CEA reinsurance program nears $4.5bn, but cat bonds hard to justify

The California Earthquake Authority (CEA) is set to increase the size of its reinsurance program with an April placement set to take its total risk transfer to $4.5 billion, but ILS investors have not seen a new catastrophe bond as currently they are hard to justify due to the cost.

The California Earthquake Authority (CEA) is a not-for-profit, publicly managed-privately funded, provider of homeowner and renters residential earthquake insurance in California. As a result it’s a heavy user of reinsurance protection and has also been sponsoring catastrophe bonds for some years.

Artemis caught up with Tim Richison, CFO of the California Earthquake Authority (CEA), to find out more about the growing role that ILS capital and investors have been playing in the CEA’s risk transfer program.

Richison explained that the CEA is set to place another large chunk of its reinsurance program in April with roughly $1 billion of limit needing to be secured. After that placement is completed the CEA will take its overall reinsurance risk transfer protection to roughly $4.5 billion.

The ILS and collateralized reinsurance markets provide a healthy 22% to 23% of the overall risk transfer that the CEA benefits from. This figure has been rising steadily over recent years, but at the last few renewals it has largely been in the form of collateralized reinsurance, rather than cat bonds.

The CEA sponsored its last cat bond in September 2015, the $250m Ursa Re Ltd. (Series 2015-1). Richison said that the CEA would very much like to revisit the cat bond market, perhaps later this year, as it appreciates the diversification of its risk capital sources, but that currently price is an issue.

The softened state of the reinsurance market means that traditional reinsurance capacity can be purchased very cheaply at the moment and large buyers, like the CEA, are able to achieve extremely attractive pricing on new placements.

“Cat bonds are hard to justify on a cost basis right now. We’re hoping to do another this year, but it must be equal to or cheaper in price than traditional reinsurance,” Richison explained.

Richison said that the April reinsurance transaction will be a $1 billion placement with a rate-on-line of just 3% and running for one-year. This constitutes the higher, more risk remote layer of the CEA’s program, hence the very low rate-on-line.

The catastrophe bond market can’t compete at that rate though, Richison explained, making it very hard to justify a cat bond coupon plus the overheads of the transaction.

“It’s a little more difficult to return to the cat bond market, when the traditional market is offering such great prices. They’re just a little more expensive than the traditional market right now,” he continued.

This billion dollar reinsurance layer placement was previously split into three contracts, with rates on-line ranging from 3% to 3.85% for a two-year slice. With it all moving to a one-year layer the traditional reinsurance market has been so competitive that cat bond investors don’t get a look in this time around.

That’s not to say that ILS investors miss out completely, as a small amount of the CEA’s April reinsurance placement will be taken by collateralized participation from ILS managers, either fronted by major reinsurers or through transformer vehicles.

However at the 3% rate-on-line this isn’t the most interesting piece of the CEA’s program to ILS investors anyway, who would more typically prefer to be allocating capital to the lower layers where the rates are more attractive.

“ILS managers know and like the CEA program, so are participating in the program still,“ Richison explained.

“We’ve grown our collateralized reinsurance quite a bit over the last two years. We like that as part of our program, but it’s the only way we can get the capital markets into it at the moment,” he continued.

Richison said he would prefer to be able to issue more cat bonds, but being a publicly managed entity he is tasked with buying risk transfer in the most cost-effective manner possible, which currently means cat bonds for this layer of risk are out of the question.

Richison said that he feels; “Disappointed that we cannot access the capital markets more through the Ursa Re vehicle, but pleased that we can still access the collateralized markets.”

The CEA is steadily increasing the overall size of its reinsurance program as changes in its product range result in a growing need for risk transfer, which it expects will continue.

Richison said that the CEA’s new products are seeing strong uptake, resulting in increasing earthquake insurance penetration in California and as a result the authority requires some more reinsurance protection.

This April placement will see the CEA’s risk transfer and reinsurance increase to around $4.5 billion and take its total protection, including bonding and other sources to just under $12 billion. Richison said that by the end of 2016 he expects the CEA will have $4.7 billion of reinsurance in place and that by the end of 2017 the CEA may need as much as $5 billion.

Richison said that he is very happy that the CEA’s program is taking off, both in terms of insurance penetration increasing and the resulting need for more reinsurance protection. As a result the CEA is keen to maintain and grow relationships with both traditional and capital markets providers of risk transfer and reinsurance.

And on the capital markets and ILS investors specifically, Richison said; “It’s a source of funding we’re going to need now and in the future.”

But at the moment, given the low-cost of traditional reinsurance, the main route for ILS and capital market investors to access the CEA’s growing program is through collateralized reinsurance participation.

Perhaps we will see more private cat bonds spun out of the CEA’s program, as a cost-effective way for ILS managers to access this major reinsurance placement, as was recently seen with the Resilience Re Ltd. (Series 15121A) transaction which featured risk from the CEA program being transformed to investors.