FONDEN, Mexico’s disaster fund, exceeds its annual budget

You would be forgiven for thinking that FONDEN, the Fund for Natural Disasters of Mexico, would be perfectly able to cope with losses from natural disasters as it has the MultiCat Mexico 2009 Ltd. catastrophe bond to fall back on. Unfortunately, the types of disasters which cause regular problems in Mexico aren’t covered by that transaction.

MultiCat Mexico provides earthquake and hurricane cover to FONDEN, but for an event to trigger the deal a hurricane must have a pressure lower than 944mb at the centre to qualify. Other tranches of MultiCat Mexico cover earthquakes above 7.4Mw. That’s great for the large natural disasters which Mexico is prone to but it’s not disasters of that magnitude which are causing FONDEN to exceed its annual budget this year.

The disasters which are causing FONDEN budget problems are heavy rainfall and mudslides caused by heavy rains. Those rains don’t even have to come from a named tropical storm, any low pressure system can cause torrential downpours in parts of Mexico due to the geography and topography. FONDEN has had to resort to using the Mexican governments extra income from oil sales to finance its claims payments this year.

FONDEN’s budget for 2010 was 7b pesos but it has already spent 12 billion pesos and it suspects that figure could increase to 25b pesos as not all losses have been assessed yet. Tropical storm Karl has the potential to exacerbate the issue and cause further flooding in Mexico in the next few days.

Luckily FONDEN has a legal clause which says they can use government oil profits to pay claims otherwise this would be devastating for the countries finances. This is yet another prime example of an opportunity for weather-index insurance products to be utilised. It seems that FONDEN itself could do with an index-linked form of rainfall insurance but there is also an opportunity for microinsurance to protect farmers and locals as well. We haven’t seen a cat bond cover rainfall risks but perhaps the next MultiCat deal should look to hedge the risks of mudslides caused by heavy rain.