Catastrophe Retro is Getting “Very Expensive”: JPMorgan

A 75 million euro contingent capital deal inked by SCOR SE last month — and the subsequent market reaction — means that catastrophe cover is getting extremely pricey at the top end which will eventually translate into better profits for Swiss Re and Munich Re, according to a report from JPMorgan Chase analysts.

“Given the share price reaction in terms of relative performance since the SCOR’s new contingent capital tranche was announced, [we] believe this implies that traditional retro, which is reinsurance for reinsurers, is VERY EXPENSIVE,” said a May 25th note from JPMorgan London analysts Michael Hunter and Akhil Mittal.

French-insurer SCOR announced on May 16th that it would replace an already exercised contingent capital facility with a new program with UBS.

Contingent capital deals allow an issuer to convert debt into equity when a triggering event occurs.

Under terms of the deal, the facility would be triggered on a pre-determined level of natural catastrophe losses from several perils including earthquakes, hurricanes and tsunamis. SCOR said the probability of the facility being triggered in its two year lifetime as 1.4%.

SCOR touted the deal in a statement, explaining that was a bargain when compared to prices for traditional retro or issuing insurance linked securities (ILS) like catastrophe bonds.

“SCOR management believes that there is a significant net economic benefit of such contingent capital solution for its shareholders, as it favorably compares with traditional retrocession or ILS and optimizes SCOR’s risk protection costs with limited potential dilutive impact,” the company said in a statement last month.

But JPMorgan points out that because of a subsequent share decline of SCOR, the contingent capital deal may turn out to be more expensive than previously estimated and may prove more contingent capital deals difficult for carriers to exploit.

The analysts explain SCOR shares have declined 2.7% (2.8% as of today) since the contingent capital announcement, underperforming the Stoxx Europe 600 Insurance Price Index which is down 1.1%. “SCOR’s underperformance us equivalent to -1.6% of 3.5 billion euro market cap, or 58 million euros, which is 77% of the 75 million contingent capital which it announced on May 16.,” the note says, explaining the benefit from the deal has all be but wiped out by the share decline.

While SCOR’s contingent capital cost woes may be bad news for some carriers and reinsurers, its’ good news for global providers Swiss Re and Munich Re that will be lifted by increased prices for retro and reinsurance cover.

“We reiterate our recommendations of [Munich Re] and [Swiss Re], the leading reinsurers in the world, because they are the leading suppliers of of reinsurance and we believe reinsurance cover, like retro cover, is relatively expensive: this supports out view that shareholders can look forward to attract levels of net profit,” the analysts said.

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