Catastrophe bonds can assist in humanitarian aid financing

Catastrophe bonds are increasingly seen as a financial structure and instrument that could secure and disburse financing for humanitarian response in a more efficient manner, with researchers and institutions now investigating how the cat bond could be utilised.

Humanitarian response is often drastically underfunded and the necessary financing often disbursed in a manner that causes it arrive late, or be poorly targeted.

This includes the response to humanitarian emergencies such those caused by conflict and war, a migration or refugee influx, health related humanitarian emergencies and even the response to climate or natural catastrophe events that result in significant population impacts.

The World Bank’s recent use of the catastrophe bond structure alongside traditional insurance and reinsurance capital for pandemic emergency response, through the creation of the Pandemic Emergency Financing Facility (PEF) and the resulting issuance of$320 million of IBRD CAR 111-112 catastrophe bonds to back the PEF, has sparked conversations about how else the cat bond structure could be put to good use to address humanitarian crises.

Researchers from the Johns Hopkins Bloomberg School of Public Health and Center for Humanitarian Health call for a complete redefinition of humanitarian financing, to take advantage of capital markets and financial structural innovation, in order to deliver and deploy emergency funding in a better way.

“Given the number of complex conflicts and the magnitude of displacement, new sources and mechanisms of financing are needed,” Paul Spiegel, a director of the Center for Humanitarian Health wrote in a recent article.

He explains that the catastrophe bond model and insurance windows are being used by multilateral organisations and says that, “An exploration of a Humanitarian Health Financing Model using bonds and insurance windows should be undertaken to assess its feasibility. At a minimum, the funds could be used as a stopgap when urgent funds are needed at the beginning of an emergency, while being backed by governments to reduce the risk.”

The research calls for, “A paradigm shift towards pre-emergency and multi-year planning using risk-transfer instruments.”

It proposes the development of a financing model for humanitarian crises specifically for the acute phases of an emergency, focusing on refugee health financing but the application of this to other, wider humanitarian response financing needs is clear.

The research looks to risk transfer instruments, from insurance and reinsurance, to catastrophe bonds and swaps, citing these as effective ways to transfer risk into the hands of funders and investors willing to take on the risks associated with crises occurring.

A Refugee Health Financing Model (FinRef) is presented in the research, that would utilise techniques such as index insurance and parametric trigger catastrophe bonds, in order to deliver contingent funding for refugee emergencies at just the right time.

The delivery of capital liquidity into the country or region affected by a humanitarian emergency quickly and at the right time is critical to enabling the best possible response, hence index or parametric triggers that release financing could be an appropriate way to mitigate the risk somewhat.

Of course someone would be required to put up the capital to back these humanitarian aid catastrophe bonds but, in the same way as the PEF, donors would also be involved in paying premiums for those benefitting from the coverage.

Whether the typical ILS market investor base would be willing to back such bonds would depend on their triggers and how the risk of attachment could be analysed and measured. However, being parametric in nature there is likely to be some appetite for any bond issuance such as this from ILS funds and definitely from major institutional investors, for whom this would also be an ideal investment opportunity with social impact.

A World Bank supported global humanitarian emergency financing facility, akin to the PEF, could be a viable mechanism to make the response to a crisis more robust.

We know that discussions at the World Bank in recent years have increasingly focused on aid and migration related issues, given the potential for major crises due to conflict, climate and other issues, so it’s natural to assume that the use of insurance, reinsurance and catastrophe bonds, in a similar way to the PEF, has also been discussed.

It’s encouraging to see the researchers work, as it shows that the catastrophe bond model of risk transfer and contingent financing has potential broader applications in areas that could provide enormous societal benefits in the future.