The government of Mexico has returned to the catastrophe bond market with the help of the World Bank and its International Bank for Reconstruction and Development (IBRD), seeking a $425 million or larger slice of parametric earthquake and hurricane disaster insurance from the capital markets through an issue we’ve named IBRD / FONDEN 2020 that is the first to incorporate sustainable development bond features.
The new transaction, which has just come to market according to sources, will be the sixth catastrophe bond that the government of Mexico’s natural disaster fund, FONDEN will be the ultimate beneficiary of.
Details on the others, the soon to mature 2018 issuance IBRD CAR 118-119, the 2017 issuance that was triggered by the Chiapas earthquake IBRD / FONDEN 2017, the 2012 cat bond that paid out after hurricane Patricia MultiCat Mexico Ltd. (Series 2012-1), the 2009 issued MultiCat Mexico 2009 Ltd., and the 2006 issuance CAT-Mex Ltd., can all be found in our extensive catastrophe bond Deal Directory.
Having benefited from a number of payouts after both earthquakes and hurricanes struck Mexico, it is encouraging to see its government returning to replace an potentially upsize on the disaster insurance coverage that it has secured through its catastrophe bonds.
This latest catastrophe bond from the World Bank and IBRD has a twist to it, in that it is the first ever cat bond where the proceeds from the sale of the notes can be used by the IBRD to finance sustainable development projects in its member countries.
It’s a hybrid structure, incorporating elements of a sustainable development bond alongside a catastrophe bond, a concept that has been broadly discussed around the market as one way to tap into investor appetite for ESG assets.
It’s assumed that means the IBRD can use this liquidity within its developmental programs and projects, but if the catastrophe bond is triggered it will make up the collateral to the agreed amount.
In this way, it is a kind of sustainable development bond investment, as well as a catastrophe linked investment, at the same time. Which may help to open up the market to an increased range of institutions and investors, broadening the insurance-linked securities (ILS) investor base.
For this new IBRD / FONDEN 2020 catastrophe bond, which we’ve named as such as the issuance has no other defining series details right now, FONDEN, the natural disaster insurance fund of Mexico, is the ultimate insured along with its trustees.
The trustee of FONDEN acts as the insured for the coverage, entering into an insurance agreement with the Mexican government-owned insurer Agroasemex S.A.
Agroasemex S.A. then enters into a reinsurance arrangement with Swiss Re, who act as the ceding reinsurance firm, and Swiss Re in turn enters into retrocessional agreements with the IBRD, the issuer of the notes.
In this case, the retrocessional reinsurance agreements will be capitalised by the sale of four tranches of catastrophe bond notes, that will be sold to capital market investors to fully collateralise the transaction.
There will be two tranches of earthquake-linked notes issued, as well as one tranche of notes covering Atlantic named storms and one covering Pacific named storms, so providing protection for the two main natural disaster perils Mexico faces, hurricane and earthquake risks.
All four tranches of notes will provide their disaster insurance coverage to the Mexican government on a parametric trigger and per-occurrence basis across a four-year term, we understand.
The covered area for both perils are the exposed areas of Mexico, as well as some small overlapping areas of the United States where earthquakes could occur and still cause significant damage in Mexico, or a hurricane could come ashore and breach the parametric trigger in the U.S. but then impact Mexico significantly as well.
At this time the transaction is offering cat bond investors $425 million of notes across the two perils of wind and quake in four tranches of catastrophe-linked Capital At Risk notes to be issued by the IBRD, we’re told.
A $125 million tranche of Class A notes is a lower-risk earthquake exposed tranche of notes, having a modelled expected loss of 0.9% and price guidance of 3% to 3.5%.
A $100 million tranche of Class B notes is a higher-risk earthquake exposed tranche, with a modelled expected loss of 5.78% and price guidance of 8.25% to 8.75%.
A $100 million tranche of Class C notes will cover named storms and hurricanes on the Atlantic coast, with a modelled expected loss of 5.61% at the base case and price guidance for investors of 10% to 10.5%.
The final tranche is a $100 million Class D layer, to cover named storms and hurricanes on the Pacific coast of Mexico, which have a modelled expected loss of 4.06% and are offered to investors with price guidance of 6.75% to 7.25%.
We understand the parametric trigger for earthquake risks is based on magnitude and location of occurrence, with Mexico broken up into boxes for each tranche of notes and payout rates of 25%, 50%, 75% and 100% of principal determined by where a quake strikes and how powerful it is.
That’s the same kind of trigger as previous World Bank earthquake cat bonds for Mexico, but we’re also told that the boxes are now much smaller around significant population centres, to allow for a more highly calibrated parametric trigger to enhance the protection.
On the named storm and hurricane side, the parametric trigger design is similar again to previous World Bank catastrophe bonds for Mexico’s FONDEN.
That means there is a line along the Atlantic and Pacific coasts, for the respective tranches of notes, over which a hurricanes eye needs to pass with a certain minimum central pressure or lower for a payout of 25%, 50% or 100% to become due.
Hence, it is location and severity that are the core components of both earthquake and hurricane parametric triggers and will define whether any tranches of this new Mexico catastrophe bond pay out over the four years it is in-force and providing the country with disaster insurance protection.
As said, it’s good to see Mexico returning to the catastrophe bond market with the assistance of the World Bank and IBRD, as well as reinsurance firm Swiss Re.
The repeat issuances from Mexico and its recoveries made from its cat bond program are a clear sign to other countries and governmental actors of the benefits of robust disaster insurance and that the capital markets, through catastrophe bonds, can provide this in a responsive, parametric trigger based format.
We’ll update you as this new IBRD / FONDEN 2020 catastrophe bond progresses to market for the government of Mexico and you can read about this and every other cat bond transaction in the Artemis Deal Directory.