Australian insurers will issue more contingent capital securities due to the country’s regulatory approach, a new report by Moody’s says.

The Australian Prudential Regulation Authority (APRA) will allow such securities to be treated as regulatory efficient capital – additional Tier 1 or Tier 2 capital, with certain restrictions such as loss-absorbing after policyholder claims.

Moody’s says while these securities have high fixed costs, they can be used to increase an insurer’s capital buffer.

“For most insurance groups, based on the regulatory frameworks to date, these capital instruments would be a relatively expensive form of debt with no regulatory capital benefit,” the report says.

“One exception to this trend has been the global reinsurer Swiss Re, which has in the past issued contingent capital securities, seeing them as a useful tool to manage its total balance sheet risk profile, notwithstanding the limited regulatory capital benefit at that time.”

Moody’s Investors Service UK MD Simon Harris says evolving regulations in Australia, Asia and Europe will encourage insurers to use these securities more.

“Many insurers globally are examining contingent capital securities issuance, given low interest rates and evolving regulatory capital requirements,” he said.

“These securities have been largely the preserve of global banks, but that could soon change.”

Mr Harris says the credit implications of contingent capital securities issues will vary by insurer and depend on factors such as size, debt profile and regulatory capital position.

“While the debt leverage and relatively high financing costs – relative to senior debt – related to contingent capital securities issues is credit-negative, they also add to loss-absorbing regulatory capital, a credit-positive,” he said.

Moody’s is seeking comments on how it will rate insurance contingent capital securities that include an equity conversion or principal writedown trigger.

In a comment paper, the ratings agency proposes examining the difference between the insurer’s current local solvency ratio and the trigger; the probability of the insurer’s solvency ratio reaching a level associated with it failing; and the loss severity if either or both of these events occur.