A renewal of the only catastrophe bond in the market that provides its sponsor with reinsurance protection for workers compensation claims caused by earthquakes is underway, as a currently $225 million Golden State Re II Ltd. (Series 2018-1) transaction has been launched to the market.
This is now the third cat bond transaction that will benefit sponsor the California State Compensation Insurance Fund, following its 2011 Golden State Re Ltd. deal and 2014 Golden State Re II Ltd. 2014-1 transaction.
The mechanics of the catastrophe bond are extremely similar, being a modelled loss triggered bond that pays out based on how a qualifying earthquake event is modelled to impact a portfolio of workers compensation insurance risk.
This still unique transaction in the cat bond market therefore links earthquake severity to workers compensation loss amounts, a paradigm that could be applied to other types of risks that could then be securitised and transferred to the capital markets.
The California State Compensation Insurance Fund (SCIF) offers workers compensation insurance to large and small employers in the state and so can be liable for claims resulting from an earthquake event that damages a workplace, such as injuries and fatalities.
Given the exposure to earthquake risk in the state of California, it makes sense to look to the capital markets for a source of reinsurance coverage that responds to earthquake occurrence and severity.
This cat bond marks the second time that this Golden State Re II Ltd. special purpose insurer, which is incorporated in Bermuda, has been used by the SCIF following the 2014 deal.
The Golden State Re II 2018 cat bond issuance will result in a single tranche of Series 2018-1 notes, currently sized at $225 million, being marketed and sold to investors, with the capital raised from the sale of the notes set to collateralize reinsurance agreements between the SPI and the sponsor SCIF.
The deal is expected to be sized at $225m or over, depending on ILS investor appetite for the transaction.
This cat bond will provide the California State Compensation Insurance Fund (SCIF) with a 4 year source of reinsurance protection, covering losses to its workers compensation insurance portfolio that are caused by earthquake events.
The reinsurance protection will be afforded on a per-occurrence basis and using a modelled loss trigger, designed and calculated by catastrophe risk modelling specialists RMS, in the same fashion as the previous Golden State cat bond issues.
The covered area is for earthquake events that strike anywhere across the entire U.S., but as with the previous cat bonds more than 95% of the SCIF’s insurance portfolio is focused on California, as its name gives away. Hence the risk associated with this cat bond is primarily focused on California or neighbouring area earthquake loss events.
The modelled loss trigger uses a variety of inputs and a calculation process to derive whether an event has triggered the cat bond.
The trigger is of similar construct to the previous Golden State cat bond deals, using the exposures of a notional portfolio of workers compensation risks in the SCIF’s portfolio, earthquake severity factors (ground motion etc), geographic distribution of the covered portfolio, types of buildings covered, time of day and the day of week an event occurs, as some of the weighting factors that will be used to determine whether the cat bond is triggered and a payout due.
After a qualifying event, which has to be an earthquake of magnitude 5.5 or greater, losses will be modelled deterministically, so not related to actual injuries and fatalities, using the earthquake event parameters and this will in turn be modelled against the notional portfolio using day/time weighting to determine an index value and notional modelled loss or payout amount.
The reason day/time is a factor is to ensure that the cat bond responds to quake events during standard working hours, when workplaces are at their fullest.
The calculation process that runs after a qualifying earthquake event occurs will derive an index value that will be compared against the transactions attachment point.
The attachment point for this cat bond is at an index value of 1,000, and the exhaustion at 4,323.5, which is a larger layer of the SCIF’s reinsurance programme than the previous deals it appears.
This suggests the SCIF is using the cat bond to sit alongside its traditional protection, so paying a percentage of its losses for major quake events, which is a shrewd move as the fixed cost and pricing of a cat bond can sit there across the four-year term allowing the Fund to measure the cost-effectiveness of its traditional reinsurance protection against it.
The initial attachment probability for the notes will be 0.49% which is almost the same as the 2014 deal’s 0.5%, while the initial exhaustion probability will be 0.03% (lower than the previous deal’s 0.11% due to the much larger layer covered) and initial expected loss is 0.14% (roughly half the 0.25% EL of the 2014 Golden State Re cat bond).
As a result the coupon guidance is very low for this cat bond, we understand, being marketed to ILS investors with a spread in a range from 1.9% to 2.2%. Again, for comparison, the coupon of the 2014 Golden State Re cat bond was 2.2%.
It’s encouraging to see this sponsor returning to the cat bond market for the third-time and this transaction continues to demonstrate a unique and innovative use-case for capital markets protection.
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