A new catastrophe bond transaction, Golden State Re II Ltd., has launched on behalf of the California State Compensation Insurance Fund (SCIF) as it looks to secure more capital market protection for workers compensation claims caused by earthquakes.
The SCIF sponsored its first catastrophe bond in December 2011. The $200m Golden State Re Ltd. cat bond secured the fund a capital markets backed source of coverage for claims they may have to pay resulting from major earthquakes. The unique transaction, which has not been repeated by anyone else until now, links earthquake severity to workers compensation loss amounts demonstrating a new use of the catastrophe bond structure.
The SCIF provides workers compensation coverage to large and small employers in California meaning that they are liable for claims such as injuries and fatalities which could result from an earthquake damaging a place of work. Given the exposure to earthquake risk in the area, as demonstrated very recently by the Napa quake, it makes sense to look to the capital markets for a coverage solution that responds to earthquake severity.
The Golden State Re cat bond is scheduled to mature in January 2015 and it is encouraging to see the SCIF coming back to the capital markets for its renewal for this source of reinsurance protection. A new special purpose vehicle has been established for this renewal issue, with Golden State Re II Ltd. being incorporated in Bermuda as a special purpose insurer.
This Golden State Re II cat bond issuance will see a single tranche of Series 2014-1 notes marketed to investors for the sponsor SCIF, Artemis understands from market sources. The deal is expected to be sized at $150m or over, depending on ILS investor appetite, according to our sources. Given the timing, as this is a very slow time of year for new cat bond issues, we’d expect the transaction to be well-received so the SCIF could easily see this deal complete at $200m to replace the cover from its 2011 cat bond, or perhaps even grow the transaction even further.
The SCIF will enter into a reinsurance agreement with Golden State Re II, in order to benefit from the source of fully-collateralized reinsurance protection. The protection will be afforded on a per-occurrence basis, we understand, using a modelled loss trigger in the same fashion as the 2011 cat bond issue. The transaction will cover the SCIF until January 2019, so more than four years which is a year longer than its 2011 issues tenure.
The covered area is for earthquake events in the entire U.S., but as with the 2011 deal as much as 99.99% of the SCIF’s insurance portfolio is focused on California, as its name gives away. As a result the risk is focused on California area earthquakes.
The modelled loss trigger uses a variety of inputs and a calculation process to derive whether an event has triggered the cat bond. The trigger is of similar construct to the 2011 deal, using the exposures of a notional portfolio of workers compensation risks in the SCIF’s portfolio, earthquake severity factors (ground motion), geographic distribution of the covered portfolio, types of buildings covered, time of day and the day of week an event occurs as some of the weighting factors.
We understand that after an event, which we believe has to be an earthquake of magnitude 5.5 or greater, losses will be modelled deterministically, so not related to actual injuries and fatalities, using the earthquake event parameters and this will be modelled against the notional portfolio using day/time weighting to determine an index value and notional modelled loss amount.
After an event has occurred which is deemed to require analysis, a calculation process will be run to derive an index value which will be compared against an attachment point. We’re told the attachment point is at 1,000, and the exhaustion at 1,903. The 2011 deal also attached at 1,000 but exhausted at 1,447, so this deal may cover a larger layer of the SCIF’s reinsurance programme.
We understand that the initial attachment probability for the notes will be 0.5%, while the initial exhaustion probability will be 0.11% and initial expected loss 0.25%. The expected loss of the 2011 deal was 0.36% for comparison, which suggests the 2014 Golden State Re II cat bond is a little lower risk.
As a result the coupon guidance is low for this cat bond, although low is to be expected in the current market environment anyway. We’re told that the deal is marketing with coupon guidance of 2.2% to 2.7%. Again for comparison, the coupon of the 2011 Golden State Re cat bond was 3.77%.
The cat bond is being brought to market by Willis Capital Markets & Advisory, acting as the sole structurer and bookrunner as it did for the 2011 deal. RMS is the risk modeller and calculation agent.
It’s good to see the California State Compensation Insurance Fund return to the catastrophe bond market and encouraging to see an issuance at this typically quiet time of year. Investors will have the time available to put into the analysis required for a deal which is a little more complex, due to the modelled loss trigger structure, so we’d expect this to be received well by investors looking for new diversification and capital deployment opportunities.
We’ll keep you posted as this transaction comes to market. We’ve added Golden State Re II Ltd. (Series 2014-1) to our catastrophe bond Deal Directory and once the transaction is completed it will also be added to our Market Dashboard and Statistics.