California Earthquake Authority seeking catastrophe bond coverage again

The California Earthquake Authority (CEA), the publicly managed organisation that provides residential earthquake insurance to Californian residents, is again looking to return to the catastrophe bond markets to transfer a portion of its earthquake risks to the capital markets. The CEA has in the past issued a number of catastrophe bonds through the Redwood Capital SPV’s using companies such as Swiss Re and Lehman Brothers to facilitate the deals.

Now the CEA is looking to secure catastrophe bond coverage this year to provide a $150m layer of additional collateralized reinsurance protection against major earthquake events in California. California sits on a number of fault lines and is very exposed to the possibility of major earthquake events hitting the state.

There was talk last year of the CEA issuing its own catastrophe bond direct to the capital markets negating the need for a reinsurer to faciliate the deal for them. However, this agenda document from a recent CEA governing board meeting (available from their website here in PDF format) shows that they are seeking a transformer approach where by a reinsurer will transfer a portion of their reinsurance cover to the capital markets to secure multi-year, collateralized cover for them. The document suggests that the cat bond will be a three year deal working on an annual aggregate basis with an annual reset, designed to provide cover from some time during 2011 to 2014. The document even specifies that the collateral used in the transaction should be U.S. Treasury money market mutual funds.

The CEA believe that the catastrophe bond investment market would be attracted to a single-peril California earthquake cat bond as there aren’t that many tranches available to invest in with that risk and they think investors will welcome the deal as a way to diversify away from U.S. hurricane risks. Of course, after the events in Japan they could find earthquake risk a slightly more difficult sell (the document was written prior to the earthquake in Japan).

The document outlines the benefits that a catastrophe bond transaction would bring to the CEA:

• Diversify CEA’s risk transfer capacity by use of the capital markets.
• Fully collateralized reinsurance giving 100% of limit on-shore security to back up the cat bond transaction.
• Unit pricing of a cat bond will be lower than for CEA’s traditional reinsurance.
• The ability to replensih capital after an event is key to the CEA, this transaction offers that means.
• The traditional reinsurance market has offered the CEA single year cover where as a cat bond offers a multi-year reinsurance agreement and, they say, an attachment point considerably lower than their reinsurance program.

The proposed catastrophe bond transaction is designed to be repeatable and scalable, meaning that the CEA can grow their capital markets cover should they choose or just issue a repeat transaction when an initial deal matured.

The document we linked to above was a draft and was discussed at a meeting of the CEA governing board on the 24th February where the board were asked to approve the continuing negotiations with the reinsurer. It is understood that approval was given and negotiations are ongoing.

We’ll keep you updated if and when any further details on the proposed cat bond come to light.