The bonds will help economies get cheaper insurance against natural disasters.
The World Bank has launched a ‘MultiCat Program’ that will allow governments and public entities in developing countries to buy insurance on affordable terms in the form of ‘catastrophe bonds’.
Mexico became the first country to issue a $290 million series of notes using the program earlier this month. The bank had worked in partnership with Mexico to develop it. The multi-donor trust fund, the Global Facility for Disaster Reduction and Recovery, financed the risk modeling analysis needed to assess the probability and severity of catastrophic events in that country.
Only three per cent of potential losses in developing countries are insured (compared to 45 per cent in developed countries). As a result, such events exact a devastating toll on public finances when governments have to cover the costs of relief and reconstruction efforts.
To help these governments, the bank has launched a new catastrophe bond issuance platform —the MultiCat Program — that will allow governments and public entities in these countries to buy insurance on affordable terms. “Most developing countries are unable to access international insurance and reinsurance markets to cover themselves against such contingent liabilities,” says the bank.
Over the past decade, there has been an increase in the intensity and damage caused by natural disasters worldwide. But emerging countries have been hit the hardest, experiencing a cumulative loss equivalent to seven per cent of their total gross domestic product due to destruction caused by natural disasters between 1977 and 2001 alone, according to a paper co-authored by World Bank expert Eugene Gurenko.
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“High and volatile insurance premiums, the complexity of contracts, and the insurance industry’s limited capacity to absorb extreme risks, bar many countries from accessing the international insurance markets,” says Ivan Zelenko, head of derivatives and structured finance at the World Bank treasury.
Countries highly vulnerable to natural disasters needed an innovative approach to optimise their risk coverage and premium terms, and mitigate the impact on government budgets.
With over $150 trillion in assets, the international capital markets have the depth and liquidity to absorb huge risks and generate timely payouts. Various financial instruments exist for this purpose, including catastrophe bonds. These bonds allow investors to diversify their assets and pay much higher interest rates, to compensate for the risk of the issuer not repaying the principal in the event of a major catastrophe.
But many disaster-prone countries cannot access these sophisticated financial instruments. This will allow governments and public entities in these countries to buy insurance on affordable terms in the form of a catastrophe bond. These bonds will provide a government with immediate access to liquidity to fund emergency relief operations after a natural disaster, thus reducing volatility in fiscal budgets, while avoiding the need to set up idle reserves.
The MultiCat platform is flexible and can support a variety of structures, including the pooling of multiple perils (earthquake, hurricane, rainfall) in different regions. The pooling of different risks helps attract new investors, enlarging the investor base and lowering the insurance premium over time.
Bonds issued under the platform will carry the MultiCat brand name and use a common legal structure and documentation, with the World Bank acting as arranger. Thus, issuing countries will benefit from the bank’s expertise in identifying and pooling risks, as also pulling together highly complex transactions and attracting a broad range of investors.
These products and services are most effective as part of a broader catastrophe risk management strategy that involves layering resources based on the severity and frequency of natural disasters.