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Moody’s calls CEA’s direct catastrophe bond credit negative for reinsurers


Ratings agency Moody’s has commented on the California Earthquake Authority (CEA) issuance of $150m of earthquake risk through their Embarcadero Re Ltd. special purpose reinsurer. The catastrophe bond deal which the CEA completed without the involvement of a traditional reinsurer for the first time could see the CEA rely less on reinsurers services in future.

Moody’s called the transaction credit positive for the CEA, as they managed to secure the cat bond cover for a lower cost than their comparable protection from traditional reinsurance markets. The transaction has been set up to be repeatable and the CEA said they could seek to make repeat issuances every four to six months if investor demand remains high. This means that they could pull further cover out of the traditional reinsurance markets, favouring the cost of catastrophe bond issuance, over coming years. Given that the CEA currently buys around $2.9 billion of reinsurance, Moody’s call’s this transaction credit negative for traditional reinsurers.

Moody’s highlight that this catastrophe bond deal comes at a time when traditional reinsurers are threatening to withdraw and be ‘stingier’ with their capital while investors are seeking to make more bets on catastrophe risks. This combined with the high catastrophe losses seen in recent months means catastrophe reinsurance rates are likely on the rise (albeit slowly). The CEA over the past 14 years has paid $2.8 billion to reinsurers, or 40% of its premium revenue, and passed on very little in losses to reinsurers. Given that they can secure cat bond cover more cheaply now, if their reinsurance rates rise as much as some traditional reinsurers suggest they’d like to see rates rise, we could see the CEA move much more of their cover to the capital markets.

Moody’s says the CEA currently pays 8.15 cents for every dollar of reinsurance on the riskiest tranche of their traditional reinsurance program. By comparison, the Embarcadero Re cat bond pays investors 6.6 percentage points over one year U.S. Treasury money-market funds (which yield close to zero right now). As well as savings on the CEA’s expenses the cat bond also secures multi-year, fixed cost and fully collateralized cover. It’s easy to see how this could become a very attractive option for the CEA which could see them increase the percentage of cover that the capital markets provides them.

We’ve spoken to a number of corporations who are now looking much more seriously at the cat bond market as a result of this transaction demonstrating that the capital markets can provide a source of reinsurance cover more cheaply than traditional reinsurance markets. EDF’s latest Pylon cat bond is also demonstrating that corporates can issue these securitizations directly and this has caused other corporates risk managers to take a serious look at cat bonds to see whether they could prove a cost-effective alternative to insurance for them.

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