Pandemic bondsPandemic Bonds: The Financial Cure We Need for COVID-19?

By Dror Etzion, Bernard Forgues, and Emmanuel Kypraios

Published 31 March 2020

Like other financial players that have embraced innovation in recent years, insurers too have developed novel tools and products. One such innovation is catastrophe bonds. A catastrophe bond provides the issuer (usually either an insurer or a reinsurer) with financial protection in case of a major catastrophe. Most catastrophe bonds cover extreme natural events such as hurricanes or earthquakes, but some bonds cover pandemics like the one the world is facing now.

Countries around the world are taking unprecedented action to stem financial collapse due to COVID-19. Governments are acting as insurers of last resort, providing liquidity to both individuals and corporations in dire straits.

In these perilous times, the insurance sector itself will also be paying out claims, whether it’s to people who have experienced damage to life or property or to businesses and even to sovereign countries.

Insurance companies are designed to bring order and stability to precarious financial situations and they have the wherewithal to do so.

Catastrophe Bonds
Like other financial players that have embraced innovation in recent years, insurers too have developed novel tools and products. One such innovation is catastrophe bonds.

A catastrophe bond provides the issuer (usually either an insurer or a reinsurer) with financial protection in case of a major catastrophe. Most catastrophe bonds cover extreme natural events such as hurricanes or earthquakes, but some bonds cover pandemics like the one the world is facing now.

In effect, when employing catastrophe bonds, insurers can access capital from large asset owners such as pension funds and other institutional investors. Insurers need this extra layer of protection for themselves, because catastrophes typically hit a region very abruptly.

This means that when a major disaster strikes, large amounts of money need to be disbursed suddenly, threatening the insurer with insolvency. Asset owners are willing to provide this coverage — for a premium, often hefty — because it can be an effective diversification strategy: earthquakes, hurricanes and pandemics are essentially unrelated to global economic trends.

Catastrophe bonds are very specific in terms of the coverage they provide. Like other insurance products, they are binding contracts that specify exactly what perils are covered and when the funds are released or “triggered.”

For instance, a catastrophe bond can be triggered if an earthquake of a certain magnitude occurs in a specific region on the U.S. West Coast within three years.

Alternatively, a bond might be triggered to recoup some of the insurance payouts following the catastrophe, but only if they exceed a certain pre-defined dollar threshold. As in regular reinsurance, catastrophe bonds provide payouts in tranches, for example to cover the losses incurred by the issuer after the first $2 billion in losses, up until $2.3 billion in losses, following a specific extreme event.

To date, 1,069 distinct bonds within 648 offerings have been issued since the first one in 1997.