Catastrophe equity put (CatEPut)
An option giving an insurer the right to sell its own shares at a preset price to an investor if a catastrophe erodes its capital, guaranteeing recapitalization when the market would refuse it.
After a major catastrophe, an insurer whose capital has melted away must recapitalize, just when its share price has fallen and investors doubt it. The catastrophe equity put solves this problem in advance: for a premium, the insurer buys from a reinsurer or investor the right to sell it shares, often preferred shares, at an agreed price, if its catastrophe losses exceed a threshold and its capital remains above a floor. The second condition protects the investor against a company already doomed. Unlike reinsurance, the instrument does not transfer the loss: it guarantees access to capital, which dilutes existing shareholders but preserves solvency and underwriting capacity. It is one form of contingent capital, which banks later adopted in the form of contingent convertible bonds.
In 1996, US insurer RLI Corp bought from reinsurer Center Re, through broker Aon, a 50 million dollar CatEPut option allowing it to issue preferred shares after a major California earthquake.
CatEPut, catastrophe equity put, cat equity put option
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