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Life insurers lead way to 'Triple X' captives

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Life insurers are driving a growing trend in forming U.S. reinsurance captives that easily dwarf the average premium volume written by property/casualty captives.

The new so-called "Triple X" facilities also have helped introduce capital markets to captive funding, say South Carolina and Vermont regulators.

"It's big dollars," said Derick A. White, director of captive insurance for the Vermont Department of Banking, Insurance, Securities and Health Care Administration. "These programs typically (write) between $100 million and $500 million a year in premiums."

In contrast, the approximately 540 active property casualty/captives in Vermont each write an average of $20 million in premiums, Mr. White said.

Vermont, which licensed its second Triple X facility in November 2006, expected to have two more formations by year-end, Mr. White said. The domicile has scheduled a Jan. 4 hearing on proposed regulations that would facilitate the formation of captives reinsuring life insurance policies by addressing their reserve requirements and annual reports.

South Carolina, which modified its regulations in 2004, has licensed 18 of the facilities.

The world's largest life insurers are forming the reinsurance captives to meet reserving requirements for universal life, whole life and term life insurance policies, sources say.

The National Assn. of Insurance Commissioners laid out the controversial reserving requirements in a model regulation implemented by most states in 2000 and 2001.

The facilities became known as Triple X captives because originally that was a placeholder name for the NAIC's model law and the reserves it called for became known as Triple X reserves, regulators said.

At the time the NAIC adopted its model, regulators believed life insurers were understating their liability so state regulations called for life insurers to increase their reserves up to fivefold, Mr. White said.

Under those regulations, insurers' need for reserves will peak about 10 years into the life of an insurance policy. That is why insurers are forming the captives now.

The captives remove hundreds of millions of dollars of reserve liability from life insurers' balance sheets. They can do so by ceding the required reserves, along with the associated premiums, to another insurance company such as a captive, Mr. White said.

Captives can obtain reserve funding through letters of credit that an affiliate of the captive's parent can provide.

They also can tap the capital markets by, for example, issuing a surplus note to a special purpose vehicle that provides the captive with cash, said Kevin Moriarity, assistant general counsel for Vermont's Department of Banking, Insurance, Securities and Health Care Administration. In turn, the special-purpose vehicle can issue a surplus note to investors who provide it with funding that ultimately flows to the captive, he said. A third party, such as an insurer or an investment bank, can guarantee investors' returns.

As evidence that the arrangements are helping the capital markets grow increasingly comfortable with captive funding, South Carolina in October licensed a facility providing accident and health insurance coverage, said Leslie M. Jones, executive assistant to the director and chief life/health actuary in the South Carolina's Department of Insurance in Charleston.

The captive's owner uses it to access capital markets to fund capital requirements for the accident and health coverage, said Ms. Jones, who declined to provide further details.

The NAIC says the model requirement, "Valuation of Life Insurance Policies Model Regulation," that spurred the growth of Triple X captives addressed a situation that had allowed life insurers to write policies without having to put up adequate reserves.

But the NAIC task force that created the model regulation relied on outdated mortality tables to determine an adequate reserve level for insurers, said Ms. Jones, who is also a member of the NAIC's Life and Health Actuarial Task Force that created the model regulation.

"It posed a significant problem for life companies because they were charging premiums based on what they expected to happen, yet they have to hold reserves based on outdated mortality tables," Ms. Jones said. "So they ended up in a funding pinch."

Reserve calculation debate

Because the reserves are considered redundant and there is little risk that they will ever be needed, the capital markets have been willing to step up and provide the reserve funding, Ms. Jones said.

Others within the NAIC, though, dispute whether the model law missed its mark in calling for increased reserves. How to best calculate reserves has been debated among actuaries and NAIC members for years, sources say.

However, there is growing recognition that a so called "formulaic" reserve approach may need to be revised for some underwriting products including life policies, Ms. Jones said.

Movements now are afoot to adjust the reserve requirements, Ms. Jones and Mr. White said.

However, it will take years for such changes to occur, sources say.

Meanwhile, regulators say they expect the formation of Triple X captives to continue as more insurers turn to them to address their reserve requirements.

The captives tend to be "deal specific" because investors want their business kept isolated, said John Hunter, chief financial officer in Cedar Rapids, Iowa, for AEGON Financial Partners, a unit of Hague, Netherlands-based AEGON.

AEGON formed Stonebridge Re in Vermont about a year ago, and The Hartford Financial Services Group licensed Champlain Life there last month.