More Developing Nations to Consider Catastrophe Bond Issuance

June 5, 2008

Governments in emerging markets are increasingly looking at the potential to tap capital markets to help fund the cost of recovery when costly natural catastrophes strike, experts say.

Some nations have already issued debt instruments — referred to as catastrophe, or “cat,” bonds — to help cover the cost of rebuilding after such disasters as earthquakes or hurricanes, and more are expected, said a panel of experts at a Standard & Poor’s insurance conference on Tuesday.

But much red tape surrounds such transactions, and there are other issues that need to be ironed out for investors.

Still, interest is growing after a string of costly disasters in Asia, including China’s recent earthquake and a tropical cyclone that devastated Myanmar.

“For China and Myanmar, we think there is a lot of potential,” said Jay Green, vice president of Swiss Re’s capital markets. He cited other such transactions that have used risk tools that can help calibrate the potential cost of future catastrophes, based on population figures.

Green, speaking on a panel at an insurance conference being held by ratings agency Standard & Poor’s on Tuesday, said Taiwan structured such a deal in 2003, and Mexico followed in 2006 with its own bond issue.

“(Mexico) was concerned about the gap between insured and economic loss,” said Green. Similar deals have also been reached for El Salvador and Guatemala, he added.

“They are looking for a quick response and the ability to distribute the money to the people who need it,” said Niraj Patel, managing director for insurance-linked securities at Genworth Financial Inc’s Genworth Investments of how governments could benefit.

Government interest in these securities is an emerging area, with the bulk of disaster bonds to date having been issued by insurance companies as a means of transferring a portion of the financial hit from natural disasters to investors.

The insurance-issued bonds have suffered relatively few losses over the last decade, and investors have generally grown more comfortable, even though the bonds carry significant risk. The bulk of investors are hedge funds and large, institutional investors.

Issuance of these securities topped $7 billion in 2007, but such government-issued bonds will have to jump some hurdles before they are widely accepted. “It is a slow and bureaucratic process; there are a lot of legal and regulatory issues that need to be investigated,” said Green.

Another issue is how to assign ratings to such instruments, a key consideration for investors.

Gary Martucci, a director at Standard & Poor’s, said he had been approached by the World Bank on whether it was possible to rate such instruments.

“Theoretically,” said Martucci, “but not (a high) “AAA” (rating) any time soon, under our criteria.”

“I think that would be the challenge,” added Martucci. “The cost of the bonds — it would cost more than it does to bring an average deal to market.”

(Reporting by Lilla Zuill, editing by Gerald E. McCormick)

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