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Insurance back in focus

6 October 2017 by Gary Kirk

After considerable debate and anticipation the first major Restricted Tier 1 (RT1) deal was announced in the insurance sector yesterday. ASR Group, the large Dutch insurer, stole a march on the rest of the sector by announcing the first euro denominated deal; €300m perpetual contingent convertible with no step-up in coupon at the first call after 10yrs. RSA did a small illiquid two-tranche SEK and DKR deal some months ago but this transaction by ASR is the inaugural transaction for the major market.

This structure is expected to be fully compliant with the Solvency 2 regime and expected to replace the old style subordinated transactions that are currently in the extended grandfathering period. Similar to the banking AT1 transactions the new RT1 carries greater risk for the investor, given the loss-absorption language and the mandatory interest cancellation, in the event of a minimum capital requirement not being met or if the Regulator notifies the issuer (due to issues of viability). As in many of the AT1 structures, the RT1 bonds will convert to ordinary shares if the conversion trigger is breached; the trigger for insurers is where the bond issuer holds less than 75% of its Solvency Capital Ratio (SCR), if it breaches the SCR for a period of 3-months, or if it breaches its Minimum Capital Ratio (MCR). As such, the coupons on the RT1 are expected to be higher in order to attract investors, together with an element of complexity premium. Initial thoughts are that the RT1 transactions will be set 4 rating notches below the issuer senior rating and 2 notches below the current Tier 2 issues.

Subordinated insurance bonds have seen significantly strong demand over the past couple of years with the sub-sector being one of the stand-out performers in fixed income markets, so timing of this new transaction is spot-on. The hold up for issuers was the uncertainty whether the authorities would allow the RT1 coupons to be paid out of pre-tax profits (like a bond coupon) or post tax profits (as for share dividends); it seems this is gradually being resolved in favour of the issuer and hence we should see a pick-up in issuance.

We think this is a welcome development for investors at a time when yield is very much a scarce commodity, although a high degree of due diligence will be required and selectivity will be essential.

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