S&P Sees European Securitizations Gaining Acceptance

January 19, 2006

Standard & Poor’s newly issued report on Corporate Securitizations notes that these types of transactions are gaining increasing acceptance as a capital management tool by European insurers, with Swiss Re and AXA leading the way.

“During 2005, we saw a number of new types of insurance risks being transferred to the capital markets,” said S&P. “Within the European non-life insurance sector, we rated two such transactions, together totaling €452 million [$546 million].”

The rating agency noted that the “two transactions – a motor securitization by AXA France IARD and a credit reinsurance securitization by Swiss Reinsurance Co. – were different from other risk transfer transactions we have historically seen.

“The motivation behind these transactions was a combination of risk transfer and a desire to bring regulatory and rating agency capital requirements in line with the companies’ view of economic capital. Increasingly large and sophisticated groups, such as Swiss Re and AXA, are acquiring risk in the conventional way but then packaging part of that risk and passing it on to the capital markets.”

Rumbles of the increasing use of securitizations, or ART’s, have been flitting around the insurance industry for years, but with the exception of some special purpose vehicles – mainly Cat bonds – they’ve never seemed to get off the ground. S&P indicates that this may be changing. It points out: “The use of securitization as a form of risk transfer and/or financing can play a large part in this [efficient use of capital], and can offer an attractive alternative to reinsurance or traditional methods of funding as part of an insurer’s overall toolbox.”

Such deals also infuse a bit of new blood into the capital markets. “For capital market investors, such transactions satisfy a craving for risk diversification and enhanced yields,” said S&P.

The article looks at “the newest structures and asset classes in insurance securitization,” and focuses in particular on the AXA and Swiss Re transactions.

S&P singled out AXA’s securitization late last year (See IJ Website Nov. 8 and 10, 2005) as breaking new ground. AXA initiated the deal to protect AXA France IARD (AXA’s main operating entity in France), “against deterioration in the loss ratio of a portfolio of motor insurance policies,” said S&P. “In this transaction, investors lose all or part of their investment if the loss ratio breaches a certain level.”

“Shortly after this transaction was brought to market, Swiss Re announced that they would also buy loss protection from the capital markets for their credit reinsurance business. Swiss Re’s securitization is called Crystal Credit Ltd. and protects against losses that stem from its portfolio of credit reinsurance treaties. Similar to AXA’s securitization, Crystal Credit noteholders are exposed to loss of principal if aggregate losses reach a certain level above the average losses observed historically.”

S&P indicated that, “according to Swiss Re’s data, investors in the most junior notes would have lost part of their money once during the past 20 years.”

“Both underlying portfolios demonstrate strong diversification and stability. AXA’s portfolio contains about three million policies from most regions in France. Although the primary credit insurance market is highly concentrated, the risks in Swiss Re’s underlying portfolio stem from several millions of trade receivables.

“The losses from the two underlying portfolios are characterized by a high frequency and a low loss severity. In AXA’s case, perils that could cause a high loss severity, such as natural catastrophes or war, are excluded from the transaction. The risk that has been passed to the capital markets is that of an unexpected increase in claims frequency or compensation payments, perhaps due to a material change in the behavior of drivers or adherence to road safety.”

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