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III. Insurance-Linked Securities
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not currently be the captive of choice, at least for new AG 48 transactions. The Limited Purpose Subsidiary statutes permit a ceding company to form a captive insurer, or “LPS,” in the same domiciliary state as the ceding insurer, which has proven to provide for a more streamlined regulatory approval process for a transaction.
d. Canada
During 2015, the first XXX/AXXX financing transaction utilizing collateral notes closed under the Canadian capital requirement resolutions companies.
2. Structures Utilized for Excess Reserve Financing
a. Limited Purpose Subsidiaries
We are not aware of any new transactions closed in 2015 that employed the use of the LPS laws in AXXX transactions. Georgia, Indiana, Iowa and Texas have each promulgated an LPS statute. The advantage of an LPS over a captive insurer is that an LPS, once licensed, may provide its ceding company parent with full credit for reinsurance without posting any security in the form of a letter of credit or a credit for reinsurance trust. Under the LPS statutes, an LPS is permitted to take statutory financial statement credit for the face amount of letters of credit as well as parental guaranties by statutory authority; the LPS need not seek regulatory approval for a permitted practice or other dispensation to use this accounting treatment. Although the promulgation of the LPS statutes was a major development in the ability to finance Regulation XXX/AXXX reserves, we have not seen the use of the LPS statutes take off as expected, likely as a result of the generally lackluster market activity in the past three years brought on by general caution on the part of insurers and regulators alike.
b. Credit-Linked Notes and Collateral Notes vs. Letters of Credit
As mentioned above, it remains to be seen whether the use of contingent credit-linked notes in a role that may be analogous to a “synthetic letter of credit” will continue, along with collateral notes, to be the structure of choice for excess reserve financing transactions. In credit-linked note transactions, an SPV issues a puttable note to a captive insurer. The captive insurer’s right to “put” a portion of the note back to the SPV in exchange for cash is contingent on the same types of conditions that would otherwise apply in a non-recourse contingent letter of credit transaction. In the recent past, the use of these notes, rather than letters of credit, has provided a means for reinsurance companies, which contractually agree to provide the funds to the SPV to satisfy the put, to enter a market that was once available only to banks. In collateral note transactions, demand notes backed by pools of assets are issued by an SPV to a credit for reinsurance trust on behalf of the captive. Collateral notes are typically rated and qualify as admitted assets. The assets that back the collateral notes can be provided by banks, reinsurance companies or other providers of collateral.
c. Funding Sources Beyond Banks
As outlined above, the market for funding sources in AXXX transactions has expanded beyond banks in recent years through the use of contingent credit-linked notes and collateral notes. Large reinsurance companies have shown a keen interest in participating in these transactions through support of the SPVs that issue the contingent notes and collateral notes. With the expansion of the group of potential funding sources for these transactions, life insurance companies can seek more competitive pricing and terms. With the limited activity in the market in 2015, it is difficult to predict with any accuracy if the market will see a continuation of the trend started in 2012 of reinsurance companies surpassing banks as the primary “risk taker” in these transactions. Because of the regulatory scrutiny over the past few years and the approaching XXX/AXXX Credit for Reinsurance Model Regulation, bank issued letters of credit may well see a comeback in 2016.
Developments and Trends in Insurance Transactions and Regulation 2015 Year in Review