Reinsurer Swiss Re is in the news today regarding the use of contingent capital, after a bank told reporters at Dow Jones that the reinsurer plans to arrange a series of meetings to roadshow a contingent convertible bond issuance. The bank source is said to be one of the institutions arranging the investor meetings, or roadshow, according to a Dow Jones report.
Contingent capital is an alternative form of capital or financing which can be triggered and made available under certain, specific pre-defined circumstances. Contingent capital bonds, or contingent convertible bonds, often known as CoCo’s, are a form of debt that converts into equity if the issuer drops below certain levels of capital. They are considered risky bond investments but are attractive to certain institutional investors due to the returns that can be made.
Contingent sources of capital have become a flexible way for companies to arrange a source of financing which is made available at precisely the time it is required. In the case of re/insurers contingent capital can come in particularly handy after major disasters and resulting losses hit their balance sheets.
Use of contingent capital has been expected to increase in the reinsurance sector as they provide a very good way to help ensure maintenance of certain capital and funding levels, something that Solvency II will increase the focus on. Swiss Re themselves discussed possibly using contingent capital almost a year ago, as we covered at the time here.
A number of insurers and reinsurers have contingent capital facilities set up to protect them. French reinsurer SCOR has a contingent source of capital which can be triggered by its loss experience from natural catastrophes, it acts as an event-driven guaranteed equity line and the reinsurer has already seen it triggered once in 2011 and extended the facility in 2012.
Insurer Allianz also set up a contingent capital facility which will pay out to them should its solvency ratio drop below a trigger point. This provides broad cover for issues which could impact their solvency, including natural catastrophes, a major mortality event or even the sovereign financial crisis in Europe.
The use of contingent capital certainly looks set to grow in the insurance and reinsurance sector and we know of a number of ongoing projects where market participants have been investigating how to embed various triggers linked to losses on specific re/insurance lines of business within a contingent facility or bond issuance. It makes perfect sense as another source of risk transfer for the re/insurance sector.
In fact catastrophe bonds provide a source of contingent capital, the payout is contingent on pre-defined parameters or loss experience, so contingent capital or convertible bonds are not all that different. Property Claims Services recently discussed the potential to use its industry loss reporting as a trigger within contingent capital deals, which is another viable way to more closely link the trigger to the reinsurance markets loss experience.
The Dow Jones report names a number of banks who will be involved in marketing or bookrunning the Swiss Re contingent capital bond issuance. Those named are Bank of America Merrill Lynch, BNP Paribas, Credit Suisse, HSBC and the Royal Bank of Scotland.
It will be interesting to see whether the issuance of a contingent capital bond or facility by Swiss Re does happen, as at this time we cannot confirm these rumours ourselves. It will also be interesting to see whether Swiss Re embeds some sort of loss experience trigger within the deal or whether it is purely based on the reinsurers capital level or solvency.
We will update you if/when we hear anymore on the rumoured deal.