This year, the market for catastrophe bond is one of the best performing debt classes. The World Bank is a major issuer and will be increasing its offerings, which should lead to an increase in sales.
Over the next five-year period, the lender will increase its outstanding cat bonds from $1 billion to $5 billion. This represents a significant increase for a market worth around $40 billion.
“It is ambitious, but realistic,” said Michael Bennett. He is the head of market solutions at World Bank Treasury’s department for structured finance and market solutions.
Cat bonds are gaining in popularity, as their returns outpace the returns of almost all other debt markets. The securities have risen by about 17% this year while US Treasuries investors lost money. These instruments reward investors for taking on the insurance-market risks, which are increasing with extreme weather events.
The World Bank, a financial aid provider to developing countries, plans to increase the number of natural disasters that are covered by cat bonds.
Bennett, in an interview, said: “I believe you’ll be seeing us do cat bonds beyond hurricanes. pandemics. and earthquakes.” This will include physical disasters such as floods and droughts.
Petra Hielkema is the chairperson of the European Insurance and Occupational Pensions Authority. She says that even in the richest corners of the globe, “there’s not enough insurance coverage” for the future losses.
She told the Economic and Monetary Affairs Committee of the European Parliament that “this is important, because we are seeing more frequent and devastating natural disasters affecting our continental than ever before.”
Many parts of the globe are not protected against natural disasters like cyclones, floods or droughts. According to the Swiss Re Institute’s natural disaster resilience index, approximately 75% of global risks were unprotected by 2022.
Investors pay the insured when certain parameters, like a pressure reading predetermined during a storm or a disaster defined by contract, are met. Investors may lose all or part of their money if all conditions are met. The money is used to cover the costs of the natural disaster.
Investors in cat bonds avoided these payouts for the most part historically. About half of the 30 cat bonds that the World Bank issued in the last decade have been triggered. This means investors are required to pay for the damages against which they sought to protect themselves.
These instruments are among a wide range of securitizations models that will be discussed at the COP28 Climate talks in Dubai, which begin on November 30th. The creation of attractive financial products around the climate risk will be key to unlocking the vast amount of private finance required to protect vulnerable nations against the fallout from global warming.
The diversification benefits of protecting countries in South Asia are a major incentive for private capital to invest in North America, said Ana Gonzalez Pelaez a fellow at University of Cambridge Institute for Sustainability Leadership. The key to increasing the availability of capital, is to have a reliable source of premiums to cover these risks.
Bennett declined to give details, but said that the World Bank has already “a few transactions in the works.”
Jamaica will return to the markets in December when a $185,000,000 hurricane cat bond matures. Colombia and Peru are also looking to tap into the market. There’s even talk of a regional cat bond that would cover Caribbean countries.
Bennett stated that the market was in a much better position now than at the end 2022, when Hurricane Ian and disruptions such as these reduced the money flowing into the industry.
Cat bonds from the AAA-rated World Bank pay a slightly lower return than bonds with a similar focus on disasters that occur in wealthier economies. Investors still get a generous premium for taking on risk.
“We’re now in a market with record premiums, and that is extremely attractive to investors like us,” Lorenzo Volpi said, deputy chief executive at Leadenhall Capital Partners. The company has around $900 million in cat bonds, some of which were issued by the World Bank.
Cat bonds offer portfolio diversification to investors, as their prices are not correlated with those of other instruments such as stocks or fixed income. They can also be used to meet the environmental, social, and governance requirements of end investors.
Schroders Plc is one of the largest holders of cat bond. It manages a portfolio of $4.5 billion in insurance-linked securities (ILS), of which a significant part is cat bonds. Around 3% of this portfolio is invested in World Bank Products.
Daniel Ineichen is Schroders head of portfolio for ILS. He said, “We’ve supported most of the deals.” These bonds are very high on our ESG ratings, because they offer insurance to developing countries that might not otherwise be able afford it.
Ineichen, however, said that Schroders generally tries to “strongly underweight” certain corners of the markets, such as wildfire and flood risk. He said that although Schroders invests, it is only marginal. It brings volatility, which is better suited for an insurance balance sheet. We think that the price is too low in comparison to the risk.
Ineichen stated that cat bond issuers will “have to raise their premiums” if they want to encourage investors to take on such risks.
The World Bank’s latest deal for Chile was a joint cat bonds and swap deal, which provided 630 million dollars of earthquake protection.
According to an analysis conducted by the UK’s Centre for Disaster Protection, investors were attracted to an expected 1% risk of loss and a risk premium of 4.75%. According to CDP, this premium is 60% higher than historical averages for bonds with an equal risk profile. This shows how expensive it has become to protect against natural disasters.
Volpi, of Leadenhall Capital Partners, suggests that this dynamic could complicate future issuance. He said that the World Bank’s challenge is to convince governments “to pay a higher premium for new issuances”.