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The effects of Contingent Convertible (CoCo) bonds on insurers' capital requirements under solvency II

Author

Listed:
  • Niedrig, Tobias
  • Gründl, Helmut

Abstract

The Liikanen Group proposes contingent convertible (CoCo) bonds as a potential mechanism to enhance financial stability in the banking industry. Especially life insurance companies could serve as CoCo bond holders as they are already the largest purchasers of bank bonds in Europe. We develop a stylized model with a direct financial connection between banking and insurance and study the effects of various types of bonds such as non-convertible bonds, write-down bonds and CoCos on banks' and insurers' risk situations. In addition, we compare insurers' capital requirements under the proposed Solvency II standard model as well as under an internal model that ex-ante anticipates additional risks due to possible conversion of the CoCo bond into bank shares. In order to check the robustness of our findings, we consider different CoCo designs (write-down factor, trigger value, holding time of bank shares) and compare the resulting capital requirements with those for holding non-convertible bonds. We identify situations in which insurers benefit from buying CoCo bonds due to lower capital requirements and higher coupon rates. Furthermore, our results highlight how the Solvency II standard model can mislead insurers in their CoCo investment decision due to economically irrational incentives.

Suggested Citation

  • Niedrig, Tobias & Gründl, Helmut, 2015. "The effects of Contingent Convertible (CoCo) bonds on insurers' capital requirements under solvency II," SAFE Working Paper Series 98, Leibniz Institute for Financial Research SAFE.
  • Handle: RePEc:zbw:safewp:98
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    References listed on IDEAS

    as
    1. Martin Eling & Hato Schmeiser & Joan T. Schmit, 2007. "The Solvency II Process: Overview and Critical Analysis," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 10(1), pages 69-85, March.
    2. Damiano Brigo & Jo~ao Garcia & Nicola Pede, 2013. "CoCo Bonds Valuation with Equity- and Credit-Calibrated First Passage Structural Models," Papers 1302.6629, arXiv.org.
    3. Stefan Avdjiev & Anastasia Kartasheva & Bilyana Bogdanova, 2013. "CoCos: a primer," BIS Quarterly Review, Bank for International Settlements, September.
    4. Paul Glasserman & Behzad Nouri, 2012. "Contingent Capital with a Capital-Ratio Trigger," Management Science, INFORMS, vol. 58(10), pages 1816-1833, October.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Contingent Convertible Capital; CoCo Bond; Basel III; Solvency II; Life Insurance; Interconnectedness;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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