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Original Risk: A Society for Change Agents

California Earthquake Authority now uses catastrophe bonds for 10% of its risk transfer


With the completion of their second earthquake catastrophe bond through the Embarcadero Re Ltd. Bermuda domiciled SPV, the California Earthquake Authority now receives 10% of its risk transfer cover from the capital markets via catastrophe bonds. The second Embarcadero Re deal, a $150m single tranche of Series 2012-1 cat bond notes, provides another layer of cover on a fixed cost, multi-year and fully collateralized basis for the CEA, allowing them to further diversify their sources of reinsurance.

The CEA has approximately $3 billion of risk transfer, mostly from private reinsurers. Using cat bonds allows them to diversify their sources of protection and fix costs in for 3 year periods. Cat bonds also allow different layers of risk to be transferred offering different levels of protection, and different levels of risk to be sold to capital markets investors. The CEA said in a press release that this latest $150m cat bond is “another step for CEA toward establishing standardized earthquake CAT bonds as a significant ongoing source of risk transfer”. That would seem to suggest that they may look to issue more cat bonds in the future and build on this $300m of capital markets sourced protection.

“Successful completion of this second transaction demonstrates CEA’s ongoing commitment to diversify and expand its claim‐paying resources,” said Glenn Pomeroy, the CEA’s CEO. “A diverse set of risk-transfer tools, combining traditional reinsurance and catastrophe bonds with post-earthquake federal loan guarantees, will help us make earthquake insurance more affordable.”

The CEA were pleased with their first Embarcadero Re cat bond, which was issued last August, they found it cost-effective and an efficient form of risk transfer. At the time that they would seek to issue further cat bonds every four to six months if the market conditions and investor appetite were right. The press release published yesterday suggested that this was still their goal.

“Using the same basic structure in these repeatable transactions makes it easier for investors to understand the deal and be comfortable with its terms, which also helps to expand the investor base and solidify market capacity for follow-on deals,” said Tim Richison, the CEA’s CFO. “As we said last August, we intend to be back in the marketplace as often as investor interest will support.”

It will be interesting to see how often they try to issue cat bonds and what percentage of their risk transfer could eventually be provided by the capital markets. In the past, traditional insurers have suggested that 5% to 10% of their reinsurance could be in cat bond form, but actually there is no reason that this couldn’t be much greater if the investor appetite was there. Cat bonds can give a cedent much greater control over the protection afforded by different layers of cover in an overall risk transfer program due to the way they can be customised and structured. The CEA is becoming a great model to watch and follow as a progressive user of cat bonds.

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