The Effects of Contingent Convertible (CoCo) Bonds on Insurers' Capital Requirements Under Solvency II

SAFE Working Paper No. 98

37 Pages Posted: 12 Apr 2015

See all articles by Tobias Niedrig

Tobias Niedrig

Goethe University Frankfurt, Chair for Insurance and Regulation; Goethe University Frankfurt, Research Center SAFE

Helmut Gründl

Goethe University Frankfurt - Department of Finance; International Center for Insurance Regulation

Multiple version iconThere are 2 versions of this paper

Date Written: February 2015

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.

Keywords: Contingent Convertible Capital, CoCo Bond, Basel III, Solvency II, Life Insurance, Interconnectedness

JEL Classification: G11, G21, G22, G28, G32

Suggested Citation

Niedrig, Tobias and Gründl, Helmut, The Effects of Contingent Convertible (CoCo) Bonds on Insurers' Capital Requirements Under Solvency II (February 2015). SAFE Working Paper No. 98. Available at SSRN: https://ssrn.com/abstract=2593035 or http://dx.doi.org/10.2139/ssrn.2593035

Tobias Niedrig (Contact Author)

Goethe University Frankfurt, Chair for Insurance and Regulation ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

HOME PAGE: http://www.icir.de

Goethe University Frankfurt, Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Helmut Gründl

Goethe University Frankfurt - Department of Finance ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60323
Germany

HOME PAGE: http://https://www.wiwi.uni-frankfurt.de/en/departments/finance/home.html

International Center for Insurance Regulation ( email )

House of Finance
Campus Westend, Goethe University
Frankfurt am Main, D-60323
Germany

HOME PAGE: http://www.icir.de

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