Subordinate debt is an agreed unsecured debt between raiser and creditor(s) who has lower priority than other creditors, yet has higher priority over the raiser’s equity capitals.
Subordinate debt fund can be counted as Tier-II capitals in measuring an insurance company’s solvency status. Thus raising subordinate debt fund has become an important means of replenishing capitals by insurance companies. It is governed by CIRC’s Interim Measures on Management of Subordinate Term Debt of Insurance Company.
Subordinate debt has inherent risk. Creditors of insurance company’s subordinate debt can seek protection by virtue of the following methods:
1. Limits on the objects: In the process of raising subordinate debt fund, the percentage of subordinated debt held by shareholder(s) of raiser and the percentage of subordinated debt mutually held by insurance company and insurance capital management company are subject to strict regulation. It’s designed to ensure the truthfulness of subordinated debt fund raising and to avoid structural risk arising from the above situations.
2. Full disclosure: To raise subordinate debt fund, a raiser is required to create prospectus and other documents to make accurate and thorough information disclosure. After the fund has been raised, the raiser is also required to disclose to creditors special financial reports, unfavorable alteration in solvency status or the prospect that the raiser is estimated to have difficulty in repaying principles or interests of the subordinated debt due.
3. Special account for the raised fund management: A raiser is required to use special account to manage subordinated debt funds and to use the funds strictly according to how they should be used prescribed in feasibility study report and fund use management plan. Besides, the funds can not be used to make up for ordinary operation loss of insurance companies.
4. Restriction on shareholder dividend: to ensure solvency of insurance companies, a raiser may repay principles and interests only if the solvency adequacy ratio is no less than 100% after the repayment. Notwithstanding, an issuer may not distribute dividend to shareholders either, as long as it is unable to repay principles and interests.
5. Creditor’s right to consent: In the event that repayment of subordinated debt needs to be delayed, creditors’ consent must be sought.