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III. Insurance-Linked Securities
AXXX without the use of a captive by adding admitted assets to the balance sheet of the insurer. Many more companies are either sitting on the sidelines, having adopted a “wait and see” attitude, or have actively begun the process of addressing the complexities of AG 48 issues with a goal of closing new transactions involving AG 48 covered policies in 2016, or adding a block of AG 48 policies to an existing transaction.
1. Summary of Deal Activity
a. AXXX Market Remains Open
Several 2015 transactions were designed to provide reserve financing for universal life policies subject to Regulation AXXX. The growth in the number of lenders willing to provide financing to fund AXXX reserves that started in 2012 continued in 2015. In most transactions in both the XXX and AXXX markets, commitments were for 10 to 20 years, although it is still common to see shorter terms intended to act as a financing bridge until other expected sources of funding become available.
b. Will Non-Recourse Transactions Remain the Structure of Choice?
In 2014, prior to the effective date of AG 48, the vast majority of deals were secured by non-recourse letters of credit, contingent notes or collateral notes, as those transactions had essentially replaced traditional letters of credit among lenders and reinsurance companies active in the AXXX/XXX market. In 2015, we saw a return of, or at least a heightened interest in, traditional letters of credit. In the past, the obligation to reimburse the bank for any draw on the letter of credit was guaranteed by a parent holding company, thus being known as a “recourse” transaction. In a non-recourse transaction, no such guaranty is required. Rather, the ability to draw on the letter of credit or contingent note is subject to certain conditions precedent. These conditions typically include the reduction of the funds backing economic reserves to zero and a reduction in a prescribed amount
Developments and Trends in Insurance Transactions and Regulation 2015 Year in Review
of the captive’s capital, and a draw limited to an amount necessary for the captive to pay claims then due. Because of these conditions, lenders and other funding sources became more comfortable assuming the risk of relying for repayment on the long-term cash flows from a block of universal life policies. With the advent of AG 48, it is uncertain how regulators will approach a non-recourse transaction where the proposed “Other Security” is a conditional draw letter of credit or a contingent draw note. Although they are not expressly forbidden by the new rules, it remains to be seen how regulators will perceive these bespoke sources of contingent funding in the age of AG 48. Collateral notes are demand notes backed by pools of assets, such as K-Notes insured utilizing the Karson Management (Bermuda) Limited platform. They may, but typically do not, contain these contingent features and therefore should remain acceptable for financing under AG 48, at least as “Other Security”.
c. Choice of Domicile for Captives and Limited Purpose Subsidiaries
Vermont remained the preferred domiciliary jurisdiction for captive life insurers in 2015. Although several states have adopted captive insurer laws or have amended and expanded existing captive insurer laws over the past few years to facilitate reserve funding transactions, 2015 saw a reversal in the trend of seeing multiple jurisdictions being utilized as captive insurer domiciliary jurisdictions, undoubtedly reflecting the overall reduction in the number of transactions in 2015 from previous years. We expect that, once the market adapts to AG 48 and the related Model Law and Model Regulation (as defined and further described in Section III.K.3.a below), we will again see several other states—including Arizona, Delaware, Nebraska and Iowa—being utilized as captive insurer domiciliary jurisdictions. We understand that the use of the recently enacted “Limited Purpose Subsidiary” statutes in several states has cooled off and, due to what some regulators have perceived as overly flexible and minimal capital requirements, the Limited Purpose Subsidiary may
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