98003 Mexico MultiCat Bond Transferring Catastrophe Risk to the Capital Markets Background Highlights Mexico is vulnerable to a number of natural hazards, including hurricanes, large earthquakes, floods, and  Mexico, one of the most experienced emerging market countries in disaster risk management, has volcanic eruptions. In 1985, two earthquakes of proactively sought to benefit from global magnitudes 8.0 and 7.5, respectively, killed more than diversification by sharing risks with international 10,000 people and destroyed 100,000 housing units in capital markets. the country. When such natural disasters occurred, the government had to shift budgetary resources away  Itwas the first country to issue a multi-peril multi- from planned public infrastructure expenses into region cat bond using the World Bank’s MultiCat reconstruction efforts. To avoid this problem, in 1996 Program. the government created a fund for natural disasters — FONDEN — to which it transfers budgetary funds for  The MultiCat Program allowed Mexico to efficiently disaster relief and reconstruction efforts. In addition, transfer a pool of disaster risk to the capital markets. Mexico developed an institutional framework for disaster preparedness involving risk assessment, risk Structure and Description reduction, the promotion of a culture of prevention, In MultiCat 2009, Mexico issued a four-tranche cat bond and insurance. With these initiatives, Mexico moved (totaling US$290 million) with a three-year maturity from an ex-post response to natural disasters to an ex- under the MultiCat Program. The issuer is a Special ante preparedness approach. Purpose Vehicle (SPV) that indirectly provides parametric FONDEN uses various instruments to support local insurance to FONDEN against earthquake risk in three states and entities in responding to natural disasters, regions around Mexico City and hurricanes on the including reserve funds and risk transfer solutions. In Atlantic and Pacific coasts. The subsequent MultiCat 2012 2006, FONDEN issued a US$160 million catastrophe was a three-tranche cat bond (totaling US$315 million) bond (CatMex) to transfer Mexico’s earthquake risk to covering two additional regions (5 regions total) for the international capital markets. It was the first earthquake risk. The parametric triggers for earthquake parametric cat bond issued by a sovereign. and hurricanes were tailored to a greater degree than in the 2009 transaction. The cat bond will repay the After the CatMex matured in 2009, Mexico decided to principal to investors unless an earthquake or hurricane further diversify its coverage by pooling multiple risks in triggers a transfer of the funds to the Mexican multiple regions. In October 2009, it issued a 3-year government. multi-peril cat bond using the World Bank’s newly established MultiCat Program, which helps sovereign Outcome and sub-sovereign entities pool multiple perils in The bond was oversubscribed, with broad distribution multiple regions and reduce insurance costs. In 2012, among investors. With this bond, Mexico transferred a Mexico issued MultiCat 2012 as a successor with a pool of disaster risk to the market for the first time; larger coverage area and much detailed structure than secured multi-year protection for the covered risks at a the 2009 transaction. fixed price; and reduced potential pressure on public Objectives budgets. Mexico effectively locked in funding for disaster relief prior to the event happening, rather than relying  Transfer disaster-related risks to the capital markets only on public budgets after the event. and reduce pressure on public budgets The demonstration effect of this transaction for other  Ensure that adequate funds are in place for relief emerging market countries is significant. It has paved the activities way for other highly exposed countries to manage fiscal  Cover multiple perils volatility and stabilize government budgets by transferring extreme natural disaster risks to capital markets, while obviating the need to build up excessive budget reserves. Operating Structure Event ⑤ Collateral Loss Payment Payment Loss Payment Solution Amount Amount Account Investment Investments Earnings Reference Rate + Interest Spread ① ② ③ SPV Investors FONDEN Insurance Agroasemex Reinsurance Swiss Re Counterparty Collateral ④ Contract Contract Contract Account Note Proceeds 1. FONDEN enters into an insurance contract with local insurance company Agroasemex. 2. Agroasemex enters into a reinsurance contract with Swiss Re to transfer all of the catastrophe risk. 3. Swiss Re enters into a derivative counterparty contract with a Cayman Islands-based special purpose vehicle (MultiCat Mexico 2009 Ltd. and MultiCat Mexico 2012 Ltd.) to transfer the catastrophe risk. 4. The SPV issues floating rate notes (Cat Bonds) to capital markets investors to hedge its obligations to Swiss Re under the counterparty contract. The proceeds received from investors are invested in US Treasury money market funds and deposited in a collateral account. 5. A separate event payment account is established with a third party bank to allow FONDEN to receive parametric loss payments directly from the SPV, subject to the insurance contract. Lessons Learned 1. Countries need to have a strong legal and institutional framework in place for disaster risk financing to facilitate the implementation of risk transfer mechanisms, which should be part of a disaster risk management framework. 2. There is potential to replicate this type of transaction for other middle-income countries. The Mexico bond was significantly oversubscribed, showing that investors continue to exhibit strong appetite for non-peak risks. 3. The availability of data and statistics about the probability and severity of a catastrophic event is key. New countries and regions attempting to tap the catastrophe bond market will need a supporting cat risk model. Donor countries with a specific interest in working on the development of disaster risk management capacity in developing countries can play an important part by financing risk modeling and transaction costs. 4. The World Bank’s role as arranger significantly increased investor comfort. Future transactions will benefit from the standardized fees and design structure offered by the MultiCat Program. Summary of Terms: Mexico MultiCat 2012 Class A Class B Class C Peril Earthquake Atlantic Hurricane Pacific Hurricane Notional (US$m) 140 75 100 Trigger Different magnitude 920 mb Between 920 ~932mb 920 mb and depth parameters Central pressure Central pressure Central pressure for each of the 5 regions 50% payout 100% payout S&P rating B B+ B- Contact Issam Abousleiman, Head of Banking Products, The World Bank, iabousleiman@worldbank.org Ivan Zelenko, Head of Structured Products and Derivatives, The World Bank, izelenko@worldbank.org Olivier Mahul, Program Manager, Disaster Risk Financing & Insurance, FCMNB and GFDRR, The World Bank, omahul@worldbank.org Hannah Yi, Policy Analyst, Disaster Risk Financing & Insurance, FCMNB and GFDRR, The World Bank, hyi@worldbank.org https://www.gfdrr.org/gfdrr/DRFI Updated February 2013 GFDRR is able to help developing countries reduce their vulnerability to natural disasters and adapt to climate change, thanks to the continued support of our GFDRR is able to help developing countries reduce their vulnerability to natural disasters and adapt to climate change, thanks to the partners: ACP Secretariat, continued support ofArab of Science, Academy ACP its partners: Technology Secretariat, and Bangladesh, Australia, Maritime Transport, Belgium, Australia, Austria, Bangladesh, Brazil, Canada, Belgium, Colombia, China, Brazil, Canada, Egypt, China, Denmark, Colombia, Denmark, Egypt, European Commission, Finland, France, Germany, Haiti, India, Indonesia, IFRC, Ireland, Islamic Development European Union, Finland, France, Germany, Haiti, India, Ireland, Italy, Japan, Luxembourg, Malawi, Mexico, The Netherlands, New Bank, Italy, Japan, Zealand, Norway, Portugal, Saudi Arabia, Senegal, Spain, South Africa, South Korea, Sweden, Switzerland, Turkey, United Kingdom, South Luxembourg, Malawi, Malaysia, Mexico, the Netherlands, New Zealand, Nigeria, Norway, Portugal, Saudi Arabia, Senegal, Solomon Islands, South Africa, Spain, Sweden, Korea,United Switzerland, States, Vietnam, Togo, Turkey, Yemen, United Kingdom, IFRC, UNDP, UNDP, UNISDR, UN/International United Strategy States, Vietnam, for Disaster the World Reduction, Bank, and The Yemen. World Bank.