The California Earthquake Authority governing board has approved the issuance of further catastrophe bonds through a transformer reinsurance vehicle (likely Embarcadero Re Ltd.) during 2012. At a recent governing board meeting approval was sought to issue up to $300m in additional catastrophe bonds this year if the market terms and pricing are conducive and the transactions meet a number of pre-defined conditions.
The recommendation presented to the governing board said:
Authorize staff to execute additional transformer-reinsurance transactions incepting on or before January 1, 2013, not to exceed $300 million in total reinsurance limit, so long as each transaction is handled as stated above, and as elaborated on in the written resolution presented to the Board on this date, and that for each executed transaction, staff present appropriate transaction information to the Board.
A CEA spokesperson told us that approval was given as long as each transaction meets the following criteria:
Future transformer-reinsurance transactions, in order to be “conforming risk-transfer transactions” eligible to be executed by CEA staff under this approach, would be subject to the following requirements:
- Any conforming risk-transfer transaction must have an inception date of January 1, 2013, or earlier.
- No conforming risk-transfer transaction, or combination of such transactions, may exceed a total limit of $300 million.
- The conforming risk-transfer transaction must be fully documented and then expressly certified by CEA executive management to be reasonably likely to achieve the three goals of CEA’s capital-markets risk transfer program, as described above:
- A multi-year, collateralized reinsurance contract
- Collateralized risk-transfer capacity, using a mechanism of indirect CEA access to the broader capital markets
- Promoting diversified risk-transfer sources, in addition to traditional reinsurance markets (i.e., the reinsurer would fund 100% of the reinsurance limit through a capital-markets transaction, generally the issuance of a catastrophe bond).
- Considering all aspects of costs and benefits associated with risk transfer, its value in all respects to the CEA, and its effect on the CEA’s financial capacity and standing, the risk-adjusted cost of the conforming risk-transfer transaction is—in the reasonable judgment of CEA management, as informed by retained experts—less than or equal to the estimated cost to the CEA of acquiring equivalent traditional reinsurance.
- Within the existing legal information framework, staff must inform the Board of all essentials of any executed conforming risk-transfer transaction at the earliest possible time, but staff would not be required to seek the Board’s approval of a conforming risk-transfer transaction before it is executed and would not seek any sort of ratification of an executed conforming risk-transfer transaction since a ratification requirement would likely create market disruption and be impracticable to achieve on a fully executed market transaction.
This is a sensible approach by the CEA, it allows them to assess the market throughout the remainder of the year and take advantage of market conditions to issue further cat bonds at the most opportune time for them. This should ensure that they can secure the pricing that they seek, achieving comparable value to their traditional reinsurance purchases. It also means that they can target a time when the investor community are likely to be open to additional deals and have a strong appetite for them, perhaps when issuance is traditionally slower during the U.S. hurricane season. From a diversification standpoint additional California earthquake cat bonds should be well received during the remainder of this year.
Recently we wrote that the CEA had now put 10% of their reinsurance into the cat bond market, if they do issue a further $300m of cat bonds this year it could take that percentage up to nearer 20% of their total cover.
It’s encouraging to see that the CEA are going to continue to issue cat bonds as and when the market conditions are conducive to do so. It demonstrates a commitment to the marketplace and a recognition of the value cat bonds add to their overall reinsurance mix.
We will of course update you as and when we hear of any future CEA cat bonds coming to market and you can read details of their previous deals in our Deal Directory.