Catastrophe bonds: Mexico issues to insure against earthquakes

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By:
Leticia Lozano
Published on:

Earthquakes have exacted a heavy toll on Mexico
Mexico broke ground this year with a $160 million, three-year catastrophe bond to cover an earthquake disaster, the first developing country to do so. With the success of that issue, Mexico’s finance ministry is now considering issuing against hurricanes and intense rains that cause flooding. As Mexico recovers from the devastation brought by Hurricane John in September and scientists warn of ever-more severe weather because of global warming, the need to protect against such disasters is clearly urgent. According to José Antonio González Anaya, the finance ministry’s insurance chief, bonds issued by the hurricane-prone US state of Florida could serve as a model for Mexico. Those bonds generally pay more interest than corporate bonds with the same rating and need a category 5 hurricane directly hitting a city to trigger them.

The finance ministry says that ideally Mexico would issue a cat bond against hurricanes before president Vicente Fox ends his term in December. Even if that goal is not met, president-elect Felipe Calderón is expected to follow a similar, pro-market economic policy and Mexico’s cat bond issuance is forecast to continue. “What’s important is to find innovative insurance schemes to protect our natural disaster fund and our public finances,” González Anaya says, adding that the bonds give the government immediate access to funds should disaster strike. He adds that Mexico went ahead with the earthquake bond first because although hurricanes are far more frequent than earthquakes, an earthquake’s intensity is easier to measure and easier to insure against. Heavy rains are even more complex disasters because risk levels must take into account the probability of mudslides and other rain-related disasters.

Whatever the specific form Mexico’s future cat bond sales take, more issuance would likely be welcomed by investors, as the paper provides diversification in Mexican credits but with no correlation to other financial risks. Interest paid by cat bonds can be high, at more than five percentage points over Libor, with the three-month Libor rate currently at around 5.4%. Soaring issuance in cat bonds worldwide – with a record $2 billion sold last year and that amount expected to double this year – is also aiding the Caribbean’s offshore tax havens to develop new business. Many bonds are sold out of special purpose vehicles in the Caribbean. Mexico’s earthquake cat bond is a Cayman Islands class B special purpose insurer known as CAT-Mex.