Tony Hillman takes a look at the prospects for securitisation becoming a financing tool of first choice for insurance risk transfer, and explains why Jersey is well placed to take advantage.
How will the securitisation of insurance risk rise beyond “niche” status and become a financing tool of first choice?The various explanations of the phrase “securitisation of insurance risk” all deal with turning to bond investors, as an alternative to the traditional reinsurance companies, to finance insurance risk. If it can be made to sound that simple, why isn't everyone doing it and why do traditional reinsurance markets continue to thrive? Let us examine the reasons:
From the point of view of the insured, during the period of the economic cycle when the insurance markets have ample capacity and rates are soft, why look any further than traditional insurance and reinsurance solutions?
From the point of view of the investor, when equities are performing well why look to the bond market (and, in particular, a relatively new and specialist “niche” in that market)? Typically, bond market investors may lack familiarity with underwriting analysis and may shy away from assessing the risks of investing in a bond issue made for the purpose of securitising insurance risk. Investors will rely heavily on an issue being rated, and there may be a view that the level of disclosure needed to obtain a rating poses a difficulty for the deal makers in the very competitive world they work in. It has also been said that investors may have concerns in case, by virtue of providing the risk finance, they are deemed to be carrying on an insurance business unlawfully. The writer's view is that if there is a real issue for investors it is likely to be in their own jurisdiction of residence rather than in the jurisdiction of the securitisation structure, and that any such fears may be genuine enough in the case of a bond issue with a single investor (or very few investors) but probably have no serious validity if applied generally to insurance risk securitisation structures, and particularly to rated and publicly offered issues.
In reality the issue is one of relative cost. Getting a securitisation structure off the ground is both time and cost intensive. The structure involves lawyers, tax advisers, auditors, bond dealers and offshore trustees and company managers.
For securitisation structures to extend beyond niche status there is a need to make this financing tool cost effective for smaller transactions. The concept of “protected cell” companies has been said to be an answer. The claim is that by protecting the assets within any individual “cell” (against claims from creditors contracting with other “cells”) these companies can serve as “permanent” structures through which numerous deals can be placed, thereby improving cost effectiveness.
Jersey has not so far embraced the concept of the protected cell company. Of course, the device of limited recourse language in contractual documentation can always be used to prevent contracting counterparties claiming against assets not intended to be at risk. Broadly, the protected cell concept aims for the same result without the need for the contractual language. It attempts to achieve its aim by designating specific corporate assets to be held within particular “cells” of the company and ensuring that counterparties contract only with a specified cell. Jersey takes the view that the protected cell company is not a panacea, since a company can incur liabilities otherwise than by way of contract. Therefore it will not always be possible to make sure there can be no creditors with claims against the corporate entity which are enforceable against all its assets.
Maybe the solution has been there all along, but has simply been ignored by advocates of the protected cell company. In the search for that solution the centuries old concept of the trust is worth close examination. In the context of insurance risk securitisation, the concept involves using a special purpose company (SPV) as issuer, to issue loan notes to the risk transferees in its capacity as trustee of a specific “special purpose” trust governed by Jersey law. In the same capacity, the SPV will enter into an insurance or reinsurance contract with the intended risk transferor, thereby utilising the funds it has raised (by issuing its loan notes) in financing the risk transfer.
The key is that the assets held by the SPV (the proceeds of issue of its loan notes, the insurance or reinsurance premium received by it from the risk transferor, and investment income) are not held by it beneficially, but are held by it subject to the relevant trust. That is the simple fact that needs to be considered in relation to the capability of “general” creditors of the SPV (and, on the same analysis, creditors of any other special purpose trust) to attack those assets of the SPV which are held to support the business of any particular risk transferor. The trust, of course, is written in terms providing for the funding out of the trust property of, first, all sums (if any) to become due from the SPV to the risk transferor under the insurance or reinsurance contract and, secondly, all sums to become due from the SPV to the loan note holders under the terms and conditions of the loan notes.
On the face of it, the centuries old concept of the trust seems to succeed where some feel the protected cell company may not.
What rôle should Jersey expect to play in that transition?
Let us examine how the structure of a single SPV running a number of deals through different special purpose trusts would fit into the Jersey regime.
• Trusts Law
The Trusts (Jersey) Law 1984 added a framework of certainty around the large and respected trust industry that already existed in the island. The Trusts Law was amended in 1989 and 1991 and has proved to be a model piece of legislation which has been referred to and borrowed by other offshore finance centres when drafting their own trusts legislation. Undoubtedly, Jersey has a comprehensive and respected body of trusts law, a very capable court system that can and does effectively enforce the law, and a good number of trusts experts amongst its legal profession capable not only of advising in Jersey but also of giving expert evidence on Jersey trusts law in proceedings taking place in the courts of other countries.
A cornerstone of Jersey's trusts law is its recognition of the principle that assets genuinely held in trust by any person (including, in this context, an SPV holding a Jersey insurance business permit) are not at risk from that person's personal creditors, or from creditors whose recourse is limited (either by agreement or by the operation of provisions in the Trusts Law intended to have that effect) to assets held as trust property of a different trust.
• Insurance Business Law
Under the Insurance Business (Jersey) Law 1996, subject to exemptions, all persons carrying on insurance business within Jersey are required to be authorised by a Jersey permit. On any analysis, a trust is not a legal entity, or “person”. Only one insurance business permit will be needed, for the SPV itself, and that of course means only one process of application and only one permit fee. Nevertheless, Jersey does not abandon control over the deals able to be put through a Jersey insurer structured in such a way. It is a requirement applicable to all Jersey insurance business permit holders that the permit holder “shall not write risks or introduce new products, other than those set out in the application, without the prior consent of [the Jersey Financial Services Commission]”. By that device the Commission's consent will be needed for each special purpose trust and the requirement for prudence that under-pins Jersey's approach to insurance business is set as the standard to be met.
Jersey's growing presence as a domicile for insurance business has now been allied to its long standing position as a premier player in the global market for international trust services. The result is that Jersey is home to a wealth of legal and regulatory experience and familiarity that place the island ideally to take advantage of growth in the insurance risk securitisation market. The forthcoming Fiduciary and Administration Business (Jersey) Law, by which Jersey's trusts services industry will be brought under the regulatory net of the Jersey Financial Services Commission, will only help to further establish Jersey as the domicile of choice for insurance risk securitisation business.
This article provides general information only and is not intended to give specific legal advice. Specific legal advice should always be obtained before taking or refraining from any action in connection with any of the matters referred to in this article.
Tony Hillman heads up the insurance business practice at Crills in Jersey. Mr Hillman graduated from Oxford University in 1979 with a first class honours degree in jurisprudence and qualified as a solicitor in England in Wales in 1982. He moved from London to Jersey to join Crills in 1984 and for many years has been closely involved in the development of Jersey's offshore insurance industry.© Antony R Hillman 1999