The recently closed Embarcadero Re Ltd. catastrophe bond, which saw the California Earthquake Authority transfer $150m of earthquake risk directly to the capital markets through their own SPV, shows that cat bond coverage can be comparable (and even cheaper) than the equivalent reinsurance coverage.
The CEA transaction didn’t utilise a traditional reinsurer like their previous Redwood series of deals which saw Swiss Re take on the CEA risk and transfer it to the capital markets through their SPV. Instead, with the help of the deals arranger Deutsche Bank, the CEA set up their own Bermuda domiciled special purpose reinsurer for the sole purpose of issuing a series of catastrophe bonds. More details in our earlier article on this transaction.
By taking the traditional reinsurer out of the transaction the CEA believe they have reduced the costs quite significantly. In fact they said that the cat bond secured the $150m of coverage more cheaply than they could have acquired it in the reinsurance market. The other benefit of directly issuing the cat bond is that the CEA has diversified their sources of reinsurance to include capital markets investors.
The CEA are so happy with the way this deal was issued that they say they intend to issue further cat bonds, if the market conditions are conducive and investor demand is high, every four to six months time. If they can achieve that, a large amount of their claims paying ability could be with capital markets investors over the next few years.
Back to cost. The CEA have managed to make a cat bond more affordable by cutting a traditional reinsurer our of the loop. Of course, that’s not the only reason this deal was good value, we suspect that Deutsche Bank played many roles in the transaction, and also the attractiveness to investors helped keep some frictional costs down.
By innovating in the issuance of cat bonds could the prices become more comparable to reinsurance across the full range of perils usually included in transactions? Is direct issuance the way forwards? Could risk modelling be performed in house? Could we see a new breed of insurance-linked securities and cat bond specialist structuring firms, who provide a full range of deal arrangement and structuring services and also arrange the set up of SPV’s and collateral tools for sponsors?
By combining roles and having less parties involved in the deal it should be possible to bring the costs down making cat bonds a more appealing option. This type of scenario could work particularly well for primary insurer cat bond sponsors and also for corporations seeking to directly issue cat bonds (which may be where the real growth in the cat bond market lies).
Are there other ways to reduce the costs of issuance? Who else can be disintermediated? If cat bond issuance can be achieved for a comparable cost to reinsurance (particularly with many reinsurers wanting to raise rates after a difficult year) the market could achieve the kind of growth that has long been promised. We welcome your thoughts, please let us know what you think in the comments below.