CEA’s third, and largest, Embarcadero Re catastrophe bond in twelve months completes

The California Earthquake Authority (CEA) have successfully completed their third catastrophe bond issuance in the last twelve months through the Embarcadero Re Ltd. transformer vehicle, bringing the total cat bond coverage the CEA benefits from to $600m. The latest issuance,  Embarcadero Re Ltd. (Series 2012-2), completed successfully and was rated yesterday, securing the CEA $300m of coverage for property losses from earthquakes in California on an annual aggregate basis.

This latest transformer issuance through Embarcadero Re saw the Bermuda domiciled transformer offer investors a single tranche of Class A notes which provide the CEA with a source of multi-year risk transfer via a reinsurance agreement, giving protection on an annual aggregate basis over a three-year risk period against property losses from earthquakes in the covered area. The funds from the sale of the notes to investors are used to collateralize a reinsurance agreement between Embarcadero Re and the CEA. As with the other Embarcadero Re deals the trigger for this latest cat bond deal is an indemnity trigger based on the CEA’s UNL.

The transaction doubled in size while it was marketing, starting at $150m and completing at $300m, and the CEA have taken advantage of market conditions to double the amount of protection they receive from the cat bond market to $600m. The cat bond market now contributes approximately 20% of the CEA’s overall reinsurance and risk transfer programme, which is evidence of the value and price-competitiveness that the CEA have found in the cat bond market.

We asked the CEA how important this latest transaction is to them. “The CEA is on target with plans to significantly diversify our claim-paying capacity,” said CEA’s CEO, Glenn Pomeroy. “The just-completed $300 million transformer- reinsurance transaction—our third such transaction in just 12 months—gives the CEA total limits of $600 million in transformer-reinsurance coverage with Embarcadero Re.” The CEA declined to comment on any future plans to revisit the cat bond market, saying that they are not currently in a position to discuss plans for additional risk-transfer.

The CEA board earlier this year gave their approval to issue as much as $300m of cat bonds during the remainder of 2012 to their financial and actuarial teams. It had been thought that this mandate would be utilised in two issuances of $150m, as they had in their earlier Embarcadero Re transactions, so we can assume that the opportunity was too attractive to place all of that limit in one tranche due to market conditions. We know from our investment community contacts that demand was high for this latest deal amongst investors so we can safely assume that the CEA took advantage of this demand to double the deals size while marketing.

This deal has a much higher attachment point than their earlier cat bond transformer deals, attaching at $6.233 billion, making it a less risky proposition for investors. Despite this, and despite the demand, the deal priced with a 5% coupon which is towards the upper end of the marketed range of 4.5% to 5.25%. As recent cat bonds have been generally been pricing at the bottom end of expectations, or even below, we can only assume that investors were demanding a premium due to the amount of California quake risk now sitting in the cat bond market.

Standard & Poor’s gave the transaction its final rating yesterday, assigning its ‘BB+’ rating to the Series 2012-II Class A notes to be issued by Embarcadero Re Ltd. S&P said “The rating is based on the lower of the rating on the catastrophe risk (BB+) and the rating on the assets in the collateral account (AAAm). Because the California Earthquake Authority (CEA) will deposit at closing 110% of the first quarterly premium into a premium deposit account, we didn’t include CEA in our credit analysis. We do not maintain an interactive rating on the CEA.”

The Bermuda Stock Exchange announced that they had admitted the single tranche of $300m of Class A notes for listing on the exchange as Section V Insurance Related Securities. This latest listing takes the BSX very close to the $5 billion mark for listed ILS and cat bonds, with now $4.988 billion listed. You can see more details on the ILS listed on the BSX in our recent article here.

It will be interesting to watch the CEA’s next moves in their risk transfer program to see whether they continue to tap into the appetite for cat bonds as the market grows or whether they feel 20% is about the right mix of the program to be attributed to the transformer. of course the CEA also utilises collateralized reinsurers for some of their coverage meaning that capital market investors actually contribute more than 20% of their risk transfer program. Could this be a sign of where the reinsurance market is going and the amount of influence the capital markets and investor backed coverage will have in the future?

Full details of Embarcadero Re Ltd. (Series 2012-2). You can view details of the CEA’s other catastrophe bonds in our Deal Directory.