The Danish Red Cross and International Federation of Red Cross and Crescent Societies are making progress with their first ever catastrophe bond transaction, revealing a tiered trigger structure designed to ensure that impactful volcanic eruptions cause the cat bond to pay out.
The international humanitarian movement announced last year that it was looking to the capital markets to issue the industry’s first pure-volcano catastrophe bond.
Operating in the humanitarian space means that the Red Cross and Red Crescent deals in extreme risks, seeing first-hand that when a region is affected by a disaster, it’s vital that capital is delivered quickly and effectively to support the best possible humanitarian response.
According to the Red Cross and Red Crescent, worldwide, 500 million people live near 1,500 active volcanoes. Furthermore, when an eruption does occur, even those that aren’t completely displaced can still experience significant financial, livelihood and human loss.
To address this, the Red Cross and Red Crescent has turned to the capital markets and the sophisticated base of insurance-linked securities (ILS) investors, and in 2019 is working towards sponsoring the world’s first pure-volcano cat bond.
The final size of the deal remains unclear, however, Adam Bornstein, an innovation finance specialist that works in the Global Innovation, Finance, and Transformation (GIFT) Team of the Red Cross and Red Crescent, told Artemis in November of last year that the deal would be privately placed with a size of around $15 million.
As an example of the potential financial impact of a volcanic eruption, when Europe’s largest volcano, Mount Etna, erupted in 2002, it resulted in economic losses of $900 million.
The Red Cross and Red Crescent volcano cat bond is being structured using a parametric trigger that ensures rapid pay out when disaster does strike.
This is vital to its function as a source of readily available funding to assist with the humanitarian response to a volcanic eruption.
Those impacted by an eruption are often in need of urgent assistance and financing, so utilising a parametric trigger, which pays out when pre-determined triggers are met, ensures the rapid disbursement of funds, especially when compared with a more traditional insurance policy that requires on-site visits and more comprehensive loss assessment.
The Red Cross and Red Crescent explained to Artemis that the trigger for its bond is based on the occurrence of a volcanic eruption, as measured by the column height of the ash plume.
Importantly, to mitigate any concerns that an eruption may not trigger the bond (so if the height of the ash plume falls just below the trigger threshold but still results in extensive financial and economic damage), the sponsor has tiered the triggers across three pre-determined ash plume heights.
The Red Cross and Red Crescent states that Mitiga Solutions, a spin-off Barcelona Supercomputer Center, has jointly developed with lead investors a long-term probabilistic model to calculate the expected financial loss to investors in the event of a volcanic eruption.
Mitiga has also developed a short-term, deterministic impact model which generates post-eruption risk scenarios which ensures at risk communities receive critical humanitarian assistance without delay
These kinds of developments help to build a more comprehensive understanding of the exposure, which in turn improves investor comfort and confidence, ultimately laying the foundations for the continued, and broader transfer of volcanic risk to the capital markets.
“The aim is to take advantage of capital markets and financial structure innovation, to deliver and deploy emergency funding in a highly efficient manner,” the Red Cross and Red Crescent said.