An Analysis of Contingent Convertibles, Their Relation to the Reinsurance Market, and Their Potential for Future Recession Avoidance

Abstract

Typically, a reinsurance company will have a recapitalization plan where they can buy stock at a discounted rate to improve capital structure after a major event occurs. Additionally, both insurance and reinsurance companies also invest heavily in catastrophe bonds which suffer a principal write-down when a natural disaster causes excessive damage in a specified area, thus relieving these companies of their obligation to pay out the debt and affording them the ability to recapitalize and pay out insurance claims. Contingent convertibles play a similar role for banks, as the securities are issued as debt, but convert to equity or suffer a principal write-down to improve capital structure in times of distress. This paper will explore the relation between these and other contingent liabilities, and evaluate the effectiveness of these new securities, in relation to historical events in both the banks sector and reinsurance markets.