California based utility the Los Angeles Department of Water and Power (LADWP) has finally secured $30 million of wildfire insurance cover from its second catastrophe bond issue, after the Power Protective Re Ltd. (Series 2021-1) deal was priced at the raised coupon level.
The eventual and successful pricing of this second Power Protective Re cat bond demonstrates that wildfire insurance, or reinsurance, capacity is available from the insurance-linked securities (ILS) market.
But the process to get to this pricing shows that this is not at any cost and ILS funds and investors are demanding higher returns for the California wildfire peril after recent losses from it.
This new Power Protective Re Ltd. catastrophe bond first hit the insurance-linked securities (ILS) market at the end of August, but things went very quiet and gaining investor acceptance for a new wildfire cat bond, at a time California was burning, proved to be challenging, we understand.
As we explained in our update on this cat bond that we published yesterday, the result of this had been a delayed issuance, September had been the original target but the issuance will now complete in October, we’re told, as well as a relatively significant increase in the coupon offered to funds and investors.
But the utility has persevered, resulting in it now securing $30 million of wildfire protection from this new Power Protective Re 2021-1 catastrophe bond, with a single tranche of notes set to issue to investors early next month.
To recap, the Los Angeles Department of Water and Power (LADWP) is the largest municipal utility operating in the United States, serving more than four million residents in the Los Angeles region of the state of California.
The utility sponsored its first wildfire cat bond last year, with a $50 million Power Protective Re Ltd. (Series 2020-1) that featured a parametric trigger.
This new Power Protective Re cat bond issuance features an indemnity trigger, which is the main change over the prior years deal, as the expected loss of the two issues was very similar.
The LADWP is accessing the capital markets for wildfire insurance protection through an insurance agreement with a protected cell of Aon’s Vermont-based White Rock cell captive vehicle, acting as a fronting carrier for the transaction.
The White Rock protected cell is reinsured by global reinsurance company Hannover Re, which is the same chain of protection as the first Power Protective Re cat bond transaction.
As a result, Hannover Re will reinsure the wildfire risks for White Rock, then interface with the capital markets vehicle, fronting the wildfire risks for the LA utility via a retrocessional reinsurance agreement with the special purpose insurer (SPI) named Power Protective Re Ltd.
This new Power Protective Re cat bond has an attachment point set at $125 million of losses to the LADWP and will cover a share of losses up to the exhaustion point of $275 million.
As a result, it could have been as large as $150 million, should the utility have elected to cover the entire layer, but as we said yesterday was likely, the deal ended up being quite small, with just a $30 million issuance settled for.
So, the single, now confirmed by our sources as $30 million in size, tranche of Series 2021-1 Class A notes will be sold to investors and the proceeds be used to collateralize a retrocessional reinsurance agreement, enabling the risk to flow from the LADWP to the capital market investors via Hannover Re and Aon’s White Rock.
The $30 million of notes will provide the LADWP with wildfire protection against losses across the state of California, on an indemnity and per-occurrence basis, across a three-year term.
The $30 million of Series 2021-1 notes that Power Protective Re will issue in early October will have a modelled expected loss of 0.64%, on an average fire hazard basis, or 0.76% on a high fire hazard basis.
At first, the notes were offered to investors with a coupon price guidance range of 10.75% to 12%, but as we explained yesterday that coupon was lifted considerably up to 15%, which is where the notes have now priced.
This price hike reflected the cat bond investors appetite to be paid in a manner they see as commensurate with the risk of California wildfires, especially as wildfire season has already been very active this year.
The 2020 issuance from Power Protective Re, which remember was a parametric structure, had an expected loss of 0.74% annualised on a high fire hazard basis, and settled to pay investors a coupon of 10.75%, giving a multiple-at-market of 14.5 times the high fire risk EL.
This new 2021 issuance, with its much higher coupon, offers investors a multiple-at-market of almost 20 times the high fire hazard EL, showing the high cost of California wildfire insurance and reinsurance protection at this time.
But, while the multiples are particularly high, this issuance shows that capacity can be sourced from the ILS market for wildfire risk in California, just that sponsors need to be prepared to pay a high rate-on-line equivalent for it.
Securing wildfire insurance and reinsurance cover for California has become increasingly challenging, especially during the season and now the peak wildfire season is fast-approaching.
So it makes sense for cat bond funds and investors to demand a return that makes them feel comfortable to assume this risk and even at this higher pricing it still could encourage other utilities to look to the catastrophe bond market in 2021 for wildfire insurance, as it shows that capacity can be available to them from the capital markets.