Recent hurricanes in Mexico show potential for broader cat bond triggers

When Mexico was hit by two hurricanes recently, the resulting damage was extensive but largely caused by rainfall, flooding and landslides rather than hurricane force winds, which meant that the countries catastrophe bond, MultiCat Mexico Ltd. (Series 2012-1), was not troubled.

The MultiCat Mexico catastrophe bond provides the government of Mexico’s natural disaster fund (FONDEN) with a source of multi-year, fully-collateralized reinsurance cover for extreme hurricane and earthquake events. The MultiCat cat bond is designed to be triggered based on actual catastrophe event parameters, a parametric trigger, and targets only the most extreme hurricane and earthquake events as a result.

However, two hurricanes which recently hit Mexico, one on each coastline, have highlighted the need for the country to have cover for less extreme hurricanes and for the severe rainfall and flooding that these storms bring. Hurricane Manuel, which hit the Pacific coast, and hurricane Ingrid, which hit the Gulf coast, are expected to between them cost between roughly USD$1.24 billion and USD$3.73 billion, with risk modeller EQECAT estimating at least $200m of insured losses from hurricane Manuel alone.

In a report on the two hurricanes and the resulting flooding, rating agency Moody’s Investor Services said that the damages from the events will drain the resources of FONDEN and that the Mexican governments natural disaster fund will prove to be insufficient to fully cover state losses from the events.

Meanwhile Goldman Sachs said that the storm damage to Mexico could hurt the countries GDP and increase the chance that the government cuts rates there. These are just the sort of impacts you’d expect to see in a country when a catastrophe bond payout would be extremely welcome.

The MultiCat Mexico catastrophe bond is designed to payout for the most extreme of events, but these hurricanes show that Mexico needs coverage for less severe events, for frequency rather than severity and for the rainfall induced flooding from tropical storms. There is nothing wrong with MultiCat, it serves an extremely valid purpose, but his does highlight an area that the cat bond market could find opportunity, if investors are prepared to back broader trigger definitions.

A broader trigger for a Mexican hurricane catastrophe bond could include multiple storm impacts within a defined period, perhaps cover an entire season, include rainfall amounts combined with storm severity or perhaps even a trigger based on reported government economic losses. So, a cat bond could include a trigger for a single major storm, a trigger for multiple less severe storms striking within a defined time period and a trigger combining occurrence of storms with rainfall amounts, for example.

The cat bond is well suited to being used as a form of sovereign level disaster protection, providing contingent financial support just when a government or country most needs it. But for cat bonds to be truly effective as sources of sovereign disaster contingent financing, broader (or perhaps wider) trigger definitions would definitely be useful.

If the trigger was designed in an explicit manner, with language clearly demonstrating what is included and what isn’t so investors can quantify the risk of an event causing a cat bond payout, then given investors appetite for ILS as an asset class right now it seems likely that such transactions could receive sufficient support to get them to market.

By broadening (or widening) triggers, to include more of the impacts and perils that major economic loss can be caused by during natural disasters, the cat bond and ILS market may also find new ways to diversify. Such efforts would likely be welcomed by governments looking for risk transfer as well as investors looking for new and diverse cat bonds to allocate capital to.