Embarcadero Re Ltd. (Series 2011-1)

The first directly issued cat bond by the CEA who have previously had cat bond cover via deals issued by their reinsurers. This transaction will be issued through Bermuda based special purpose insurer Embarcadero Reinsurance Ltd. which has been set up specifically for this transaction and was incorporated in Bermuda on the 22nd June. It’s a single tranche cat bond deal with a size of $150m.

Embarcadero Re Ltd. provides the CEA with indemnified risk transfer for a layer of their state of California earthquake risks via a reinsurance agreement on an annual aggregate basis over a three-year risk period. It covers only earthquake shake risks, not other perils often associated with quakes such as tsunami or fire following. Only residential property is covered. The deal matures in August 2014.

Covered losses are based on the ultimate net loss of the CEA, based on the claims payments they made after a quake event. The attachment point for the first loss period will be $3.287 billion and investor principal will only begin to be eroded once that point is passed. The actual epicentre of an earthquake does not have to be within the California state bounds for it to qualify as the CEA covers losses for earthquake shaking within the state, no matter where the epicentre occurs.

The deal is reset annually but the losses from a previous year can be carried over to count to the aggregate amount in certain cases. This aggregate qualifying losses can continue to affect the attachment point for each year of the deals lifetime which is a useful feature for the CEA as smaller quakes which happen more regularly will make the likelihood of a payment increase slightly.

Pproceeds of the sale of the notes will be deposited in a collateral account and invested in U.S. Treasury money market funds. Interest will be paid quarterly at a rate equal to the investment yield on U.S. money market funds plus an interest spread which is equal to the premium payment from the CEA. The rate of interest may change based on any change in the probability of attachment due to covered events.

Interestingly, the CEA managed to close this deal at a cheaper cost than the equivalent in traditional reinsurance making similar structures more appealing to other corporate issuers. You can read more about how and why the California Earthquake Authority issued catastrophe bonds in our article().