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Excess Reserve Financing

A U.S. life insurer is looking to finance their excess reserves related to their universal life policies with secondary guarantees (UL-SG). They set up a captive reinsurance entity in a U.S. domicile that allows special purpose vehicles or limited purpose subsidiaries and then enter into a reinsurance agreement where the reserves from the UL-SG are ceded to the captive.

U.S. life insurers selling level premium term insurance are subject to actuarial reserves required to be held under the NAIC Valuation of Life Insurance Policies Model Regulation (#830), which is commonly referred to as Regulation XXX. U.S. life insurers selling universal life products with secondary guarantees are subject to actuarial reserves required to be held under the NAIC Actuarial Guidance XXXVIII, which is commonly referred to as AG 38 or AXXX. These reserves are perceived to be “excessive” because they exceed the amount of reserves that the insurer has calculated for GAAP purposes to hold for the policies. To relieve the strain on capital and surplus on a statutory basis the insurer forms a captive reinsurer and cedes risks on a block of policies to the captive. In the early stages of this type of structure the captive issued surplus notes to investors and the proceeds were placed in a reserve credit trust. The proceeds from the offering covered the amount of excess reserves related to the policies. Interest on the debt is repaid from premium and investment income. The current trend (over the past five years) is to set up a non-recourse LOC facility that the captive is allowed to report as an “admitted asset” for statutory purposes instead of going through the process of issuing surplus notes. Banks that issue non-recourse LOCs face the remote risk of a draw when mortality is much higher than anticipated. In order to mitigate this risk the White Rock facility was utilised. Because the risk is long-term a life license was obtained from the Bermuda Monetary Authority so subsequent arrangements simply need to go through review and approval by the White Rock board which typically takes a couple of weeks.

To mitigate the risk of any potential draw on the LOC the bank purchased a financial guarantee from their White Rock Cell #1 who in turn obtained a credit insurance policy for the financial guarantee risk from their White Rock Cell #2. Cell #2 cedes the risk to an unaffiliated reinsurer under a Hedge Reinsurance Agreement which is fully collateralized through a trust account for the benefit of Cell #2.