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III. Insurance-Linked Securities
In response to these market pressures, many of the larger ILS-dedicated funds have sought to replicate insurance and traditional reinsurance structures to achieve returns, including collateralized reinsurance and MGA fronting transactions. As capital becomes a commodity, larger funds have sought positions closer to the underlying risk. For example, in 2014 and 2015, certain funds established a Lloyd’s syndicate and entered into various fronting arrangements and MGA structures. ILS funds have also deepened their reliance on collateralized reinsurance placed outside of the bond market. We expect fund-driven deals and structures to be the emerging story of 2016, as the clout and market presence of the largest ILS funds continue to crystalize in the highly competitive property catastrophe market.
C. Section4(a)(2)PrivatePlacements
As the sophistication and modeling expertise of ILS investors has grown in recent years, interest in private placement Cat Bonds and other ILS structures under Section 4(a)(2) of the Securities Act of 1933 (the “Securities Act”) has increased. While Cat Bonds are (and will remain) principally offered pursuant to Rule 144A under the Securities Act, the popularity of private placements under Section 4(a)(2) as a streamlined alternative is beginning to take hold. For instance, AIG completed its $300 million Compass Re II transaction in 2015, the largest Section 4(a)(2) private placement Cat Bond since the financial crisis. The transaction was particularly interesting because AIG has also been a committed participant in the Rule 144A Cat Bond market, with over $1 billion in aggregate principal outstanding, and because of the involvement of start-up broker Rewire Holdings. In addition, several other market participants have recently established proprietary platforms to take advantage of the private placement market, including Aon Benfield Securities’s CATstream, Horseshoe/JLT’s Market Re, Kane’s SAC program, Tokio Solution’s Tokio Tensai Platform and Willis’s Resilience Re, among others. See “Cat Bond Lite Platforms” in Section III.D below for further detail.
As an alternative to more traditional Rule 144A transactions, private placement Cat Bonds offer sponsors the benefits of a streamlined structure, modeling and subject business
Developments and Trends in Insurance Transactions and Regulation 2015 Year in Review
disclosure, as well as decreased transaction costs. This is especially important for first time sponsors, particularly smaller insurance companies who may not have adequate internal resources to undertake a full Rule 144A offering process, or for whom traditional reinsurance may be competitively priced on an “all-in” basis. Consequently, we expect these private placement structures to continue to increase in popularity in 2016.
Section 4(a)(2) of the Securities Act exempts from registration “transactions by an issuer not involving any public offering.” To qualify for this exemption, the purchasers of the securities must, among other things, either have sufficient knowledge and experience in finance and business matters to be “sophisticated investors” (i.e., be able to evaluate the risks and merits of the investment), or be able to bear the investment’s economic risk. They must also have access to the type of information normally provided in a prospectus for a registered securities offering.
Because Section 4(a)(2) exempts the initial sale of securities directly from the issuer, an investor will need to rely on another exemption, such as Rule 144A, in connection with the resale of securities (Rule 144A applies to downstream sales by non-issuers to qualified institutional buyers).
As a purely technical matter, a Section 4(a)(2) private placement can be resold under Rule 144A if the investor qualification and information requirements under Rule 144A have been satisfied. There are often structural and legal considerations to address, however, before broader resale should be permitted by an issuer, particularly in book-entry format. We highlight two of these considerations below.
Any offer and sale of securities with sufficient nexus to the United States, whether the initial sale by the issuer or an investor resale, remains subject to the anti-fraud provisions of Rule 10b-5 under the Securities Exchange Act of 1934 (the “Exchange Act”). In order to establish a claim under Rule 10b-5, an investor must demonstrate, among other things, that the defendant made a misstatement or omission of a material fact
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