Catastrophe bonds now contribute more than 20% of the California Earthquake Authority’s risk transfer and reinsurance coverage and there will likely be more to come as the organisation looks to leverage its transformers again in 2015.
The California Earthquake Authority (CEA), a not-for-profit, publicly managed-privately funded, provider of homeowner and renters residential earthquake insurance in California, has added $400m of catastrophe bond coverage through its most recent transformer transaction, Ursa Re Ltd. (Series 2014-1), in December.
The CEA’s 2015 risk transfer strategy was presented to its governing board recently and it opens the door for more catastrophe bonds to be issued using Ursa Re Ltd. in 2015. The strategy proposes a risk transfer program featuring both traditional and transformer reinsurance, which contribute to a total claims paying capacity to meet a minimum of a 1-in-450 year level up to a maximum of a 1-in-550 year level.
At all times the strategy for 2015 stipulates that the CEA’s staff will seek to obtain the lowest pricing possible, while also setting a preference for more multi-year contracts in order to minimise the risks of any sudden jump in catastrophe risk pricing affecting its entire program in one go.
The CEA has been on a journey to move towards increasing use of multi-year reinsurance covers, alongside multi-year catastrophe bond transactions. This has enabled it to greatly reduce the impacts that a hardening market may have on it. The contracts that are in place are often staggered for maturity, meaning that any increase in rates would only impact the renewals immediately following it, rather than its entire risk transfer capacity.
At the same time as moving towards a multi-year approach to risk transfer, something that market conditions and the growing amount of third-party ILS capital in reinsurance have facilitated, the CEA has also increased its risk transfer purchases steadily.
As of December 1st 2014, the CEA reports a total risk transfer program reinsurance limit of $4.159 billion, which is a significant increase over the course of the last year and a half, the number stood at around $3.4 billion at mid-year 2013.
At that time, with the Ursa Re Ltd. catastrophe bond coming into force on the 1st December, the CEA had $850m of reinsurance limit available from its three in-force cat bonds, the $400m Ursa Re Ltd. (Series 2014-1) which runs to the end of November 2017, $150m from Embarcadero Re Ltd. (Series 2012-1) which matures in February 2015 and $300m from Embarcadero Re Ltd. (Series 2012-2) which matures in August 2015.
So catastrophe bonds currently contribute 20.5% of the CEA’s total risk transfer limit, the highest proportion of its program from transformer cat bond issues in its history. Glenn Pomeroy, the CEA’s CEO, told Artemis at the time that leveraging the capital markets results in more capacity, greater competition and benefits the CEA’s customer base as a result.
With the two Embarcadero Re cat bond set to mature in 2015, with the first as soon as February, we would expect to see the CEA returning to the catastrophe bond market in early 2015 with a renewal deal. Competition will again likely be fierce from the traditional reinsurance market for this layer of the CEA’s program, but the benefits of diversifying risk capital sources will likely mean that another transformer deal is completed anyway, we’d imagine.
Demonstrating the shift to multi-year coverage across both traditional reinsurance and the transformer contracts, the CEA reports that more than half of its in-force risk transfer at December 1st is on a multi-year basis, while just 44% is one year.
Of the risk transfer contracts signed during 2014, of which there were thirteen in total during the year, five of these were on a multi-year basis.
The CEA explained that these multi-year reinsurance and risk transfer contracts; “Provide the CEA with uninterrupted long-term financing at lower prices. Multi-year contracts reduce the risk of a single year’s market conditions’ preventing the CEA from obtaining risk-transfer capacity at suitable pricing, on favorable terms.”
During 2014 attractive reinsurance and capital market conditions enabled the CEA to meet its 1-in-450 year claims-paying capacity target, while also reducing the costs of its risk transfer program. The CEA now purchases its reinsurance across the whole year, not sticking strictly to the main renewal seasons, which again serves to stagger its need to renew specific contracts.
The combination of multi-year purchases, a staggered approach to renewing, the use of transformers to directly access capital market investors and the attractive pricing of reinsurance and cat bonds, all serve to help the CEA optimise its risk transfer.
The CEA explained; “The resulting program minimizes the risk of adverse economic conditions having a negative effect on pricing. By buying throughout the year, the CEA can better match its need for risk-transfer to changes in exposures.”
So the CEA looks set to continue its strategy of seeking to achieve greater cover, on multi-year terms, with staggered renewals across the year, while taking advantage of the best pricing available from both the traditional reinsurance and capital market.
We’d expect to see a new catastrophe bond from the CEA at some point in the first-half of 2015, as the organisation looks to renew one or perhaps even both of its maturing Embarcadero Re cat bonds.