The California Earthquake Authority (CEA) completed a ground-breaking $150m catastrophe bond transaction through their newly set-up Embarcadero Re Bermudian reinsurance transformer vehicle at the beginning of August. The transaction was directly transferred to the capital markets through their own Bermuda SPV, thus forgoing the need for a reinsurer participating in the transaction as in their previous cat bonds. This made the deal more efficient and cost-effective for the CEA.
At the time that the first Embarcadero Re Ltd. cat bond completed the CEA said that they planned to return to the catastrophe bond market every 4 to 6 months if the market conditions were right and it was more cost-effective than traditional reinsurance. Embarcadero Re has been set up so that the structure can be re-used to issue future tranches of notes which will help to make each future issue even cheaper for the CEA.
At a recent CEA governing board meeting the subject of risk transfer for the next year was raised and approval sought for the financial structure and risk transfer plans.
The documentation from the meeting shows the CEA’s intention to further utilise Embarcadero Re where possible:
Historically, the CEA has relied heavily on reinsurance— predominantly, traditional reinsurance — for approximately one-third of its total claim-paying capacity. With the recent, highly successful transformer-reinsurance transaction completed, however, the CEA has access to the capital markets for risk transfer, which means an additional strong source of claim-paying capacity and risk transfer, going forward.
The CEA now seeks to have $3.283 billion worth of risk transfer in place by April 2012. How much of this is made up of traditional reinsurance and how much is through cat bonds issued through their transformer vehicle is hard to predict, as that will depend entirely on the market conditions when they seek out risk transfer.
The recent Embarcadero Re Ltd. transaction was cheaper than a comparable layer of traditional reinsurance in the CEA’s current risk transfer program. The transformer layer of $150m over three years issued by Embarcadero Re Ltd. had a rate-on-line of 7.78% while a $200m layer of reinsurance for just one year had a rate-on-line of 8.15%. If the CEA can repeatedly get multi-year, fully collateralized reinsurance cover through their cat bond issuances then we could see them repeat Embarcadero Re Ltd. many times. With $3.283 billion of risk transfer to secure, how much of that could be provided by the capital markets?