Efficient, precise, refined, the World Bank’s latest cat bond

by Artemis on August 7, 2017

The parametric trigger in the latest catastrophe bond to be issued with the assistance of the World Bank, the $360 million Mexico earthquakes and named storm cat bond IBRD / FONDEN 2017, offers the sponsoring government of Mexico a more efficient layer of risk transfer, due to its more precise and refined structure, according to GC Securities.

The cat bond issuance was completed last week, with the World Bank hailing the transaction as an example of “innovative financial solutions” that can assist governments to “eradicate poverty and boost shared prosperity.”

Mexico has long utilised the global reinsurance markets for its disaster risk transfer and financing needs, with the capital markets then beginning to play a role with the 2006 CAT-Mex Ltd. cat bond transaction, which was then followed in 2009 by MultiCat Mexico 2009 Ltd. with the World Bank’s support and then in the MultiCat Mexico Ltd. (Series 2012-1) transaction.

With each use of the capital markets as a source of protection the parametric triggers underlying the structure have been further developed, in order to more closely match the coverage with the expected economic impacts to Mexico.

With the 2017 deal, which is the first to have been issued using the World Bank’s Capital-At-Risk notes program, Mexico benefits from a more tuned coverage thanks to further innovation within the trigger design.

GC Securities, the investment banking and insurance-linked securities (ILS) specialist unit of reinsurance broker Guy Carpenter acted as joint structuring agent and joint manager for the transaction, alongside reinsurer Munich Re, and was also the sole bookrunner and initial purchaser of the notes.

GC Securities has now been responsible for placing all six insurance-linked security (ILS) series for the IBRD’s Capital-at-Risk notes program, which the firm says reaffirms its commitment to the public sector.

Commenting on the transaction, Aidan Pope, CEO of Latin America and the Caribbean at Guy Carpenter, said; “The World Bank Capital-at-Risk notes protecting FONDEN provide a very cost-efficient source of risk transfer and maximizes protection in one of the regions with the greatest exposure. With this issuance, the government of Mexico has increased its resiliency in line with their overall macroprudential risk management strategy.”

GC Securities said that 37 capital market investors supported the transaction and that “robust” interest from investors, which were largely ILS fund managers, helped to drive pricing down making the coverage more efficient for Mexico.

As has been seen with many cat bonds lately, the pricing of this latest World Bank transaction was extremely keen.

With all three tranches of capital-at-risk notes issued pricing between 50 and 60 basis points below the initial guidance, the benefit to Mexico of cheaper and more efficient coverage is clear.

“All three classes rank amongst the top 10 cat bonds issued thus far in 2017, based on the lowest margin between the annualized risk spread and the annual expected loss. Furthermore, using the same margin metric, the Class A and Class C Notes rank amongst the top 10 cat bonds issued ever,” GC Securities explained.

With lower pricing and broader coverage the latest cat bond for Fonden represents a more efficient layer of risk transfer, GC Securities said.

“The more precise parametric trigger significantly increases the number of trigger boxes by peril and uses a step payment structure rather than a mostly binary payout structure,” the company explained, which helps to provide more granularity when structuring the deal to best support the Mexican government’s needs.

“Depending on an earthquake’s location, moment magnitude and depth, the earthquake event payouts that reduce principal are in four 25 percent increments, while the Named Storm bonds, which are based on storm track and the minimum calculated central pressure for each Named Storm Gate, have event payouts that reduce principal at 25, 50, and 100 percent,” GC Securities continued.

Commenting on the refined trigger design, Cory Anger, Global Head of ILS Origination and Structuring for GC Securities, said; “The refined ‘Cat-in-a-Box’ structure for earthquake and the use of Named Storm Boxes for named storms in the World Bank Capital-at-Risk notes benefitting FONDEN better aligns the earthquake or storm severity hazard parameters and the actual loss suffered by the government of Mexico, given the trigger improvements and broader geographic scope.

“Additionally, the transparent trigger better expedites payments to support Mexico’s recovery efforts and needs.”

A more refined approach to trigger design, in order to offer a more precise coverage match for the government’s exposure should ensure that any payouts are more closely linked to the actual impacts suffered.

Mexico itself hailed the transaction as an example of socially responsible finance, where the markets can help to support disaster recovery and risk financing, through a responsive structure that pays out on occurrence of catastrophe parameters.

The repeated visits to the capital markets for catastrophe bond coverage make the Mexican government the most active sovereign sponsor of cat bonds to-date. As the country’s needs for risk transfer increase it is to be expected that the cat bond market and parametric coverage will continue to play a vital role in preparing the country for the worst and helping it to recover should disaster strike.

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