The CEO of the American Property Casualty Insurance Association (APCIA) has joined the calls on the California legislature to issue catastrophe bonds in order to recapitalise and stabilise the FAIR Plan in the wake of the damaging wildfire losses of recent weeks.
It’s not immediately clear whether this is a call for the cat bond structure we are focused on, so a securitized structure that provides insurance and reinsurance related risk capital to sponsors and is directly linked to the occurrence of natural events, or for a more traditional bond backed financing.But, either way, looking to the capital markets to help in recapitalising and also reinsuring the FAIR Plan is going to be critical.
David Sampson, APCIA president and CEO, stated, “Insurers are committed to helping Californians recover and rebuild from the devastating wildfires. As part of this recovery, it is essential that the state legislature issue catastrophe bonds to recapitalize and restabilize the California FAIR Plan, which provides a critical safety net for homeowners.
“The Department of Insurance has already taken a necessary first step to preserving the immediate solvency of the Plan by allowing it to obtain a line of credit, but additional long-term funding is needed to spread its catastrophic losses out over time. We look forward to working with the Department and elected officials to ensure the viability and availability of the FAIR plan and the insurance market in the state.”
The reason it’s not immediately clear what type of financial security Sampson is referring to, is that members of the California legislature have been using the term catastrophe bond to describe traditional bonding to support the recapitalisation of the FAIR Plan as well.
Replenishing and then increasing the claims paying capacity of California’s FAIR Plan is seen as critical in the wake of the recent Los Angeles wildfires, given losses from those fires could all but wipe out its current financial resources.
Quickly after the extent of the financial impacts of the wildfires, two California assembly members introduced a new bill discussing the use of capital markets to support FAIR Plan claims paying capacity.
Assembly members Lisa Calderon (D-Whittier) and David Alvarez (D-San Diego) introduced Assembley Bill 226, sating that it will “assist in issuing catastrophe bonds and help finance the costs of insurance claims, increasing claims-paying capacity of the FAIR Plan.”
Continuing, “The FAIR Plan Stabilization Act (Assembly Bill 226) authorizes the Fair Access to Insurance Requirements Plan to request the California Infrastructure and Economic Development Bank to issue bonds if the FAIR Plan faces liquidity challenges in the event of a major catastrophe such as a wildfire.”
However, you can read the bill text here and it does not mention catastrophe bonds at all, rather seeming to refer to traditional bonding that would be issued by the California Infrastructure and Economic Development Bank.
California Infrastructure and Economic Development Bank is the state’s general-purpose infrastructure financing authority and has also been used to issue securities such as green bonds in the past.
Which is where this could get interesting. As there seems no reason that California’s development bank couldn’t issue securities that reference, through their legal documents and agreements, a reinsurance related agreement with the FAIR Plan and the necessary legal wordings to secure investor interests at the same time, so providing a catastrophe bond-like mechanism but home-grown.
While it feels like the bill may be a bit challenging to read, between whether this is really a call for traditional bonding to secure refinancing after a catastrophe, or for the catastrophe bonds we know. The reality is a development bank with a treasury might be able to issue its own securities that could achieve similar goals with great efficiency and without the need to look offshore.
We’ve said before that the US should be looking to whether its own institutions (at municipal, state and federal levels) that already have capabilities to issue securities in a range of forms, could issue what we know as catastrophe bonds, or a similar home-grown structure designed to suit, to secure disaster risk capital from institutional investors.
Taxation always comes up as an issue here, as seen with some insurance-linked securities (ILS) domiciles ambitions, but the California Infrastructure and Economic Development Bank is already legislated to issue both taxable and tax-exempt bonds.
Sampson’s call for the state to issue catastrophe bonds is a timely reminder of the role of the capital markets in reinsurance and the whole reason the cat bond market was developed in the first place.
California is going to struggle with the cost of reinsurance risk capital after these wildfires, rates are certain to rise.
The state needs to look to the most efficient and effective ways to crowd-in capital to support its catastrophe risk and a state financial entity issuing its own brand of catastrophe bonds (insurance-linked or disaster-linked such as parametric), directly using its own treasury to avoid certain costs, while still offering the tax terms investors typically want to see in such an offering, could be a compelling way to recapitalise and risk finance for the future.
It might also show an interesting way forwards and set an example for other state insurance entities such as the California Earthquake Authority (CEA), for who reinsurance costs have become more of an issue in recent years.
Of course, what’s important is not the semantics or words being used, but the fact the legislature in California will now discuss a bill that could raise the prospects of its own development bank issuing a third-party capitalised security designed to recapitalise the claims paying capacity of the FAIR Plan.
If that turns out to be purely natural catastrophe risk-linked, or insurance indemnity-linked, as in the cat bonds we know, it could set an example for how governments can leverage their own treasuries and financial institutions to source efficient and responsive funding for natural disasters, as well as for climate related risks.
These government, state, or municipal entities require access to all sources of efficient financing and within those arrangements insurance-linked and parametric structures can play a very beneficial role. Which in securities form can drive participation from global investors in supporting risk transfer and resilience building for natural catastrophe exposed regions of the world, like California.
Read all of our coverage related to the Los Angeles, California wildfires here.
