CEA unable to fully renew reinsurance in October, foresees 1/1 challenges

The California Earthquake Authority (CEA) was unable to fully renew all of its expiring reinsurance at October 1st resulting in a further shrinking of its risk transfer program and now the CEA is unsure whether it can renew all its expiring limit at the January 1st 2023 renewal as well.

The staff of the California Earthquake Authority (CEA) provided its Board with an update on reinsurance and risk transfer yesterday, providing a market outlook that was gloomy at best.

The outlook explained all of the challenges facing global reinsurance markets, as well as the changed appetites of institutional investors and elevation of capital costs in capital markets, driving home the difficult situation major reinsurance and risk transfer buyers now face as market prices and terms harden considerably.

The CEA is reckoned to be the second-largest buyer of reinsurance in the world and even though its program has been loss free for some years now, while also not being affected by climate change, the Authority expects its reinsurance and risk transfer costs will be higher going forwards.

As the CEA tries to purchase enough reinsurance and risk transfer protection to cover a minimum return period, that metric has been lowered in recent years as the reinsurance market became more challenging and coverage more costly.

The CEA’s staff are now targeted with procuring sufficient risk transfer and reinsurance to support claim-paying capacity at no less than the 1-in-350 year level and no greater than the 1-in-500 year level, something they have achieved to-date.

But they seem less sure about their ability to continue to do that, with reinsurance rates hardening and capacity less available.

The CEA faced its first real challenge in renewing its October 1st reinsurance program.

The staff explained that, “The CEA was unable to secure enough reinsurance capacity to fully renew its expiring October 1 reinsurance program and that which was placed was renewed at higher rates on line.”

After which they forecast more challenges to come, as, “Certain private reinsurance layers coming up for expiration cannot be renewed at all, or will be renewed only at lower capacity and increased rates on line, owing to capital concerns of reinsurers.”

The CEA has benefited from its staggered approach to renewing reinsurance, its use of multi-year coverage and also its use of catastrophe bonds that diversify its sources of risk capital.

But even with these in mind, the CEA’s reinsurance and risk transfer program had shrunk to just over $9 billion at November 1st 2022.

That’s down from just under $9.3 billion of reinsurance and cat bonds at May 31st 2022, and $9.44bn at December 31st 2021.

Catastrophe bonds make up $1.97 billion of the $9 billion reinsurance tower at this time.

But, the CEA had $400 million of its cat bond backed reinsurance capacity mature at the end of November, so now that figure has fallen to $1.57 billion and the overall reinsurance tower has shrunk further.

At November 1st, the CEA’s reinsurance arrangements stood at roughly the 1-in-385 year claims paying level, which again will have fallen by this stage with the maturing cat bond coverage.

But for 2023, the CEA is not particularly confident it can stay above the 1-in-350 year level, given how reinsurance market conditions are moving.

The January 1 renewal will see the CEA looking to renew some $3.5 billion of expiring reinsurance capacity, a significant sum.

“The January 1 renewal looks like to face challenges to replace the expiring limit given current market conditions, even though it is likely to be placed at a significantly higher rate-on-line than the expiring January 2022 program,” the CEA staff explained yesterday.

“Unless market conditions turn quickly, which seems unlikely to happen, the next largest syndicated CEA program, the April 1 2023 renewal of $1.4 billion of expiring capacity, is likely to have similar results,” they forecast.

Adding that, “In all likelihood, therefore, the dollar amount of risk transfer capacity the CEA will be able to purchase in the near future will be reduced – but by how much, or for how long, cannot currently be known.

“Some reinsurers may be willing to provide additional capacity, but not at prices the CEA would be inclined to pay as it would result in very large premium rate increases for all CEA policyholders. Some reinsurers, on the other hand, may not have sufficient capacity to provide to the CEA regardless of price.”

Which means maintaining the minimum 1-in-350 year claims paying capacity level will be difficult, perhaps as soon as at the January 1st 2023 renewals, the CEA staff warned.

They don’t suggest changing the target, saying that if it is missed then they will seek to make up the claims paying capacity at the earliest opportunity.

The CEA may also find the catastrophe bond market can provide some of the capacity traditional reinsurance cannot, or vice versa and sponsoring cat bonds away from the congestion of the main reinsurance renewal may prove a better strategy for such a large risk transfer buyer.

For 2023, the staff proposed buying as much risk transfer capacity as is “economically feasible under prevailing market conditions” and then trying to bring the level back up to the 1-in-350 year as soon as possible after, should it fall short at the renewals.

As a significant buyer of reinsurance and risk transfer, the CEA faces more challenges than many and the $3.5 billion of limit it targets at the January renewals could prove a stretch.

It will be interesting to see how its mix of protection, in terms of cat bonds vs traditional reinsurance, adjusts while the market remains so hard, also how the CEA adapts and whether it turns to additional revenue bonds, if the hard reinsurance market proves prolonged.