French reinsurance giant SCOR has established its fourth contingent capital facility, securing an EUR 300 million source of responsive capital coverage for natural catastrophe and extreme mortality events.
SCOR has been a regular issuer of contingent capital since 2010, when the reinsurance firm first added a line of contingent equity capital to its tower of protection with a EUR 150m natural catastrophe coverage facility spanning three years.
That first facility paid out for the reinsurance firm, as catastrophes in Q1 2011 triggered the contingent capital and enabled SCOR to drawdown on EUR 75 million of the facility, which it subsequently topped back up in 2012.
Then SCOR returned in 2013 with a larger EUR 200 million contingent capital facility that the reinsurance company extended to cover both both natural catastrophe and extreme life (mortality) events for the first time.
This was followed in 2016 with another renewal of the contingent capital facility, with SCOR also growing it to EUR 300 million of protection, across both nat cat and mortality risks.
Now, SCOR has renewed the contingent capital facility again, recognising the effectiveness of the protection it offers and the efficiency of this form of capital as a supporting piece of its retrocessional reinsurance needs.
Commenting on the news, Denis Kessler, Chairman & Chief Executive Officer of SCOR, said, “Our new strategic plan “Quantum Leap” sets out ambitious profitability and solvency targets given the current financial and economic environment. This new contingent capital facility is an essential part of the active capital management policy that is at the heart of our strategy. This facility protects SCOR’s solvency, at a very low cost for our shareholders, against events such as a global pandemic or a natural catastrophe of historic proportions.”
Again, this facility is a contingent equity line arranged with a major banking group, J.P. Morgan in this case, still providing EUR 300 million of risk coverage in case of extreme natural catastrophe or life related events that impact mortality.
SCOR said the latest contingent capital arrangement is “consistent with the previous facilities” and will come into force on January 1st 2020, after the existing facilities term ends, then run for three years.
SCOR said the facility presents a “very cost-effective alternative to traditional retro and ILS,” which this year may have been even more important as the reinsurance firm has taken longer to secure its retrocession program than normal as rates rose significantly for its aggregate layers.
The contingent capital facility can be triggered by significant natural catastrophe or extreme mortality events, calibrated to pay out at levels that will protect SCOR’s own solvency level.
The probability of the facility being triggered is very low, at similar levels to previous facilities and SCOR said that this reduces the probability-weighted costs of the coverage for it.
If the facility gets triggered during its three-year term, a drawdown could result in an aggregate increase in SCOR’s share capital of up to EUR 300 million (including issuance premium).
A triggering of the facility can only occur when SCOR’s total annual aggregated losses or claims from natural catastrophes or extreme events affecting mortality claims above a pre-defined threshold between January 1st 2020, and December 31st 2022.
This immediate liquidity in SCOR’s equity would occur through the issuance of a corresponding amount of shares up to EUR 300 million in value, that would then be sold via a firm subscription commitment with J.P. Morgan and ultimately add to SCOR’s solvency capital.
SCOR notes that the facility is recognised in its internal model and has received favorable qualitative and quantitative assessments from rating agencies and that it is highly likely it reaches its term without being triggered, so not becoming dilutive to the reinsurance firm’s shareholders, given its remoteness.
While a contingent equity line such as this can be considered dilutive, it is there to ensure capital solvency after major loss events occur. Without this, the effect on SCOR’s share price from the catastrophe or mortality loss could actually be much worse for its investors than any dilutive effects.
A slight dilution to equity capital is far preferable to a major financial loss from a large catastrophe or mortality event. Having this facility in place would position SCOR mor favourably for trading out of major global loss events and the liquidity can likely be secured more rapidly than some other forms of retro protection after it triggers.
Securing a responsive source of capital that is calibrated to pay out after major losses occur is valuable for SCOR, even more so given this does not come from the retro reinsurance or insurance-linked securities (ILS) markets and so is diversifying for its capital and protection towers.
The coverage that this contingent capital facility provides SCOR is very similar to a catastrophe bond, or a multi-year aggregate excess of loss reinsurance transaction. But the structure helps to diversify the reinsurers’ sources of risk capital and is targeted specifically to protect solvency ratios, by boosting equity capital in times of need.
Contingent capital and also contingent convertible transactions have been used by other re/insurers in the past for catastrophe reinsurance coverage, but they still remain a much rarer capital markets risk transfer structure to-date.
SCOR provided a full explanation of the structure which we have included below:
Characteristics of the contingent equity line
The transaction will give rise to the issuance of approximately 9.4 million warrants issued by SCOR to J.P. Morgan. Each warrant gives J.P. Morgan the right to subscribe to two new SCOR shares without exceeding 10% of SCOR’s share capital.
The issuance of the warrants was authorized by the 20th resolution of the Extraordinary General Meeting of SCOR shareholders on April 26, 2019, and was approved by a resolution of its Board of Directors on October 23, 2019.
Under the transaction agreement, SCOR has undertaken to drawdown the facility upon the occurrence of a triggering event resulting from natural or non-natural catastrophes as described below, and J.P. Morgan has undertaken to exercise accordingly the number of warrants necessary for the subscription of EUR 300 million¹ (issuance premium included) of new shares in two separate tranches of EUR 150 million each.
The drawdowns of the facility will only be available when:
- the amount of the estimated ultimate net loss² incurred by the SCOR group as an insurer or reinsurer (as reviewed by SCOR’s statutory auditors) reaches pre-defined thresholds in a given calendar year from January 1, 2020, to December 31, 2022, as a direct result of the occurrence within that year of one or more natural catastrophe-type events, including but not limited to:
- earthquake, seaquake, earthquake shock, seismic and/or volcanic disturbance/eruption,
- hurricane, rainstorm, storm, tempest, tornado, cyclone, typhoon,
- tidal wave, tsunami, flood,
- hail, winter weather/freeze, ice storm, weight of snow, avalanche,
- meteor/asteroid impact,
- landslip, landslide, mudslide, bush fire, forest fire and lightning.Or, when
- the amount of ultimate net claims³ of the SCOR group’s life reinsurance segment over two (2) consecutive semesters over the period from July 1, 2019, to December 31, 2022, (as reviewed by SCOR’s statutory auditors) reaches pre-defined thresholds as the consequence, in particular, of one or more of the following life business related events:
- deviation of epidemic, pandemic or a similar incidence or wide spread of one or more medical conditions deriving from any disease(s),
- acts of war, acts of terrorism,
- accidents due to non-natural cause(s),
- material deviation from forecast biometric trends (mortality, morbidity, disability or longevity) recorded by the life segment for any reason whatsoever.
In addition, subject to no drawdown having already been conducted under the facility, if the daily volume-weighted average price of the SCOR shares on Euronext Paris falls below EUR 10 (i.e. a price level close to the par value of the SCOR shares), an individual tranche of EUR 150 million (issuance premium included) will be drawn down in order to ensure the availability of this financial cover (the warrants being non-exercisable below par value) if a natural or non-natural catastrophe-type event occurs during the remainder of the Risk Coverage Period.
The warrants will remain exercisable until three months after the expiry of the Risk Coverage Period.
In accordance with the authorization granted by the General Meeting of SCOR shareholders on April 26, 2019, the maximum number of new shares issued in the event of exercise of the warrants may not exceed 10% of SCOR’s share capital.
All subscriptions for new shares by J.P. Morgan will be made at a price equal to the volume-weighted average price of the SCOR shares on Euronext Paris over the three trading days preceding the exercise of the warrants, with a discount of 5%.
J.P. Morgan is committed to subscribing to the new shares but does not intend to become a long-term shareholder of SCOR and will resell the shares by way of private placements and/or sales on the open market. In this respect SCOR and J.P. Morgan have entered into a profit sharing arrangement whereby 75% of the gain, if any, will be retroceded to SCOR. If the resale of the new shares occurs immediately upon exercise of the warrants through an off-market transaction, the profit share ratio owed to SCOR will be paid in the form of SCOR shares in order to limit the dilutive impact of the transaction for SCOR’s shareholders.
From the notification of the occurrence of a triggering event by SCOR to J.P. Morgan until the exercise of the warrants, J.P. Morgan will be prohibited from engaging in hedging transactions on SCOR shares, other than ordinary course of business transactions undertaken independently by J.P. Morgan ‘s affiliated banking and brokerage businesses.
By way of illustration:
a/ Under current market conditions (i.e. an issuance price of EUR 36.4 based on a 5% discount on a three-trading day volume-weighted average price of EUR 38.34 per share), drawdown of the total cover (EUR 300 million) would account for a maximum of 4.4 % of SCOR’s share capital5.
b/ In the highly adverse event that a single tranche of EUR 150 million is drawn down due to the fall of SCOR’s share price, based on a 3-trading day volume-weighted average price of EUR 10 per share (i.e. an issuance price of EUR 9.5 per share after the 5% discount) the transaction would account for 8.4 % of SCOR’s share capital6.
Given these theoretical dilution levels, and because the number of new shares issued upon exercise of the warrants cannot exceed 10% of SCOR’s share capital, no prospectus for the AMF will be prepared in connection with the setting up of this contingent equity line. Should the contingent capital be triggered and issued, SCOR will make the appropriate disclosures to the market in compliance with applicable market regulations as at the time of issuance of the new shares, regarding the circumstances of such issuance, the amount of the drawdown, the issuance price, the number of shares issued and the consequences of such issuance for its shareholders.
The transaction will have no impact on SCOR’s 2019 accounts except for the immaterial subscription amount received by SCOR from J.P. Morgan for the warrant issuance (EUR 0.001 per warrant).
Limited potential dilutive impact of the transaction for SCOR shareholders
This financial coverage is an event-driven contingent capital equity line, which may only be triggered by the occurrence of the aforementioned triggering events. Its potential dilutive impact therefore depends on the probability of occurrence of such triggering events, as well as on the share price at the time of trigger.
SCOR’s management believes that such a contingent capital solution provides a significant net economic benefit for its shareholders, as it favorably compares to traditional retrocession and ILS and it optimizes SCOR’s risk protection costs with a limited potential dilutive impact. SCOR estimates that the annual probability of any of the triggers occurring over the program is less than 2%, which in practice puts the probable average dilution at approximately 0.1%7.
The following chart summarizes the potential dilutive impact of the transaction under various scenarios for a shareholder holding 1% of SCOR’s share capital prior to the share issuance (calculated on the basis of the number of shares that make up the share capital as at October 31, 2019).
(1) Based on the dilution of share capital as at October 31, 2019.
(2) Based on the dilution of share capital as at October 31 2019 which would result from the exercise of all the outstanding stock options, whether exercisable or not (including all out-of-the-money options as at the date of this press release) and final acquisition of all the outstanding shares granted free of charge.
This table should be read as follows: a shareholder currently holding 1% of SCOR’s share capital (on a non-diluted basis) would hold, on the occurrence of a triggering event, 0.958% of the capital following exercise of the warrants on the basis of an issuance price of EUR 36.4 per share (including discount).
1 Without exceeding 10% of SCOR’s share capital
2 The estimated ultimate net loss is the aggregate of the individual estimated ultimate net losses of all natural catastrophe events in a given calendar year. The individual estimated ultimate net loss is the estimated pre-tax impact of any qualifying natural catastrophe event, net of all recoveries (reinsurance and derivatives) and additional expenses as recorded in the SCOR group books.
3 The ultimate net claims amount is the aggregate of all claims relating to non-natural catastrophe events affecting the SCOR group’s life segment over a two (2) semester time period (i.e. amount of gross benefits and claims – amount of ceded benefits and claims over the time period considered).
4 From November 29, 2019, to December 3, 2019.
5 On the basis of SCOR’s share capital made up of 187,000,516 shares as at October 31, 2019, as publicly disclosed on November 7, 2019.
6 Idem note 5.
7 On the basis of an issuance price of EUR 36.4 per share.