The California Earthquake Authority (CEA) are in the process of bringing their third catastrophe bond deal to market through the Embarcadero Re Ltd. transformer vehicle. The latest deal in the cat bond market in Q3, Embarcadero Re Ltd. (Series 2012-2), will issue a single tranche of Class A notes to be sold to investors which are designed to provide the CEA with a multi-year source of protection from property losses due to earthquakes in California on an annual aggregate basis.
The deal uses an indemnity trigger and cover is afforded to the CEA via a reinsurance agreement with Embarcadero Re which gives them this annual aggregate protection for a three-year risk period. The funds from the sale of the notes to capital market investors are used to collateralize the reinsurance agreement between Embarcadero Re and the CEA. The transaction began marketing at $150m of cover.
Interestingly, the CEA had earlier this year given their approval to issue as much as $300m of cat bonds during the remainder of 2012. At the time we expected that they would issue two further cat bonds of $150m, as they already have in the Embarcadero Re series of deals. That would bring their total cat bond cover to $600m. This would take the contribution of cat bonds within the CEA’s overall risk transfer programme to nearly 20%, it sat at 10% back in February when they had two cat bonds totalling $300m.
Now, we’re told by sources, that Embarcadero Re Ltd. (Series 2012-2) will close at $300m, having doubled in size from the $150m it began marketing at. This means that the CEA will have used up the total $300m mandate they had approved for use in cat bonds during 2012 and cat bonds will, when this deal completes, comprise somewhere around 20% of their overall risk transfer program. It will be interesting to see whether they approve capital to be used in any further cat bond deals this year. The CEA has always said that they would issue cat bonds selectively, as the market conditions were most conducive to purchase cover at reasonable rates. The CEA have stated that they found their recent cat bonds to be cheaper than the equivalent reinsurance and it’s likely that the cost achieved with this latest deal had a lot to do with it upsizing (along with investor appetite for a diversifying deal)
The Embarcadero Re 2012-2 deal was marketed with a coupon range of 4.5% to 5.25% and we’re told that when the deal prices it will pay a coupon of Treasury Money Market Funds plus 5%. So pricing is towards the higher end of the range which could be due to the amount of California quake risk which is now in the cat bond market, largely thanks to the CEA, with investors demanding a reasonable payment for taking on more of this risk.
It is testament to the increasing maturity and influence of the catastrophe bond market that we see an insurer such as the California Earthquake Authority place so much of their risk into the cat bond market. As they move towards 20% of their reinsurance being cat bonds, while more of it is collateralized through investor backed reinsurance players, the CEA is rapidly becoming one of the biggest users of the capital markets for reinsurance protection.