Epidemic bonds from the WHO

There is also insurance against pandemic outbreaks, for example, the WHO issued two bond classes in 2017, with coupons of 6.9 and 11.5 percent. At the initiative of the WHO, the World Bank began issuing pandemic bonds after the Ebola outbreaks in 2014 and 2016, after the organisation concluded that if West African countries had received rapid financial assistance, only 10 percent of the total death rate would have been occured. Pandemia is an epidémia affecting a large area, it does not necessarily constitute a global concern.

Disaster bonds are well-established tools of the insurance industry, which for a long time were not known to the general public, their original purpose was to reduce and vaporate the risk. Today, they operate like high-coupon, risky corporate bond market products. An insurance company shall issue a security with a higher yield than the normal market, which, if the size of the natural disaster reaches a predetermined level, shall start to act as collateral. The investor either receives nothing back or can only obtain a fraction of the original amount, and the funds will be used to finance the insurance company’s payments. According to the Financial Times, this bond type, whose official name is Insurance-Linked Security, usually does not receive an official credit rating, but is priced and traded in similar to the upper levels of the “junk” class.

Unlike this, pandemic bonds pay the WHO when an epidemic reaches a detailed level, which is called trigger level. The main difference is the timeline: insurance needs usually occur after the weather disaster has passed, while stopping the epidemic is conditional on the rapid availability of funds. Therefore, trigger of pandemic bonds is usually a disease-achieved case number.

Based on experience, by 2016, the World Bank had established the Pandemic Emergency Financing Facility (PEF), and several reinsurers, such as Munich Re and Swiss Re, were behind the bonds. The corona virus now appears to be a good trigger for $320 million worth of IBRD CAR 111-112 bonds. In addition to the bond, the PEF also includes a $105 million swap agreement, which was also linked to pandemic risk. It is therefore clear that the official case and mortality numbers reported, the determination of the duration and geographical spread of the epidemic are not simply for the purpose of providing information. If the epidemic becomes dangerous for a larger population, the WHO no longer has only the usual resources available.

The aforementioned bond consists of two classes, Class A was issued with a coupon of 6.9 percent, Class B 11.5 percent, the first recorded by investor specialist almost 70 percent, but the second was 42 percent purchased by pension funds entered and only 35 percent got into the profession‘s hands. Both classes are more than 70 percent owned by European financial investors and the riskier Class B is supposed to expire this summer.

The policy concept, pricing and its astonishing long-term issue prospectus have been widely criticized, here’s an example from the Financial Times:

Source: Financial Times

The 225 million Class A trigger condition is 2,500 deaths in the initial country, of which at least 250 have been followed by each other, as well as 20 deaths in another country. Class A bonds are not valued as zero by this event, but 16.67 percent of the base denomination is spent on anti-epidemic purposes. The payment rules for Class B of 95 million are even more complicated, where the value of the bond also depends on the number of deaths in the non-originating countries. If during the SARS we had such a bond available, 37.5 percent of the $95 million would have been written off from investors’ accounts and translated to fight the epidemic. What may be surprising is that the price movements of the two bonds mentioned do not yet show concerns about the corona virus, even though the epidemics of recent years have almost activated the trigger mechanism.

There are also cynical doubters who believe the bond could lead players to commit horrific crimes to meet the trigger level. For political reasons, the raison d’être of the entire asset class is also being questioned, I quote again from the Financial Times:

Source: Financial Times

Global epidemiological bonds issued by the World Bank are a small part of the total cat bond market. As key interest rates fell below zero worldwide and as the effects of climate change began to show, the market’s size rose from $22 billion in 2007 to $98 billion by the end of 2019. These bonds are attractive because of their high yields and can theoretically be suitable for diversification purposes because they do not correlate with developed markets. However, the practice shows otherwise. The price behavior of pandemic bonds are virtually identical to those of high-yield non-investment-grade bonds. A major epidemic at first always causes an economic downturn, so a high correlation is understandable. Weather bonds are lower with economic cycles, making them more suitable for diversification. For many, buying such a bond may seem betting and irresponsible. But if you look at it from the insurance industry side, the reinsurers’ position is clear: ‘everything is secureable, you just need enough data’.

Source: Chicago Fed

The original of this article was published in the 14 February issue of theVilaggazdasag, printed economic daily.

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