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Rating Action:

Moody's affirms California Earthquake Authority revenue bonds; changes outlook to negative

04 Mar 2010

$220.5 million of outstanding Series 2006-B revenue bonds affected.

New York, March 04, 2010 -- Moody's Investors Service has affirmed the A3 rating on the California Earthquake Authority's (CEA) 6.169% fixed rate Series 2006-B revenue bonds (mature July 20, 2016) and changed the rating outlook to negative from stable. The outlook was changed to negative because risk exposure has become elevated relative to claims-paying capacity and could increase further as the CEA continues to raise public awareness of the importance of earthquake insurance.

The CEA is a privately financed, publicly managed entity that offers residential earthquake insurance in California through participating insurance companies.

Moody's A3 rating on the CEA bonds is based on the security provided by pledged revenues, which consist principally of pledged policyholder premiums and investment earnings. Pledged revenues are the sole source of credit support for the bonds.

The main risk to bondholders, in Moody's opinion, is the possibility that state authorities may curtail CEA's activities under certain circumstances. Notably, if a major earthquake causes the CEA to believe that its claims-paying capacity will no longer be sufficient to meet policyholder claims in full, then by law the state insurance commissioner must order the CEA to stop renewing or writing new policies. While the commissioner may lift such an order at any time, until then, pledged revenues would no longer be sufficient to service the bonds. Accordingly, Moody's rating is based on a probabilistic assessment of CEA's claims-paying capacity to meet policyholder claims in full and a possible expected loss to the bonds given CEA's loss curves from peril modeling.

"We changed the rating outlook to negative because CEA's risk exposure has increased faster than its claims-paying resources," said Kevin Lee, a senior credit officer at Moody's. In particular, exposure-in-force has grown from $227.4 billion at 12/31/2006 to $280.7 billion at 12/31/2009 (+23.4%) whereas claims-paying capacity has only grown from $8.7 billion to $9.7 billion (+11.4%) over the same period. As of December 31, 2009, CEA's claims-paying capacity can absorb annual earthquake modeled losses corresponding to about a 1-in-500 year return period.

Moody's expects to resolve the outlook within the next 12 months. The outlook would likely return to stable if the CEA can maintain its claims-paying capacity at levels that can absorb losses at or above a 1-in-500 year return period (through buildup of capital, use of reinsurance, increase in premium rates, a federally guaranteed, post-event debt program, etc.). The rating would likely be downgraded otherwise. Moody's also expects debt service coverage (ratio of pledged revenues to maximum annual debt service) to remain above 5x (estimated 11x for full year 2009).

According to CEA's bond counsel, the state insurance commissioner would still have a fiduciary duty to enable the CEA to repay bondholders even after he issues a cease-and-desist order to the CEA. Moody's has not accorded any benefit to this possible remedy because it falls outside the bond's indenture (i.e., the indenture states a cease-and-desist order constitutes an event of default if it lasts for longer than 60 days) and it is uncertain how the CEA would repay bondholders if pledged revenues were to cease.

The CEA bonds are not backed by the faith and credit of the State of California. Moody's has not contemplated any support from the state, nor does it believe that the state's budget issues will have a material impact on CEA's pledged revenues due to the bondholder protection afforded by the indenture's non-impairment covenant.

The following rating has been affirmed and the outlook changed to negative from stable:

California Earthquake Authority -- 6.169% Series 2006-B Revenue Bonds at A3

The CEA was created by the California Legislature in 1996 to enhance availability of residential earthquake insurance following the Northridge Earthquake. As of December 31, 2009 it had estimated claims-paying capacity of $9.7 billion, consisting of $3.5 billion in available capital, $0.3 billion of revenue bond proceeds, $3.1 billion of reinsurance protection and $2.8 billion of post-event industry assessment capacity. Since its inception, CEA has paid out $3.7 million in losses and loss adjustment expenses.

The last rating action on CEA was on July 12, 2006 when Moody's assigned an A3 rating to the revenue bonds.

The principal methodology used in rating the CEA was Moody's Global Rating Methodology for Property and Casualty Insurers, published July 2008 and available on www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. The rating was also assigned by evaluating factors believed to be relevant to the credit profile of the issuer such as i) the business risk and competitive position of the issuer versus others within its industry or sector, ii) the capital structure and financial risk of the issuer, iii) the projected performance of the issuer over the near to intermediate term, iv) the issuer's history of achieving consistent operating performance and meeting budget or financial plan goals, v) the nature of the dedicated revenue stream pledged to the bonds, vi) the debt service coverage provided by such revenue stream, vii) the legal structure that documents the revenue stream and the source of payment, and viii) and the issuer's management and governance structure related to payment. These attributes were compared against other issuers both within and outside of CEA's core peer group and the rating is believed to be comparable to ratings assigned to other issuers of similar credit risk. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.

New York
Kevin Lee
VP - Senior Credit Officer
Financial Institutions Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Stanislas Rouyer
Senior Vice President
Financial Institutions Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's affirms California Earthquake Authority revenue bonds; changes outlook to negative
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