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Transaction Includes Cut-through Reinsurance that Can Be Model for Other Deals

MBIA Inc. and FGIC Corp. have announced an agreement that will provide reinsurance to $184 billion of municipal bonds currently insured by Financial Guaranty Insurance Company (FGIC). The deal resulted from a competitive process undertaken at the direction of, and overseen by, the New York State Insurance Department and includes the innovative use of "cut-through" reinsurance for a large book of existing financial guaranty business, Insurance Superintendent Eric Dinallo announced today. The specifics of the transaction must still be submitted to the Insurance Department for approval.

In addition, the Department has approved the commutation between FGIC and FGIC UK and Calyon with respect to a commitment by FGIC UK to issue a $1.875 billion financial guaranty policy on a complex basket of distressed asset backed securities. FGIC UK paid Calyon $200 million for the commutation.

"Assuming the terms of the reinsurance deal meet regulatory requirements, it should provide substantial improvement for everyone-the municipal and structured policyholders of FGIC, the policyholders of MBIA, and both companies," Dinallo said. "The innovative use of cut-through reinsurance provides a model that I expect can be used to improve the rating of the municipal bonds currently insured by other downgraded bond insurers, while freeing up capital to pay the claims of other policyholders. I'm proud that the Insurance Department was able to play a constructive role by facilitating and overseeing the bidding process that resulted in a beneficial, market-based transaction."

Cut-through reinsurance generally means that a policyholder can file a claim directly with the reinsurer if the insurance company that issued the policy goes bankrupt, thus avoiding the delays usually associated with bankruptcy. This cut-through reinsurance is innovative in three ways:

  1. Policyholders can usually only use cut-through reinsurance after the insurance company that issued the policy goes bankrupt. Here, owners of municipal bonds backed by FGIC have a choice. They can go to FGIC or go directly to MBIA with any claims. This increases the assurance that a policyholder will be paid promptly for a claim.
  2. Cut-through reinsurance is typically offered to help sell a new policy. Here it is being used retrospectively for existing policies.
  3. Cut-through reinsurance is normally offered policy by policy. Here it is being provided all at once for a large group.

"We believe that cut-through reinsurance could prove invaluable in helping lift the ratings of municipal bonds now covered by other bond insurers, including Syncora and CIFG," Dinallo said.

FGIC had been downgraded from AAA to ratings that range from BB to CCC, which means that the municipal bonds it insured were also downgraded, unless the issuer had its own independent higher rating. As a result of this transaction, the bonds now reinsured could be upgraded to as high as AA. Also, FGIC municipal policyholders will benefit from a stable reinsurer backing their policies. FGIC's structured finance counterparties will benefit from approximately $1 billion of additional capital resources supporting their policies in the form of capital release, contingency reserve release and a cash ceding commission. As part of this process, FGIC continues to have extensive discussions with its CDO structured finance counterparties.

While the majority of FGIC municipal bonds are included in the reinsurance transaction, a small number, including bonds issued by Jefferson County, Alabama, were not included and will continue to be insured only by FGIC.

The transaction also strengthens MBIA's insurance company in ways that provide substantial benefit to policyholders.

  • The transaction will result in greater earnings and cash flow to the insurance company. It also creates operational and capital synergies.
  • The insurance company will be larger and with a greater percentage of its book concentrated in the stable, low loss municipal business.
  • Both of the above should fortify MBIA's ratings by improving its financial position. Policyholders would benefit from the maintaining or improving of MBIA's ratings.
  • The transaction is an effective use of excess capital at a time when the company is able to write limited new business.

The deal resulted from an auction and a search process for bidders directed by the Insurance Department. Many bidders participated and provided bids. FGIC selected the best offer and negotiated the final terms.

It is expected that the companies will file an application for approval of the transaction on Tuesday, September 2, 2008. That will begin a 10-business-day public comment period, during which all interested parties are free to comment on the transaction before the Department makes its final determination. The application will be public and available from FGIC.

"As we move forward with the evaluation process, we hope that anyone who has a comment will share it with us. We want to ensure that both companies moving forward are stronger for all policyholders," Dinallo said.

This transaction is part of the Insurance Department's continuing implementation of its three point plan for the bond insurance industry.

  1. Bring in new capital and new players to ensure a competitive market providing bond insurance to those who need it. To date, the Department has facilitated the addition of $10 billion in capital.
  2. Protect the policyholders of the distressed companies by finding solutions, including reinsurance for the municipal bonds.
  3. Develop new rules for the bond insurers to prevent similar problems in the future.

Department of Financial Services


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