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

The first pandemic bond was issued in 2003, when Swiss Re floated a $400 million offering to provide coverage against extreme mortality events such as war, terrorism, pandemics or nuclear attack.

The bond would trigger if the mortality index (which measures annual general mortality in five countries, the U.S., the United Kingdom, France, Switzerland and Italy) exceeded 130 per cent of its baseline due to any of these scenarios.

Since then, a total of 27 additional catastrophe bonds have been issued with a pandemic component. To date, none of them have been triggered.

Who Benefits When Catastrophe Strikes?
The use of catastrophe bonds, perhaps unsurprisingly, is controversial. One critique emphasizes the huge uncertainty inherent in attempting to quantify what are, by definition, very rare, unpredictable events.

Others have noted that catastrophe modelling is problematic in that it harnesses tacit knowledge shared within closed, opaque communities. In our research, we discovered that catastrophe models don’t function any better than guesswork, and seem to have become popular mainly because of the absence of high-return options in more traditional stocks and corporate bonds.

This controversy seems to be especially acute for pandemic bonds. For example, opining about the latest bond with a pandemic component — the Pandemic Emergency Financing Facility (PEF) sponsored by the World Bank — Lawrence Summers, the former U.S. treasury secretary, went so far as to call it is “goofy” and an “embarrassing mistake.” After reading the 386-page prospectus, we agree.

That’s because, from a public welfare perspective — as we are all learning now — the speediness of response is crucial. The PEF states clearly in the prospectus that its purpose is “to help prevent rare, high-severity disease outbreaks from becoming pandemics.” This means that it should trigger and pay out before a disease like COVID-19 becomes a pandemic, not after.

In conclusion, some healthy skepticism is warranted when considering the social value of catastrophe bonds.

Conceptually, they can be a useful financial tool, but the devil is in the details: What exactly is written in the fine print? How accurately is the risk modelled? How big are the payouts to investors? How quickly are the funds disbursed?

A bond triggered by a World Health Organization declaration of a pandemic, with immediate payouts and large sums of money available, would be a bond with high social value. A bond that provides too little money too late — or none at all — is just financialization run amok.

Dror Etzion is Associate Professor, Strategy and Organizations, McGill University. Bernard Forgues is Professor of organization theory, EM Lyon. Emmanuel Kypraios is Assistant Professor in Management, School of Business, National University of Ireland Maynooth. This article is published courtesy of The Conversation.