Pacific Alliance hopes to expand cat bond to cover cyclones, floods, droughts

The Pacific Alliance, a Latin American trade bloc made up of Chile, Colombia, Mexico and Peru, would like to expand on the coverage provided by their catastrophe bonds, with hydro-meteorological risks including tropical cyclones, drought, floods and even cold weather all mooted as potential perils to include.

The Ministries of Finance of the Pacific Alliance members met in late 2020 to discuss next steps in their disaster risk financing and catastrophe bond journey.

The Pacific Alliance trade bloc nations in Latin America currently benefit from a combined $1.36 billion of catastrophe bond backed earthquake insurance protection, in a landmark multi-country cat bond issuance brought to market in early 2018.

The Pacific Alliance cat bond transaction was the largest single issuance of catastrophe bonds ever facilitated by the World Bank, in fact the largest sovereign risk insurance transaction ever seen.

Now, the member nations would like to work towards an expanded catastrophe bond cover, that provides protection against a range of other perils that affect the region.

A working group has been evaluating the effectiveness of the first Pacific Alliance cat bond and discussing the trade bloc’s goals for a renewal issuance.

Coverage of other weather and climate related perils has been established as a priority and the trade bloc would like to achieve this either by including coverage within a renewal of its earthquake cat bond, or issuing a separate bond, or another hedging instrument if a cat bond proves not well-suited to covering a range of hydro-meteorological exposures.

All four countries have evaluated the first Pacific Alliance cat bond issuance as a positive success, given it achieved the goal of securing disaster risk insurance that could respond rapidly in the event of a damaging earthquake.

Of course, Peru has already benefited from its participation in the catastrophe bond issue, after the country received a $60 million payout when an earthquake triggered its catastrophe bond protection under its part of the Pacific Alliance deal.

That payout went directly to the Republic of Peru’s disaster fund, with the use of funds then determined by the Technical Secretariat of the FONDES disaster fund.

In evaluating the first cat bond, the Pacific Alliance members agreed that having fast-paying sources of disaster insurance such as this is essential and that in Peru’s case it helped relief and recovery resources be disbursed to precisely where they were needed.

In addition, the evaluation process also looked at the collaboration with the World Bank on the catastrophe bond issuance and the trade bloc members agreed that this cooperation should continue.

The group have been evaluating the inclusion of additional risks for some time now, but this has now been focused onto hydro-meteorological risks, such as tropical cyclone, flood, drought and extreme cold or frost events.

This year, this work will continue and will focus on how a cat bond issuance, or other hedging mechanism, can be structured to provide coverage for an expanded range of perils, with cost of issuance in mind and the efficiency of the disaster insurance protection.

The current Pacific Alliance catastrophe bond runs its coverage until mid-February 2021, meaning any repeat issuance should hit the market relatively soon if continuity of protection is to be achieved.

Of course, if the expansion of the catastrophe bonds is on the cards, that could delay a renewal as the new perils are modelled and included in any future Pacific Alliance catastrophe bond deal.

Sources suggest a delay and break in coverage is entirely possible, as the future of the Pacific Alliance catastrophe bond is considered and it may not be renewed before its maturity, but could come back to market at a later date.

With such positive messaging out of the countries protected, it is to be hoped we see a renewal of the maturing earthquake cat bonds at some stage, and perhaps the addition of other peril coverage as well.

Mexico has since issued its own World Bank cat bond, which runs to 2024 and covers both earthquake and hurricane risks, so it will be interesting to see whether it plays a part in any renewal of the Pacific Alliance issuance.

You can read all about the Pacific Alliance catastrophe bonds, which are split into four separate country-specific transactions in our Deal Directory as: a Chilean earthquake bond IBRD CAR 116; a Colombian earthquake bond IBRD CAR 117; two Mexican earthquake bond series IBRD CAR 118-119 (due to the two series of notes involved); and a Peruvian earthquake cat bond IBRD CAR 120.

Mexico’s new quake and hurricane catastrophe bond that was issued this year can be found here: IBRD / FONDEN 2020.