CEA’s need for reinsurance (and cat bonds) to grow significantly

The California Earthquake Authority (CEA) projects that it could need as much as a stunning $48 billion of claims paying capacity in a decades time, a considerable increase on the amount it has in force today, suggesting the CEA will increasingly call on the reinsurance and catastrophe bond market for growing support.

The CEA, a not-for-profit residential earthquake insurance provider in the state of California, has been growing its use of reinsurance capacity in recent years, a significant chunk of which has been coming from insurance-linked securities (ILS) funds and investors from the capital markets.

In fact, the CEA’s reinsurance program, including catastrophe bonds or transformer coverage as it calls them, reached a new record size surpassing $8 billion for the first time after the January renewals.

At the time the CEA said that it had an ambition to grow the amount of risk transfer it has, from reinsurance and ILS markets, to as much as $10 billion of protection by 2022, but that figure may be outstripped if the claims paying capacity target of $48 billion in the next decade is achieved.

As of March 1st 2018, the CEA had roughly $15.9 billion of claims paying capacity in force, over $8 billion of which came from reinsurance and ILS markets.

But at a CEA Board meeting, Glenn Pomeroy, Chief Executive Officer of the CEA, said that the insurer is actually projecting a need for a significant increase in claims paying capacity by the end of the next decade.

Pomeroy projects that, based on a modest rate of projected growth, the CEA will need to need to increase its claim-paying capacity from $17 billion to a huge $48 billion of financing and risk transfer.

The CEA utilises numerous forms of capital in its calculation of claims paying capacity, including the insurers available capital, the risk transfer layer of reinsurance and catastrophe bonds, revenue bonding, post-earthquake industry assessments and other assessment layers.

As of March 2018, the CEA’s claim-paying resources were roughly 50% contributed to by the risk transfer, reinsurance and cat bonds layer of the funding tower, reflecting the vital role that private market risk transfer now plays for the CEA.

Looking back the percentage of the claims paying capacity of the CEA made up of risk transfer has increased significantly.

Back as recently as 2016 risk transfer was just 41% of the CEA’s total claim paying capacity, in 2012 it made up 35% of the capacity total, while in 2006 risk transfer was just 21% of the CEA’s claims paying funding.

With the CEA projecting a need for a whopping $48 billion of claim-paying capacity in a decade or so’s time, it will be interesting to see whether the use of risk transfer, reinsurance and catastrophe bonds keeps pace.

If risk transfer remained roughly 50% of the total claims paying capacity acquired by the CEA, that would mean a risk transfer program of $24 billion, a huge increase on the current program.

Within the current program, which was just slightly over $8 billion in size as of March 2018, the use of catastrophe bonds made up a significant 26% of the reinsurance capacity provided, at $2.075 billion.

Imagine the cat bond market providing 26% of a $24 billion CEA risk transfer program in just over a decades time? That would be a welcome $6.24 billion of California earthquake cat bonds, a 200% increase from the transformer of cat bond component of the CEA’s program uses today.

However the percentage contribution of each risk transfer component works out, it is almost guaranteed that the CEA will need reinsurance and ILS capacity to be available in increasing volumes each year as its claims paying capacity needs grow towards the projected $48 billion.