The California Earthquake Authority (CEA) are to return to the catastrophe bond market for the third time in a year to sponsor another transaction through the Embarcadero Re Ltd. transformer vehicle. As we wrote back in May, the CEA governing board approved the issuance of further catastrophe bonds through a transformer reinsurance vehicle. At that time approval was given to issue as much as $300m of cat bonds during the remainder of 2012 and this will be the first issuance from that mandate.
In August 2011 Embarcadero Re Ltd. (Series 2011-1) was issued securing the first $150m of cat bond cover for the CEA through this transformer. They followed that up with another $150m transaction in January 2012 with Embarcadero Re Ltd. (Series 2012-1). The CEA has said of those transactions that they allowed them to secure reinsurance cover at a more competitive cost than the traditional reinsurance markets while allowing them to diversify their sources of cover. With this latest transaction they are confirming their commitment to the ILS market once again.
This new issuance, Embarcadero Re Ltd. (Series 2012-2), will see the Bermuda domiciled special purpose insurer offer investors a single tranche of Class A notes which are designed to provide the CEA with a source of multi-year risk transfer via a reinsurance agreement giving protection on an annual aggregate basis for a three-year risk period against property losses from earthquakes in the covered area. The funds from the sale of the notes are used to collateralize a reinsurance agreement between Embarcadero Re and the CEA. As with the other Embarcadero Re deals the trigger will be an indemnity trigger and any losses are based on the CEA’s ultimate net loss.
We understand from a number of sources that the CEA is hoping to raise $150m of cover from this transaction but there may be a chance for them to increase that as demand is likely to be high for this transaction. It will offer ILS and cat bond investors an opportunity to acquire new dealflow at a time when the market can be slower due to the U.S. hurricane season. The transaction is also likely to be popular as a diversifying peril.
The cover afforded by this 2012-2 issuance by Embarcadero Re will be for residential properties that are insured by the CEA and includes some renters, no commercial properties are covered by this deal. The transaction has an attachment point for the first loss occurrence period of $6.233 billion and an exhaustion point of $6.533 billion. The high attachment point makes this deal less risky than the other two Embarcadero Re deals, the Series 2011-1 deal attached at $3.287 billion of losses and the Series 2012-1 deal attached at $2.91 billion. So this latest cat bond from the CEA will provide a layer of reinsurance protection much higher up their overall program of protection.
Looking at historical events, the 1906 San Francisco earthquake would have caused a 100% loss of principal and the 1994 Northridge earthquake would have caused a 27.2% loss of principal.
The transaction is subject to an annual reset where attachment probabilities will be reset where it will be kept constant unless there are some qualifying losses which cause a dropdown event and eroded retention level on the transaction. This deal has an attachment probability in the first year of 0.77%.
Collateral from the sale of the notes will be invested in U.S. Treasury money market funds.
Ratings agency Standard & Poor’s have given the single tranche of Embarcadero Re Ltd. Series 2012-2 notes a preliminary rating of ‘BB+’.
We’re told by contacts that this transaction is marketing with an expected coupon range of 4.5% to 5.25% above Treasuries, a coupon rate which reflects the lower risk nature of this transaction compared to the other Embarcadero Re deals.
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