Micro-catastrophe bonds show growing potential for use in disaster risk financing: OECD

A trend towards smaller catastrophe bond issues becoming more feasible as market infrastructure improves has been highlighted by the Organisation for Economic Co-operation and Development (OECD), who suggest that what they term micro-catastrophe bonds have relevant application in disaster risk financing initiatives.

A policy brief authored by Kensuke Molnar-Tanaka and Prasiwi Ibrahim of the OECD Development Centre calls for insurance and catastrophe bonds to be considered as part of the micro-disaster risk financing toolkit for emerging parts of Asia.

The majority of natural disaster losses remain uninsured in emerging Asia, leaving the population vulnerable to financial shocks.

The authors believe that, “Micro-disaster risk financing tools, including micro-disaster risk insurance and micro-catastrophe bonds, can better respond to the specific losses that communities experience, based on more granular knowledge of local risks and needs.”

They elaborate, “While governments and their development co-operation partners have strengthened the use of large-scale, national disaster risk financing (DRF) instruments such as contingency funds, parametric insurance, and catastrophe bonds over the past decade, households, small businesses and local governments often remain financially exposed when disasters strike. Many losses are not insured, meaning that families may lose income and assets, businesses may struggle to reopen, and local authorities may face immediate recovery costs without adequate funding.”

They see strengthening micro-disaster risk finance as one way to complement the larger national programmes, by delivering support more quickly to local communities.

In addition, the paper highlights how smaller disaster risk financing arrangements, including micro-cat bonds, can be tailored to a more localised region and so better match the needs and risks of the local populations, including farmers and small businesses.

Micro-insurance is already widely adopted to deliver timely and responsive financial protection when catastrophes occur, often through the use of locally calibrated parametric triggers.

But, having noticed a growing trend for smaller catastrophe bond issues in the Artemis Deal Directory, often privately placed deals, the authors suggest that this could be an approach that can crowd in institutional capital to help deliver more localised disaster risk financing arrangements with the support of capital market investors.

Citing Artemis data they state, “Micro-catastrophe bonds remain a niche instrument but are becoming more feasible as issuance sizes decline and market infrastructure improves. Catastrophe-bond markets are showing signs of greater flexibility: between 2020 and 2025, 24 catastrophe bonds of USD 5 million or less were issued, compared with only five between 2014 and 2020, and 2026 saw the smallest recorded catastrophe bond to date at USD 2 million.”

Alongside micro-insurance arrangements for disaster risk, micro-cat bonds can “provide predictable liquidity after disasters, reduce pressure on public finances and encourage financial preparedness,” the authors explain.

While the catastrophe bond market remains largely comprised of larger Rule 144A syndicated issuances, typically sized at US $100 million or more, the fact similar capital market risk transfer arrangements can be executed in much smaller sizes is seen as having potential for the micro-disaster risk financing needs of emerging Asia.

“Micro-catastrophe bonds (Micro-CAT bonds) refer to significantly smaller issuances that provide more targeted coverage and can address different layers of disaster risk. Although still uncommon, Micro-CAT bonds have the potential to expand market-based disaster risk financing to specific communities, municipalities and sectors that may not be served by larger transactions,” the authors wrote.

Smaller cat bonds would mean they can be designed more closely to protect the specific risks a community or sector faces, while more closely matching payouts with locally experienced losses, the OECD staff believe.

The authors analysis of Artemis’ data found that smaller catastrophe bonds are becoming more prevalent in the market over-time, while the smallest cat bond issuance seen has gradually declined over-time as well.

“While micro-CAT bonds remain a niche segment of the market, these trends suggest growing potential for their use in disaster risk financing,” the paper states.

Using the example of the $3 million Dunant Re IC Limited (Series 2021-1) catastrophe bond that was sponsored by the Danish Red Cross to provide volcanic eruption risk protection from the capital markets, the authors state, “Its relatively small size and highly targeted coverage illustrate how catastrophe bonds can be adapted to specific risks and populations. Similar structures could potentially be applied to support disaster protection for smaller cities, communities or economics sectors.”

Adding that, “These transactions demonstrate that catastrophe bonds can increasingly support small, targeted issuances. Although only a limited number of such transactions are completed each year, they suggest scope for further development of Micro-CAT bonds within broader disaster risk financing frameworks.”

Finally, the authors call for local government involvement in micro-disaster risk financing, while capital markets can be intermediated by intermediaries such as NGOs or development banks.

In addition, government authorities should invest in hazard monitoring, measurement and exposure data, as “Clear institutional responsibility for trigger data, combined with appropriate data-sharing arrangements, can reduce transaction costs and improve the performance of both microinsurance and Micro-CAT bonds.”

While the majority of the small and typically private catastrophe bonds included in our Deal Directory are hedging transactions within the insurance and reinsurance market, or arrangements that help an investor access risk, the Dunant Re example is a good one as it shows the utility of the catastrophe bond structure in smaller size to provide novel and localised risk transfer protection, while routing the capital to support the risk financing from institutional investors.

That has clear application in regional and local disaster risk financing, so it’s encouraging to see the OECD highlight the trend and the fact the catastrophe bond market seems increasingly capable of bringing these smaller deals to market.