Financial Services market dynamics - insurance outlook

Insurance is increasingly an important part of the capital stack of financial Institutions who are looking more and more at alternative risk transfer (ART) and financing strategies, in addition to traditional insurance coverages.

A growing number of companies are partnering with insurers to manage risk and regulatory capital requirements in an optimized fashion or to the unlock the value of collateral, exploring a range of bespoke solutions (see examples below) that can help companies to achieve the right balance of return, risk and capital for their businesses.

“Providing capital relief to banks on their loan and credit line portfolios is an area of growing interest,” says Grant Maxwell, Global Head of ART at AGCS. “ART solutions can help with liquidity facilities for securitization of unusual asset portfolios or wrapping of collateral for lending opportunities where the collateral is difficult for the lender to recognize or analyze.”

In addition, risk transfer solutions can also be utilized for improving company valuation, an interesting consideration for private equity firms, for example.

With some budgets under pressure in a harder insurance market, financial institutions are also increasingly exploring ways to make use of captive insurers to compensate for changes in the insurance markets or finance more difficult to place risks.

“An increasing number of clients in the financial institutions space are inquiring about captives and alternative risk transfer solutions to manage elements of their directors and officers (D&O), cyber and error and omissions (E&O) programmes, for example,” says Christof Bentele, Head of Client Management for ART at AGCS. “But also beyond financial lines insurance products, we are seeing a growing interest in structured insurance or reinsurance solutions, spanning across a variety of risks and insurance classes of business. Clearly, this goes along with an increased appetite for risk retention by financial institutions.”

Each transaction typically is situation-specific, reflects the company’s objectives and limitations and is consequently individually structured, analyzed and modeled.

• 1: A US-based life insurance company had to set up reserves for its portfolio of individual fixed annuities. The reserves mandated by the regulators were based on unreasonable assumptions, and were in excess of the economic reserves. The difference between the regulatory reserves and excess reserves was financed by a bank by issuing a contingent letter of credit. As the annuity portfolio grew, the size of the letter of credit exceeded the bank’s exposure limit. ART co-participated on the letter of credit, which reduced the bank’s net exposure and allowed it to continue to expand the business.
• 2: The company is in the business of providing a liquidity facility agreement (“LFA”) for securitizations. Under the Basel III rules, the capital treatment of the LFA follows that of the most senior note in its corresponding securitization, somewhat regardless of the particular features of the LFA and indeed the securitization. Owing to ART’s ability to recognize the very strong overcollateralization of the LFA, ART was able to provide the client with regulatory compliant paper which allowed it to treat the LFA as AA-rated, thereby materially improving the capital treatment of the underlying business.
• 3: A portfolio of green energy loans had been securitized, with a rating agency mandated interest reserve facility. The reserve facility was trapping some of the cash that could be used to extend new loans. ART provided a non-cash liquidity facility utilizing its high credit rating. The facility allowed the sponsor to free up the needed working capital.