California Earthquake Authority likely to be beneficiary to new catastrophe bond

by Artemis on July 7, 2011

The California Earthquake Authority (CEA), the publicly managed organisation that provides residential earthquake insurance to Californian residents, held its latest governing board meeting on the 30th June. At the meeting, one of the agenda items was to continue discussions and seek approval to move forwards with plans to transfer a portion of their risks to the capital markets through a reinsurance transformer deal likely to involve a catastrophe bond.

The CEA confirmed to us that the agenda item (which we covered previously here) has been unanimously approved and they will now move ahead with plans to progress the transaction working with a Bermuda based reinsurance partner. They stress that the CEA is not issuing a catastrophe bond, rather they are entering into a transformer reinsurance contract with a Bermuda reinsurer and they have been told that the risk capital for it will be financed by the reinsurers issuance of a cat bond. That’s a common approach, often the issuing re/insurer of a cat bond is not the final beneficiary of the transaction.

The CEA are seeking $150m of additional reinsurance cover through the transaction, although we would point out that given the market conditions if the deal does indeed result in the issuance of a catastrophe bond they could secure more cover than that considering the significant demand from investors for diversification opportunities at the moment. Whatever the deal size ends up being, a pure California earthquake catastrophe bond issued on behalf of the CEA is sure to be well received.

The CEA told us that the reinsurer will place the limit of the reinsurance contract, $150m, in a securitized collateral account from which the CEA could draw funds in the event that they need to fund claims payments after an event. They also stated that the reinsurance cover will not attach until and unless that collateral account is funded. The reinsurer has told the CEA that it expects that the reinsurance contract can be fully funded by the 1st August. That suggest the deal structure is ready to go and all that is required is to market the cat bond notes to potential investors.

The CEA point out that the terms of the structure are not final and are still under negotiation meaning that they cannot disclose anything further at this time. They have kindly provided a diagram of the structure and flow of the transaction, below, which is typical of a cat bond transaction. We’ll update you as and when this deal comes to market.

Proposed structure of catastrophe bond

Proposed structure of catastrophe bond

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