Reinsurer Swiss Re’s contingent capital bond issuance came to market last month and succeeded in securing the Swiss based reinsurer a $750m source of capital protection linked to its solvency from investors. The transaction received a lot of attention in the press as it came to market and was reported to have been oversubscribed as investors sought another way to acquire yield in these difficult financial markets.
A contingent capital bond allows the issuer to attract investors to provide it with a source of capital which is ‘contingent’ on some pre-defined criteria being met. In the case of this transaction Swiss Re would benefit from the capital if the notes it sold were triggered by a drop in the reinsurers solvency ratio.
In this way contingent capital is similar to a catastrophe bond, it provides capital when a triggering event occurs. Except of course a contingent capital bond is not insurance or reinsurance and so is accounted for differently. It provides another tool which insurers and reinsurers can use to secure themselves an additional source of capital, of course depending on the acceptance of investors in the capital markets.
In Swiss Re’s case investors were very accepting and snapped up $750m of contingent notes in this deal. Ratings agency Fitch has now rated the notes, which it is calling contingent write-off notes as the notes are written off and payout in full on a trigger event occurring, and has given them a rating of ‘BBB+’.
The rating announcement gives us a little more detail on the contingent bond issuance which was not available before. The notes are first callable in 2019, up to which point they pay investors a fixed annual coupon of 6.375%. The interest rate would then reset to the five-year mid-swap rate plus 5.21%. According to Fitch the notes are subordinated to senior creditors and there is an optional interest deferral facility depending on certain conditions with any deferred interest being cumulative.
Fitch said it has rated the contingent notes three notches below Swiss Re’s ‘A+’ Issuer Default Rating, in accordance with its insurance rating methodology.
Fitch explained; “For Swiss Re’s contingent write-off notes, Fitch has notched once for recovery expectations (Below Average) and then deducted a further two notches for going concern loss absorption features, which are deemed to be more aggressive, due to the presence of the write-off feature. Loss absorption is considered to be more punitive than recovery, given that principal write-off could occur at a point when Swiss Re continues to be viewed as a going concern.”
Interestingly Fitch gives us some more details on the trigger than we had previously. Full principal write-off would be triggered if Swiss Re’s solvency, as measured by the Swiss Solvency Test (SST), falls below 125%. At fiscal year 2012 Swiss Re’s SST stood at 207%, at fiscal year 2011 it was slightly higher at 210%.
Fitch said that the $750m of rated contingent write-off notes have been deemed to have a low trigger given the SST level for Swiss Re currently being high.
It’s an interesting transaction which would help Swiss Re should it face a major financial hit from anything which affected its solvency level. This could include catastrophe events, reinsurance losses, pandemics and even the fall-out of Eurozone financial issues or other global economic impacts. Literally any event that could cause Swiss Re’s solvency level to drop dramatically is in effect covered to some degree by the capital buffer this contingent capital transaction provides. Whether a $750m capital buffer would actually be sufficient to protect the firm should Swiss Re’s solvency drop quite so far as to trigger it is another issue entirely.
Read our other recent articles on this transaction and contingent capital in general: