California focused electrical utility PG&E Corporation (the Pacific Gas and Electric Company) now benefits from $200 million of insurance protection against losses related to wildfires, through the completion of Cal Phoenix Re Ltd. (Series 2018-1), the first catastrophe bond to benefit a corporate sponsor using an indemnity trigger.
It had been hoped that the transaction would increase in size, as we reported last week, as the target rose to up to $225 million, while at the same time the proposed coupon pricing jumped.
But the Cal Phoenix Re Ltd. California wildfire catastrophe bond did not upsize in the end, instead settling at the $200 million it was first marketed at.
While the cat bond protects PG&E with three years of insurance cover for property damages caused by wildfires in the state of California, it is for third-party wildfire liability, so damages to property caused by wildfires for which PG&E is liable, rather than damages to its own infrastructure.
The successful issuance of the Cal Phoenix Re cat bond delivered three firsts for the cat bond market, being the only cat bond to-date that solely covers wildfire risks, the first cat bond to offer coverage for third-party liability property damages, and being the first corportate cat bond to utilise an indemnity trigger.
Typically, catastrophe bonds with corporate sponsors have used parametric triggers, as there is no strict insurable interest involved.
But here the Cal Phoenix Re cat bond has been structured to make use of entities acting as intermediary re/insurers, to provide insurance and reinsurance for the risks that PG&E is seeking coverage for.
The underlying risk is being ceded via Energy Insurance Mutual as the insured party (of which PG&E is a member and insured), which is in turn provided with reinsurance by Tokio Millennium Re AG.
Hence, the proceeds of the sale of the $200 million single tranche of notes issued by Cal Phoenix Re Ltd. now collateralize a retrocessional reinsurance agreement between the issuing special purpose insurer and Tokio Millennium Re, which in turn reinsures Energy Insurance Mutual, which then insures the PG&E Corporation wildfire related risk.
It’s an effective way to enable PG&E to gain coverage on an indemnity basis, but more importantly for a risk for which it would be extremely complex to put together a parametric trigger.
It may be easy enough to derive when a wildfire occurs, when and how widely it burns, but identifying the liability for the wildfire with a parametric trigger is not so easy as yet (think sensors in the future though).
As a result this becomes the first catastrophe bond to provide a corporate sponsor (PG&E) with risk transfer that includes loss adjustment expenses such as litigation risks related to third-party wildfire related property damages, an innovative way to achieve this kind of coverage and one that could be applied in other business lines perhaps.
The Cal Phoenix Re wildfire cat bond deal was targeting $200 million at launch and despite the hopes of a slight upsizing to $225 million, it failed to achieve this we now understand.
However, the coupon paid to investors stuck with the uplift that had been proposed. At first the notes, which have an initial expected loss of 1.01%, were offered to investors with coupon guidance of 6% to 6.5%. But that was then increased and the coupon priced at a higher level of 7.5%, in order to satisfy investor demand for being compensated for taking on the underlying risks.
It’s encouraging to see the transaction completing and now PG&E joins other corporate beneficiaries of catastrophe bond backed insurance and reinsurance protection.
It’s also encouraging to see more firsts in the cat bond market in 2018, which bode well for further market expansion and growth in the years ahead as the coverage becomes more flexible and new ways to cascade the protection down to corporate sponsors are found.