Chile looks to catastrophe bonds for disaster insurance

Chile is the latest sovereign government that is reportedly looking to a catastrophe bond issuance, providing a responsive source of disaster risk insurance or financing, as part of a goal to become more responsible about disaster and weather risk management.

Speaking at the IMF and World Bank annual meetings held in Lima, Peru earlier this month, Rodrigo Valdes, Chile’s Finance Minister, revealed that the South American nation is actively looking into catastrophe bonds as a potential source of financing for disaster and severe weather risks.

Increasingly, sovereign governments are looking outside of normal insurance and reinsurance market capital for disaster risk protection and recovery financing. The capital market providers of disaster insurance and reinsurance protection, so the specialist insurance-linked securities (ILS) fund managers and investors, are seen as an efficient source of capacity that governments can tap into.

Chile is looking to intermediary organisations like the World Bank to help it look into catastrophe bonds, according to Valdes, which suggests that another MultiCat style cat bond could be on the cards. Having faced 8 major disasters in the last two years, the most recent being the Chile earthquake a month ago, the government needs to find a way to make the expense easier to bear.

Chile has an admirable disaster alert and response operational framework in place, meaning that it can protect as many lives as possible when the worst happens, but the financial cost of disasters creates a burden which causes the government to reallocate budgets as a result.

“The country has learned to handle these situations well in terms of operation,” Valdes explained, but adding that Chile lacked the financial means and resources required for disaster response.

As a result the finance ministry of Chile is exploring catastrophe bonds as one possible mechanism that could provide capital in response to disasters such as earthquakes, volcanic eruptions or flooding.

Valdes notes that other countries have insurance in place for these risks, including catastrophe bonds which he called a kind of direct insurance, but Chile has yet to develop the financial mechanism to make responding to disasters better financed.

Valdes said that it would be akin to going to an insurance company and explained the importance of cost to Chile. For Chile to sponsor a catastrophe bond the cost would need to be comparable with traditional insurance or reinsurance, something that working with the World Bank can assist with as the Bank’s acting as intermediary can reduce frictional costs.

This is not the first time Chile has looked to catastrophe bonds as a potential risk transfer and financing tool for disasters. The country investigated cat bonds prior to the financial crisis, but the timing was not right and likely neither was the cost.

With the cost of catastrophe bond risk capital now at or near the lowest point it’s ever been countries like Chile may find they can access the capital markets more easily than before.

Chile is not the only country currently looking to catastrophe bonds. The Philippines finance minister continues to state that the country is seeking a cat bond issuance by the end of this year, supported by the World Bank.

The interest in cat bonds, parametric triggers and accessing the capital markets for responsive disaster risk financing continues to grow. What the market now needs to see is some of these conversations coming to fruition.