Financing Pandemic Risk
Could capital markets offer an alternative to transfer the risk of financial losses caused by pandemics? The fast spread of the Zika virus in the past few months has made this question a valuable one for companies around the world.
The answer might well be yes. There are already instances of insurance and reinsurance firms selling pandemic risks to capital markets. And investors appear to be keen on buying them.
“We like to buy this kind of risk. It can be a good diversifier to a global portfolio,” said Christophe Fritsch, co-head, securitized and structured assets, at AXA Investment Managers.
The challenge of a pandemic risk bond is to define triggers and conditions for the coverage.
Past market transactions involve insurance-linked securities that transfer pandemic risks, often along with other excess mortality events such as terrorism. They are used by insurers and reinsurers as an extra tool to manage their regulatory capital reserves.
But an initiative by the World Bank to issue pandemic bonds could lead the way for other kinds of issuers to employ similar capital markets instruments. The World Bank’s bond employs a parametric trigger that helps speed up payments when companies may need some urgent cash flow.
Bill Dubinsky, a managing director at Willis Capital Markets & Advisory, said a likely candidate could be an airport that sees dramatically reduced traffic if there is a pandemic in the country.
If the risk had been transferred to the capital markets, he said, the airport could have a considerable degree of cash flow through the duration of the outbreak.
The challenge is to define triggers and conditions for the coverage.
The trigger of the World Bank’s bond, which should be placed with investors in the Fall, is linked to the level of confirmed deaths caused during a pandemic event. It might not be the best option in the case of pandemics such as Zika, where the number of deaths is fairly low, and companies face other effects such as the interruption of business or loss of revenues indirectly associated to the disease.
But other indicators, such as number of people infected in a limited period of time, could be employed, as is already the case with some parametric insurance coverage purchased by the tourism and airline industry.
The World Bank bond will test the market to assess whether there is appetite from investors for pandemic risks issued by players outside the insurance and reinsurance industries.
Priya Basu, a manager at the development finance department at the World Bank, said she expects the bond will pay a coupon of about 8.5 percent a year, which would be lower than the opening price for other CAT bond initiatives previously launched by the organization, such as the Caribbean Catastrophe Risk Insurance Facility.
The World Bank’s pandemic bond is part of a broader project called Pandemic Emergency Financing Facility, or PEF, which includes both a bond and insurance element, and aims to make $500 million available for pandemic emergencies at 77 poor countries.
The bond is expected to raise $300 million, while $200 million will be placed in the reinsurance market. Munich Re and Swiss Re are the insurance partners of the project.
The costs related to the bonds and insurance premiums are subsidized by donor countries, but the idea is that the facility will become a purely market-based one in the future.
“We are working both on a bond issuance and with the reinsurance market because we want to target a range of different investors with different risk appetites,” Basu said. “We expect that, over time, countries will be able to pay their own premiums and coupons.”
“One of the goals of the World Bank is to promote the utilization of market-based catastrophe schemes by governments that would otherwise struggle to provide urgent assistance to its citizens.” — Priya Basu, manager, development finance department, World Bank
The coverage would be activated when the aggregate number of deaths caused by a pandemic, as confirmed by the World Health Organization, reaches a certain limit. The formula also includes data about the rate of growth of the disease and the acceleration in the number of fatal cases. The index is calculated globally, but the payout is only released to the 77 countries covered by the program.
The facility is complemented by a cash component, worth between $60 million to $100 million, which can be employed in case of a severe pandemic that does not cause enough deaths to trigger either the bond or the insurance coverage.
According to Basu, that is the money that could be used for Zika outbreaks, where the number of expected deaths is relatively low.
“There is a financing gap from the moment it is clear that there is an outbreak with pandemic potential, but it has not become pandemic yet. That is when the PEF comes in,” she said. “The parametric trigger enables us to respond in a much quicker and more timely manner.”
One of the goals of the World Bank is to promote the utilization of market-based catastrophe schemes by governments that would otherwise struggle to provide urgent assistance to its citizens, Busa said.
In her view, the use of facilities such as the PEF could result in significant savings of public resources and, especially, in reducing losses of life. If PEF was up and running back in 2014, she said, international money to fight off the the Ebola pandemic could have started to flow to the affected countries more quickly.
Instead, it took extra months to gain any steam, resulting in the cost of billions of dollars and thousands of lives.
The disease covered by the $500 million bond and insurance facility includes some kinds of influenza, SARS, MERS, Ebola, Marburg and other zoonotic diseases like the Lassa Fever.