FAQ on Hybrid Capital
THIS LETTER AND THE ACCOMPANYING FREQUENTLY ASKED QUESTIONS ARE FOR INFORMATION PURPOSES
ONLY AND SHOULD NOT BE CONSTRUED AS AN OFFER, PERSONAL RECOMMENDATION OR SOLICITATION TO
CONCLUDE A TRANSACTION AND SHOULD NOT BE TREATED AS GIVING INVESTMENT ADVICE. THE TERMS OF ANY
INVESTMENT WILL BE EXCLUSIVELY SUBJECT TO THE DETAILED PROVISIONS, INCLUDING RISK CONSIDERATIONS,
CONTAINED IN THE PROSPECTUS OR OTHER ISSUER DOCUMENTATION FOR THE ISSUE OF CAPITAL SECURITIES.
FROM THE CHAIRMAN
Dear Member
I am writing to you to inform you that the Club has approved the issue of around $100 million of callable perpetual subordinated
debt ("hybrid capital") to be listed on the London Stock Exchange. Just as hybrid capital has been issued by many insurance
companies to bolster their solvency position without diluting shareholders' interests, the Club's hybrid capital will augment the
Club's solvency position without diluting Members' interests.
The Club currently meets its objective of having at all times sufficient capital to meet its solvency requirements as agreed between
the Club and the Financial Services Authority under the Individual Capital Assessment regime. However, although that Individual
Capital Assessment regime is meant to anticipate the solvency requirements of the Solvency II directive, there is a risk that
regulators and politicians will increase solvency requirements faster than the Club can build its free reserves between now
and the anticipated implementation of the Solvency II directive in 2012. It is with this in mind that the Board decided to
approve the issue of hybrid capital.
Hybrid capital is capital that is structured as debt, but has equity-like features. It is also subordinated to all other creditors, but on
winding-up of the Club ranks ahead of the Members' entitlement to the surplus remaining after all Members' claims have been paid.
As a result, the cost of hybrid capital is closer to the cost of equity than the cost of debt. The Club's proposed hybrid capital issue
has a fixed coupon of 9% per annum during the first 5 years. After the 5th anniversary of the issue the rate becomes a floating
rate with a pre-determined spread and at the 10th anniversary a step-up of 1% will be added to this pre determined spread. The
predetermined spread will be the difference between the fixed rate coupon and the five year mid-swap rate at the time of issuance.
As mentioned above, the issue has equity-like features which are designed to absorb losses. The issue has no maturity date and
cannot be called by the investors. The Club has the right to repay the issue from the 5th anniversary of the issue. The step-up of
1% at the 10th anniversary is meant to provide an economic incentive for the Club to call the issue at or after that date but the
Club is not obliged to call the issue at any time.
The Club can also defer interest payments in certain circumstances, but there are certain safeguards to protect investors.
For example, the Club will then not be allowed to declare a mutual dividend.
The net cost of issuing hybrid capital (excluding transaction costs) is the difference of the interest payable on the hybrid capital
securities and the investment income received in respect of the proceeds of the issue. Assuming that during the first 5 years of the
issue the proceeds would be invested in 5 year US government bonds, the net annual cost to the Club would be approximately
$4.5 million. The net cost to the Club will be funded from the Contingency Account and will not therefore affect the calculation of
Members' acceptable loss ratios.
The Club has already secured commitments from a small number of Members approached as part of a pre-marketing process. The
Board recognised that many Members with a good understanding of the Club and its particular credit characteristics might wish to
consider the Club's hybrid capital as an investment opportunity and therefore decided that Members who are legally permitted to do
so would be given the opportunity to invest. Not all Members will be eligible by virtue of their country of residence, and having
taken legal advice on the relevant securities laws and regulations, the Board has decided only to offer participation in the issue to
Members in certain jurisdictions. Those Members will receive a separate notification from UBS enclosing the formal prospectus
detailing the terms of the offer.
This is the first issue of hybrid capital by a mutual P&I club, but this form of capital is common in the wider insurance industry. The
Board is strongly of the view that it provides a cost-efficient way of increasing the Club's regulatory solvency capital over and
above the free reserves. The Club will continue to maintain its traditional reserves at a level consistent with the operational
requirements of the Club as a mutual P&I insurer. The hybrid capital will form an additional safeguard against any future
requirement to increase solvency capital.
I attach to this letter a list of frequently asked questions, but please feel free to contact me or your usual contact at the Managers if
you have any unanswered queries.
Yours sincerely
T Biggi
Chairman
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