Kroll Bond Rating Agency (KBRA) assigns a rating of AA- with a Stable Outlook to the Revenue Bonds Series 2020B issued by the California Earthquake Authority (CEA).
California Earthquake Authority’s Revenue Bonds ("Bonds") will be issued to enhance its claims paying capacity (CPC), diversify its capital structure, and reduce the cost of its risk transfer program. The rating is based on KBRA’s assessment of the CEA’s financial strength as an essential insurance provider in the state of California as well as key structural aspects of the Bonds. The Bonds benefit from a pledged security interest in future premiums collected on CEA earthquake policies across the state as well as a pledge of CEA’s Available Capital as defined under the California Insurance Code. As of October 17, 2020, CEA’s Available Capital totaled $5.96 billion. CEA’s CPC also includes an $9.55 billion risk transfer layer as well as an additional $1.15 billion available from the proceeds of previous revenue bond issuances.
Key Credit Considerations
CEA has multiple sources of CPC totaling $19.32 billion, which exceeds a modelled 1-400-year return period loss event and is more than two times the modelled loss to the CEA’s portfolio from the Northridge Earthquake - if it were to occur today. CEA is the leading insurer for residential earthquake risk in California and has demonstrated deep knowledge and technical capabilities for this highly specialized insurance risk. CEA only insures residential properties with policies that typically provide somewhat lower coverage and higher deductibles than private market earthquake insurance providers.
As a result of the CEA Act (1996), CEA maintains a dominant market presence and diversified distribution network of predominantly industry leading participating insurers. In addition, the CEA maintains a high credit quality investment portfolio and a low operating expense ratio – exclusive of reinsurance ceding commissions.
The proposed revenue bond program will include annual issuances in the amount of $300-$375 million and will be timed and structured to provide for a minimum of 3.0x annual debt service coverage from pledged revenue during the entire tenor of the planned debt. In addition, CEA is required by law to price policies in an actuarially sound manner and pledges to set premium rates sufficient to support debt service.
Offsetting these credit strengths is the potential of execution risk, as there has not been a major earthquake in California since Northridge. The CEA employs contractors, employees subject to civil-service provisions, and an extensive network of vendors to perform many CEA functions. The functionality of claims handling and other processing operations following a major event has not been tested.
Further, historical earthquake events and data are limited. Modeled earthquake losses could be subject to significant model error. This is somewhat mitigated by CEA’s use of outputs from three different catastrophe models, which all generate similar loss levels at return periods greater than 1-250. In addition to model error, there is the potential of significant unmodelled events.
Key rating sensitivities for an upgrade include significant CPC growth relative to PMLs over the long-term, along with a favorable change to the composition of CPC, with reduced reliance on risk transfer mechanism and Available Capital becoming the predominant source of claims funding and favorable regulatory and/or legislative changes.
Key rating sensitivities for downgrade include a decline in risk transfer ability or credit quality of reinsurance program, deterioration of CPC from a meaningful loss event/series of events which is not promptly replenished, a significant increase in PMLs above CPC over time or regulatory and/or legislative changes negatively affecting the function and scope of the CEA.
KBRA’s ratings incorporate all material credit factors including those that relate to Environmental, Social and Governance (ESG) factors. Throughout every analysis, KBRA captures the impact of ESG factors in the same manner as all other credit-relevant factors. More information on ESG Considerations for the Insurance sector can be found here.
Among the ESG factors that have impact on this rating analysis are Social factors. The CEA is a not-for-profit, publicly managed, privately funded risk-bearing entity created by the California Legislature. This insurance provides an important financial backstop designed to support Californians in the event of an earthquake by funding the restoration of damaged property. The CEA is fulfilling an explicit public policy objective to provide insurance that would not otherwise be available through the private insurance markets. The CEA’s unique statutory mandate has distinct implications with respect to the long-term viability of the enterprise. KBRA factors this into its credit analysis as part of its Qualitative Rating Determinant 3: Company Profile and Risk Management.
Further information on key credit considerations, sensitivity analyses that consider what factors can affect these credit ratings and how they could lead to an upgrade or a downgrade, and ESG factors (where they are a key driver behind the change to the credit rating or rating outlook) can be found in the full rating report referenced above.
A description of all substantially material sources that were used to prepare the credit rating and information on the methodology(ies) (inclusive of any material models and sensitivity analyses of the relevant key rating assumptions, as applicable) used in determining the credit rating is available in the U.S. Information Disclosure Form located here.
Information on the meaning of each rating category can be located here.
Further disclosures relating to this rating action are available in the U.S. Information Disclosure Form referenced above. Additional information regarding KBRA policies, methodologies, rating scales and disclosures are available at www.kbra.com.
KBRA is a full-service credit rating agency registered as an NRSRO with the U.S. Securities and Exchange Commission. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus. KBRA is also recognized by the National Association of Insurance Commissioners as a Credit Rating Provider and is a certified Credit Rating Agency (CRA) with the European Securities and Markets Authority (ESMA). Kroll Bond Rating Agency Europe is registered with ESMA as a CRA.
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