation news page .

Insurance risk securitisation market:

This is another interesting application of securitisation concept. Trading in insurance risk is very common over centuries – insurance companies have a well-established re-insurance market. However, securitisation has made a significant difference to the way insurance risk is traded – by making it into a commodity and taking it to the capital market instead of the insurance market.

Insurance risk securitisation is not a very old phenomenon – it has existed for last about 6-7 years and some 20 instances of cat bonds issuances exist. The Economist (February 29, 1998, pp. 73-74) reported that bonds are being used to spread insurance risk beyond insurance companies. The large insurance company losses in 1992's Hurricane Andrew and 1994's Northridge earthquake have convinced many insurance companies that a way to spread these risks outside of the insurance industry is needed. Initially called "cat," or catastrophe bonds, an issue might provide a higher than market interest rate with the quid pro quo that an insurance loss might eat into the bond investor's principal. Suddenly, the world of insurance has become the domain of investment banking. Since 1996, $1.1 billion of the bonds have been sold. Another approach is for an insurance company to sell puts on its own stock to be able to raise capital in the time of need. These risk management techniques will have profound impacts on the reinsurance business and on the insurance industry in general as securitization of risk moves beyond the packaging of loans.

Insurance risk securitisation marks a very significant development in the process of development of both capital markets and insurance: they seem to be coming together. Convergence is the central theme of development, in this respect, risk securitization is one of the key developments of our time.

Insurance risk securitisation relies upon the tremendous potential of capital markets in absorbing risk. Because global capital markets are so vast – publicly traded stocks and bonds have a total value of more than USD 50 trillion – they offer a promising means of funding protection for even the largest potential catastrophes. Capital market insurance solutions also allow the industry to reduce counterparty risk and diversify funding sources. Investors purchasing the securities can earn high-risk adjusted returns while diversifying their portfolios.

Market for catastrophe bonds:

A survey in Financial Times 6th Sept., 2000 says that the total amount of cat bonds issued to date is approximately USD 5 billion. See news report here. There are more reports on our news pages.

Articles on insurance risk securitisation:

Links on risk securitisation:

Securitisation of Embeded value in Life insurance policies

by Vinod Kothari

While risk securitisation has been around for quite a while, and securitisation of future annuities or endowment contributions is also akin to routice securitisations, a new asset class in securitisation market has recently been introduced – securitisation of value-of-in-force life insurance policies, or embedded value of life insurance.

Unlike other alternative risk transfer devices, this securitisation is not essentially a risk transfer device – it is predominantly a device to monetize the profits inherent in already-contracted life insurance policies. It is comparable to the securitisation of servicing fees of a servicer, or the residual profits of a business, or fees of asset managers.

In life insurance business, the key cashflows of the insurer consist of:

  • Inflows:

    • Premiums
    • annuities
    • investment income and capital receipts
    • fee income (for specific insurance contracts only)
  • Outflows:

    • Policy benefits
    • annuity payments
    • Investments
    • Surrenders
    • Expenses, both origination and continuing
    • Capital expenditure and investments
    • Taxes

The value of in-force life insurance policies tries to capitalise the net surplus out of these cashflows. Sometimes also known as "block of business Securitisation" (since the early usage of such funding was to refinance the initial expenses incurred in acquiring new blocks of policies), this funding method is based on structured finance principles whereby the residual income of the securitised block is monetized upfront.

One of the early examples of this method is American Skandia Life Assurance Company (ASLAC). From 1996-2000, ASLAC issued thirteen securitization transactions designed to capitalize the embedded values in blocks of variable annuity
contracts issued by ASLAC. The trusts issuing the notes are collateralized by a portion of future fees, expense charges, and contingent deferred sales charges (CDSC) expected to be realized on the annuity policies. In its 2000-2001 GAAP annual report, the company listed twelve outstanding issues from 1997 through 2000 with total initial issue value of $862,000.

Hanover Re has also used this device.

However, the most commonly cited example is that of National Provident Institutions (NPI), a UK based company that did a unique securitisation in 1998 selling certain interests is an open pool of life insurance policies using the device used by several UK companies called "whole business securitisations" (see our page here). The transaction involved a huge size of policies worth USD 4.08 billion with an embedded value of USD 487 million.

Added 25th Jan 2006

Looking at the transactions towards end of 2005, it seems life insurance embedded value securitisation is going to bloom.

The reasons are several – first of all, as insurance capital regulations move towards Solvency II, there will be an increasing need for insurance companies to improve the quality and regulatory certainty of their regulatory surplus assets. Currently, insurance regulators in certain cases do permit capturing of profits out of in-force policy pools as a part of the embedded value. But over time, regulators expect insurance companies to remove the "implicit items", that is, value of in-force policies, from the regulatory assets.

Surplus assets are to life insurance companies what regulatory capital is to banks. As banks are able to leverage their regulatory capital, so are insurance companies able to leverage the supervisory suplus assets to write more policies. Securitisation helps the insurance to either reduce their insurance liability (by seeking a reinsurannce with the funding raised by securitisation), or to increase the value of their supervisory assets by seeking a contingent loan from a reinsuring SPV.

Structurally, an embedded value securitisation for life insurance companies is similar to operating revenues securitisation or corporate securitisation. However, the significant difference is that whereas corporate securitisations relate to profits from an on-going business with both existing and future assets, in embedded value securitisations, we are essentially concerned with profits from an existing, called in-force block of life policies. These policies are responsible for a profit in future, which is, in fact, locked in today (subject, of course to the volitalities), but would be realised in future. This profit will be responsible for (a) recovering the cost of underwriting or acquiring the policies; and (b) residual profits. The value-in-force securitization is a way of monetization of that profit to finance the new business strain as also to create surplus assets to enhance business capacity of the insurer.

The main structures used for value in force securitisations include (a) reinsurance structure; (b) contingent loan structure. In the reinsurance structure, the issuing SPV raises funding and provides the same, most likely way way of a contingent loan, to the rensuring SPV, which in turn grants a reinsurance cover to the parent company. Alternatively, the issuing SPV may provide a contingent loan to the insurance company which may be paid from out of the surplus from business. In either case, the idea is to raise funding that represents emerging surplus from an existing block.

Yet another pathbreaking transaction in the life insurance segment was transfer of catastrophic mortality risk in a defined pool of life policies. Swiss Re recently did this transaction, using the well known catastrophe risk transfer device to transfer excess mortality risk in life business.

The critical issue in life insurance securitisation at this point is the ratings – rating agencies have not been comfortable with giving ratings to the embedded value transactions above the rating of the insurance company itself. The underlying reasons are two – one, the dependence on servicing of the policies implying a position which is not easy to migrate to a back up servicer; and secondly, the implicit subordination of the investors to the policy holders, as, for insurance regulators, the interests of the policy holders are supreme. Life insurance securitizations do not use true sale structure – hence the rating cap seems to make sense, but given the fact the profit is locked in the day the policies are written, after, of course, stressing the assuptions, a part of the profit is no different from the value of a commercial real estate in CMBS transactions. Hence, with a given LTV ratio or advance rate, a higher rating sounds logical.

The maturity of the embedded value securitisation market is visible given the fact that the advance rate in the latest Swiss Re transaction was as high as 82%. But this part of the market surely has a long way to go, and will possibly find lots of other applications in businesses which incur costs upfront for profits in future – in essence, most businesses.

Insurance linked securities: the emergence of a new asset class

Added 17thJan 2007

Over last few years, insurance linked securities (ILS) is fast emerging as a new class by itself. Pioneering efforts of Swiss Re apart, the market in general seems to be more inclined to accept inew forms of risk based financial instruments. Credit derivatives have become very well known already with volumes zooming to nearly USD 30 trillion by end of 2006. Insurance linked securities represent just another form of risk-anchored securities.

Different forms of insurance risk based instruments are entering the market -catastrophe, excess mortality, life insurance embedded value, etc.

The outstanding volume of ILS was estimated at about USD 23 billion in mid 2006.