Farmers Insurance Exchange (Farmers) has successfully renewed its $500 million catastrophe contingent surplus loan note facility for the third time. The facility provides Farmers with an option to access the capital markets following a major catastrophe event.
The $500m facility complements the capital structure of Farmers, and provides it with further diversity in its sources of risk capital, with both bank and non-bank lenders participating in the transaction. It enables the insurer to access the capital markets as a source of risk transfer capacity at the time it needs it most, due to the facility having an embedded catastrophe trigger.
Joint bookrunners for the renewal of this facility were Commerzbank AG, RBS Securities Inc. and reinsurance firm Swiss Re, who all took active syndication roles on the transaction.
The facility was initially developed in 2007 and renewed in 2012, as Farmers sought new sources of risk capital to complement its reinsurance programme. The ability of a contingent capital facility to respond in times of need, after major catastrophe loss events, provides it with a source of just-in-time capital and leverages access to the capital markets, diversifying away from a reliance solely on the reinsurance market.
For 2015, the facility was optimised for Farmers latest renewal. As a capital management tool it provides Farmers with the option to access capital quickly at a time when Farmers and its customers need it most. Additionally, the structure preserves the Farmers capital strength and adequacy, by obtaining regulatory capital relief.
Through the facility, Farmers can issue 5-year surplus loan notes, at pre-agreed interest levels during a two-year commitment period (followed by three annual extensions), in the event that the firms losses from predefined catastrophe events reach a specified trigger level.
With that in mind the facility works a little like an indemnity catastrophe bond, providing capital when Farmers losses reach the predetermined level, but without the need to sell the notes in advance. Instead the notes are issued at pre-agreed rates after the catastrophe event occurs.
This makes contingent capital surplus note arrangements a good complement to a reinsurance programme, providing the same rapid capital relief as a cat bond or other triggered structure, but with the capital available on tap instead of sitting in collateral.
“This facility would bring capital relief to Farmers in the remote event losses from a significant natural catastrophe stretches our traditional risk transfer structures. The fact that we are able to provide this relief in a unique structure which is substantially less costly than the traditional alternatives is a good deal for both Farmers and our customers,” commented Ron Myhan, Chief Financial Officer of Farmers.
As ever, the cost of risk transfer capital is key and this facility comes in cheaper than traditional alternatives and possibly cheaper than a catastrophe bond, at least up front. It is surprising that more insurers and reinsurers haven’t sought to utilise contingent capital facilities such as this to augment their risk transfer, as they provide a responsive and cost-effective alternative.
“We appreciate the multinational support we have received from the participants in this facility. The best deals are always those where both sides win, and we believe this facility is truly one of those deals,” Myhan added.
Richard Furk, Client Executive at Commerzbank, added; “We were delighted to work again with Farmers on this unusual form of capital instrument, bringing together bank and non-bank investors to maximise the interaction between their capital requirements and risk protection.”
“Despite the improvements in the credit markets since 2012, syndicating such a facility is always an interesting challenge due to its various non-standard features such as the contingent nature and the embedded catastrophe trigger which requires lenders not only to assess the credit profile but also consider the impact of natural catastrophe events,” commented Philipp Kusche, Director, Insurance-Linked Securities at Swiss Re.
“Aligning the embedded catastrophe trigger within the facility more closely with Farmers’ traditional reinsurance coverage allowed us to make the transaction more efficient for Farmers, while reducing the maturity and commitment period compared to the 2012 transaction made it more appealing for lenders,” Kusche continued.
Gianfranco Lot, Managing Director and Client Executive at Swiss Re, said; “The excellent reputation of Farmers and use of capital markets and reinsurance technology allowed the company to obtain an efficiently priced transaction supported by a broad panel of lenders.”
It’s good to see this facility renewed as it is a prime example of an innovative use of capital markets tools to effect risk transfer on a contingent basis. As the capital markets lenders and institutional investors become more familiar with these types of transactions we will likely see more of them structured in years to come.