Mexico has returned to the catastrophe bond market with a new transaction seeking a source of reinsurance risk transfer for its Fund for Natural Disasters (El Fondo de Desastres Naturales), better known as FONDEN, in a $290 million deal we’ve called IBRD / FONDEN 2017, assisted by the World Bank.
Like the recently completed pandemic cat bond, we’re told this return to the cat bond market for Mexico’s FONDEN is being issued by the World Bank Group’s multilateral development bank, the International Bank for Reconstruction and Development (IBRD) which is facilitating the transaction through the issue of three tranches of catastrophe-linked Capital At Risk notes.
The IBRD will issue three series of catastrophe-linked Capital At Risk notes (CAR Series 113, CAR Series 114 and CAR Series 115) through its debt issuance facility, which will be sold to qualified investors and insurance-linked securities (ILS) specialists.
At launch the three tranches are seeking a total of $290 million of protection for the ultimate sponsor, which is FONDEN, although the deal has a complex series of counterparties involved, with the trustee of FONDEN technically the insured, the Mexican government-owned insurer Agroasemex S.A. sitting in between and entering into a reinsurance arrangement with Munich Re who act as ceding reinsurance firm and enter into retrocessional agreements with the IBRD.
The notes issued by the IBRD will provide FONDEN with parametric insurance protection against losses due to earthquakes and named storms on both the Pacific and Atlantic coasts. The parametric trigger features boxes for each peril, with different levels of payout possible depending on where or how powerfully an earthquake or named storm strikes Mexico.
A payout as low as 25% of the notes principal could be possible, under the terms the parametric trigger has been structured with.
The currently $120 million sized CAR Series 113 Class A notes under this issuance will provide the parametric earthquake protection, across a three-year term, and can have a 25%, 50%, 75% or 100% payout, depending on a qualifying event’s characteristics. These earthquake linked notes have a modelled attachment probability of 5.73%, an expected loss of 3.43% and are going to be marketed to investors offering a risk margin of between 5% and 5.5%, we understand.
The Class B CAR Series 114 notes will provide Atlantic named storm protection and are sized at $85 million, with coverage over a three wind season term and a 25%, 50% or 100% payout possible. This tranche of notes have a modelled attachment probability of 7.97%, an expected loss of 5.56% and will be marketed offering a risk margin in a range from 9.9% to 10.5%.
The final Class C Series 115 tranche will offer the Pacific named storm protection, and are also sized at $85 million with their coverage over a three wind season term and 25%, 50% or 100% payouts possible. This tranche has a modelled attachment probability of 5.8%, an expected loss of 3.96% and will be marketed offering a risk margin in a range from 6.5% to 7.1%.
This parametric catastrophe bond transaction will provide FONDEN and the Mexican government with a source of risk transfer or insurance capacity that will be able to pay out more quickly than a traditional arrangement and with a trigger that should be relatively transparent.
The parametric box arrangement is not perhaps as simple as other parametric cat bonds, but this has been structured so as to offer the maximum protection to the areas carrying the greatest exposure for the country.
It’s encouraging to see the Mexican government look to the capital markets once again, to provide a rapid paying source of efficient risk transfer for its natural disaster fund. Alongside the other reinsurance arrangements FONDEN will have in place the catastrophe bonds provide it with valuable diversification of capital sources as well.