Securitisation is the isolation of a pool of assets and the repackaging of those assets for trading in capital markets. Securitisation began in the 1970s with US banks selling off pools of mortgage-backed loans. By 2002, some $450bn of assets had been securitised. The first insurance securitisations were related to property and casualty in the 1990s. Life securitisations followed with the sales of rights to future profits from blocks of life policies and annuities.
The mechanics of securitisation
The basic idea behind securitisation is to move an asset off-balance sheet, usually done by transferring the asset to a special purpose vehicle (SPV). The SPV then issues securities to investors who contribute funds. The SPV remits some or all of these funds to the originating institution, which in which in return transfers the asset to the cash flows generated by the asset. Typically there are different classes of security, with different claims and different seniority rights to the underlying cash flows. Most of these arrangements will contain features to protect participating parties, including over-collateralisation, subordination as well as external guarantees.
Benefits of securitisation
Securitisation is particularly useful for insurers as it offers a more efficient way for many types of insurance risks to be traded in capital markets rather than held on-balance sheets, allowing for insurance companies to take advantage of available capital. For investors, insurance securitisation offers the opportunity to invest in life-related risks, opening formerly inaccessible investment outlets involving mortality and longevity risks. These are attractive as life risks have little correlation with other risks, adding little extra risk to a diversified portfolio.
“Block of business” securitisations
These have been used to capitalise expected future profits from a block of business, recover embedded values and exit from a geographical line of business. Writing new business puts pressure on a company’s capital as most of the costs in writing new life policies are incurred in the first year of the policy and amortised across the remainder of the term. Securitisation helps to relieve this pressure by allowing immediate access to expected future profits; an attractive option if the company is experiencing rapid growth in a particular line of business.
Mortality and longevity bonds
Mortality bonds with at least one payment tied to a mortality index, and their purpose is to protect life insurers and annuity providers against the adverse consequences of an unanticipated extreme deterioration in mortality. Longevity bonds offer payments tied to a longevity-related variable, such as the survivorship rate of a specified cohort, and are designed to protect insurance companies or annuity providers against an unanticipated increase in longevity.
Pension bulk buyout securitisations
Pension bulk buyouts are a recent class of securitisations with an active market is in the UK, where buyout funds such as Paternoster (backed by Deutsche Bank) and Synesis Life (backed by JPMorgan) have been running since 2006.
Annuity books and their assets contain a range of risks. The main matching assets for annuity liabilities are corporate and government bonds, the coupons and principal on which are used to make the payments on the annuities. The main risks on the asset side are from credit and interest rate risk, while the risks facing those paying annuities and pensions are inflation and longevity risks. Companies therefore sell off unwanted risks and retain those that the company feels comfortable managing.
The idea behind pension bulk buyout securitisations is for a counterparty to take on some or all of the risks of a pension fund. A leveraged (or structured) buyout offers one method and is used for pension schemes in deficit where the sponsor wishes to wind up.
This article is an edited version of an entry in the “Encyclopedia of Quantitative Risk Analysis and Assessment”, Copyright © 2008 John Wiley & Sons Ltd. Used by permission.
