CEA tops up 2012 reinsurance, reveals risk transfer plans for 2013, catastrophe bonds to feature

The California Earthquake Authority (CEA) has released some details of their risk transfer and reinsurance plans for the remainder of 2012 and for 2013 after a board meeting held on the 23rd August. Documents published on the CEA’s website show that they continue to focus on achieving cost-effective risk transfer through the use of traditional reinsurance and collateralized cover through the issuance of catastrophe bonds via a transformer vehicle.

Recently the CEA completed their largest cat bond transaction to date with the issuance of the $300m Embarcadero Re Ltd. (Series 2012-2). After that deal completed the CEA had increased the contribution that cat bonds make to their overall risk transfer to not far off 18%, with $600m of active cat bonds issued through the Embarcadero transformer, the other deals being Embarcadero Re Ltd. (Series 2012-1) and Embarcadero Re Ltd. (Series 2011-1) which were both $150m. That took their overall risk transfer for 2012 to over $3.45 billion and the CEA have now added another $100m of protection through a novel reinsurance transaction.

At the board meeting a proposal was put forward for an additional $100m of traditional reinsurance cover. The proposed cover was both unusual and innovative as the CEA were looking for a source of traditional reinsurance which would closely match their transformer cat bond cover. The CEA’s staff had negotiated a $100m traditional reinsurance contract with multi-year features that would allow them to fit it into their overall risk transfer in a more effective manner. The three-year reinsurance contract was due to incept on the 1st September and run until 31st August 2015.

This multi-year reinsurance cover allowed the CEA to combine traditional reinsurance cover with what they call some of the “key features” of their transformer reinsurance contracts. Features that the policy has in common with cat bonds; include that it accumulates losses on an annual aggregate basis, allows for an annual reset controlling premium movements, deductible, attachment and exhaustion point, and a drop-down feature.

The CEA board meeting notes show that the annual premium for this innovative one year reinsurance contract is $5.7m. The CEA staff recommended that the board approve the purchase of this contract so that it could be bound effective 1st September.

We spoke with the CEA’s representatives to find out whether this new reinsurance had been approved by their governing board. They told us that the $100m contract had been approved and bound and also told us that the provider of the new $100m limit reinsurance contract is Allianz Global Risks U.S.

Glenn Pomeroy, CEO of the California Earthquake Authority, said; “We are always looking for risk-transfer transactions that benefit the CEA. This new $100-million, three-year transaction provided CEA with valuable and economical multi-year cover, which in turn adds welcome price stability for our risk-transfer program.”

With this new $100m multi-year reinsurance contract in place the CEA now has over $3.55 billion of risk transfer available for the remainder of 2012, with the $600m of cat bonds from their transformer now contributing slightly less at just under 17%.

The board meeting also featured discussions about the CEA’s plans for risk transfer for 2013. With the January renewals fast approaching it is important that large reinsurance programs are planned in advance to ensure that the best carriers and pricing are available at the point of binding. The CEA staff note that multi-year cover, in the form of transformer reinsurance or traditional contracts like the one they have just negotiated, are particularly important as they relieve some uncertainty on availability of risk transfer capacity at renewals.

For 2013 the CEA want to have sufficient risk transfer to meet their target 1-in-500-year claims paying capacity level. To achieve this they say they must have $3.404 billion of risk transfer in place on 1st January 2013 and $3.557 billion in place on 1st April 2013. The multi-year contract which the CEA just signed was due to an increase in their exposure from new policies, and this increased in risk transfer and reinsurance requirements will continue in 2013.

The CEA board approved the staff to work on a proposal to acquire sufficient risk transfer for 2013. At their upcoming October board meeting the arrangements for the 1st January renewals will be discussed, while arrangements for the 1st April renewal will be discussed at a board meeting in February. The CEA will aim to acquire an optimal mix of both traditional and transformer reinsurance for both renewals.

How that mix will play out remains to be seen and will depend on market conditions, reinsurance rates and investor appetite for more California earthquake cat bonds. If the cat bond market is still buoyant then we fully expect that the CEA will add to the $600m of cat bond cover they have in place. If for some reason the capital markets are not as welcoming then it is likely that the CEA will place more of their risk in the traditional markets, although they may try to repeat the multi-year nature of their 1st September reinsurance contract.

CEA CEO Glenn Pomeroy said; “The CEA will continue in 2013 to look for opportunities (including appropriate transformer and other innovative prospects) that provide favorable terms and conditions, promote healthy diversity in the CEA’s financial structure, and strengthen the CEA’s overall risk-transfer and claim-paying capacity.”