Contingent capital

After a major catastrophe, an insurer needs to rebuild its own funds at exactly the moment when raising capital costs most: its share price has fallen, investors are wary, competitors are also trying to raise. Contingent capital solves this problem by buying the right to raise in advance. The insurer pays a fee to investors, who commit to subscribe, if a defined event occurs, shares, hybrid securities or debt at a price set in advance. The first forms, in the 1990s, were share put options triggered by a catastrophe, the catastrophe equity puts. The trigger may be the insurer's loss, an industry loss index or a fall in its own funds below a threshold. Unlike reinsurance, contingent capital does not transfer risk: the insurer still bears the loss, it only obtains the funding to absorb it, and dilutes its shareholders. It is therefore insurance of liquidity and solvency more than insurance of the loss. Its limits are well known: counterparty risk, since the investor must be able to pay at the worst moment, and prudential treatment, regulators not always giving promised capital the value of paid-in capital.