Over 800 million people live within 100km of an active volcano around the world. To prepare for a potential eruption, the Danish Red Cross and International Federation of Red Cross and Crescent Societies, alongside industry partners, are planning a catastrophe bond to cover risks associated with 10 volcanoes in 4 regions. This will likely be one of the most globally focused cat bonds to ever hit the market.
The Red Cross’ volcano cat bond will target covering the risks associated with ten volcanoes from across South, Central and North America, as well as Asian & African countries.
Never before has a catastrophe bond included such a broad spread of exposures, but given the focus of each exposure is a single volcano and the risk of it erupting at a certain level of severity, it makes the modelling possible for a transaction covering risks across a wide-spread of the globe.
Cat bonds can often include multiple perils from around the world, with some of the most varied being the large retrocessional reinsurance cat bonds that have in the past covered a range of risks such as one which covered: U.S. named storm, U.S. earthquake, Canada earthquake, U.S. severe thunderstorm, European windstorm, Australian tropical cyclone, Australian earthquake.
But these are distinct perils across different parts of the world, where as the Red Cross’ volcano cat bond looks to cover a single type of peril, but in multiple, diversely distributed locations.
Ten volcanoes have been selected for coverage for its first foray in the catastrophe bond market, with the volcanic peaks that are considered to pose the greatest humanitarian threat chosen.
Among these are three volcanoes in Ecuador (Cotopaxi, Tungurahua and Pichincha), two in Indonesia (Merapi and Raung), one in Chile (Villa Rica), one in Colombia (Nevado del Ruiz), one in Guatemala (Fuego), one in Mexico (Popocatépetl) and one in Cameroon (Mount Cameroon).
All of these volcanoes have a substantial population of greater than one million people and economic assets within a 100km distance, which is the distance where the fallout of an eruption would be expected to have the greatest impact.
In addition, all of these volcanoes are well-monitored and studied, meaning that the cat bond trigger can be assessed and any triggering event determined independently.
Working in partnership with Solidum, MITIGA Solutions, DFID, and Global Parametrics, the Red Cross’ catastrophe bond endeavour is a significant step for an organisation that had not entered this market before, with much of the work undertaken and led by its in-house innovative financing team experts.
We spoke with Adam Bornstein, part of the Global Innovative Finance Team of the Red Cross, who explained more about the current status of its cat bond initiative.
“Disrupting how large institutions, like the Red Cross think about risk transfer, effectiveness and efficiency, and early action risk financing, is invigorating and inspiring not only my Red Cross colleagues to think differently about their work, but also how other humanitarian organizations, such as UNICEF, look to weave ILS products into their own programs,” he said.
This work is key, as financing some of the costs of disaster upfront using parametric instruments linked to the occurrence of specific catastrophe events is a great way for organisations like the Red Cross to secure predictable capital inflows when the worst happens.
Progress is being steadily made and the Red Cross hopes to bring the volcanic risk cat bond transaction to market in the next few months.
Bornstein said, “Danish Red Cross and its extraordinary partners, Solidum, Mitiga, DFID, and Global Parametrics, have been working towards specific milestones for the past 12 months, and while this volcano cat bond has taken slightly longer to get to market than most cat bonds, there has been a tremendous amount of learning (and socializing) along the way.
“We’re thinking that by the end of Q1 2020, we’ll be in the market insuring up to 10 volcanoes in 4 regions, which is slightly ambitious but from the start this collective has been swinging for the fences.”
The work to get an innovative new cat bond peril to market has taken significant effort and importantly the Danish Red Cross has significant buy-in from across the organisation, allowing it to think bigger about the use of insurance-linked securities (ILS) and cat bonds as part of the solutions for other problems they are working on.
“Along the way, Birgitte Bischoff Ebbesen, Head of International Department at Danish Red Cross, created space and encouraged the team to look beyond cat bonds as a product – to think about ILS as a platform and ecosystem. In parallel to the core volcano cat bond, we’ve been working on several extension solutions that focus on building resiliency in vulnerable communities. If the cat bond is a top-down intervention, then something like the blockchain based Community Inclusion Currencies that the Red Cross is rolling out with Grassroots Economics Foundation and Sempo, addresses these issues from the bottom-up,” Bornstein said.
The end goal will be to broaden the use of responsive financing mechanisms for humanitarian and disaster related needs of the organisation, with ILS and parametric triggers likely to play an important role.
Bornstein explained, “Currently, the Red Cross, together with MITIGA Solutions and the Barcelona Supercomputing Centre, are experimenting with ways that further develop MITIGA’s deterministic risk model that powers the volcano cat bond, into a solution that, among other activities, can be easily integrated into, and extract data from, blockchain based platforms like CICs. The versatility and analytical nature of this mechanism allows the Red Cross and its partners to overlay parametric ILS, microfinance, and humanitarian assistance in such a way that we’re forces to reset our definition of value for money.
“To echo Dr. Alex Marti, CEO of Mitiga Solutions, instead of waiting for the worst to come, we’re using supercomputers and scientific models to create robust early warning systems to trigger insurance payouts in a timely fashion.”