Why World Bank’s Controversial Pandemic Bonds Didn’t Function as Hoped

In late January 2015, just after the deadliest outbreak of Ebola in history, then-World Bank President Jim Yong Kim stood in front of a group of Georgetown University students and professors to introduce a new approach to fighting pandemics.

Fresh from the annual gathering of power brokers and policy makers in Davos, Kim described a new type of financial product – “pandemic bonds” – that he hoped would persuade private investors to swell the World Bank’s coffers. Quoting former U.S. Treasury Secretary Lawrence Summers, Kim said: “Investing in health is the right thing to do ethically and morally, but it’s also the right thing to do if you can do basic arithmetic.”

Five years later, Summers had some different words for Kim, though you probably won’t hear the former World Bank president repeat them in public. The approach was “a dumb idea,” Summers said in a February 2020 email to a Harvard colleague seen by Bloomberg News. Modeled on catastrophe debt that pays insurance claims on natural disasters, the program was too complicated and ultimately unnecessary, he suggested, “like me insuring my toaster.”

Trumpeted by the World Bank at their launch as an innovative example of a public-private partnership, pandemic bonds have since become the subject of intense criticism for failing to divert money fast enough to battle deadly waves of Ebola and COVID-19. Academics from Harvard to the London School of Economics have lambasted the program for being ineffective and expensive, and the World Bank has confirmed it won’t issue a second round of the debt.

As COVID-19’s devastating human and economic tolls continue to rise, the controversy over pandemic bonds is part of a wider debate over how policy makers should respond to viral outbreaks and who should foot the bill. The harshest critics of the World Bank’s experiment have questioned whether it’s appropriate to tie responsibility for public health to private investment at all. Others stop short of rejecting the premise wholesale, calling instead for more innovation and perseverance.

“We can’t abandon the concept because the first effort failed,” said Stephen Morrison, director of the Global Health Policy Center at the Center for Strategic and International Studies, a Washington D.C.-based think tank. “We need to come back to this problem with new ideas on how to do it better.”

Unlike previous World Bank presidents, Kim didn’t come from the world of politics or finance. With doctorates in medicine and anthropology from Harvard, his early academic and practical work focused on community health interventions in the developing world; when he was awarded a MacArthur Fellowship in 2003, the foundation cited his work fighting drug-resistant tuberculosis in Russian prisons and Peruvian ghettos.

He was also on the record as a critic of the World Bank, at one point co-editing a book that called for the shutdown of the institution, with its sprawling post-World War II international development infrastructure. By taking the reins, Kim controlled some $59 billion in annual loans, leading Forbes to eventually name the doctor one of the world’s most powerful people.

Stunned by the severity of the Ebola outbreak that would eventually kill more than 11,000, according to the World Health Organization, Kim directed his staff to study fresh ways of raising funds that could be used to fight pandemics at the earliest possible moment. International aid organizations and governments hadn’t responded fast enough to Ebola, only recognizing its severity once it reached the U.S. and Europe. Help had come too late.

“Public sources of financing, either from public treasuries and/or development partners, were not reliable sources of contingency or surge financing” for imminent disasters such as the growing threat of a pandemic, Kim wrote in an e-mail in response to questions.

Staff at the World Bank struck on the idea of something similar to catastrophe debt, which for decades has helped insurers raise funds to cover payouts associated with hurricanes and earthquakes. With the help of two of the world’s biggest reinsurance companies – Swiss Re and Munich Re – the lender began a multi-year process to design and market what some hoped would become a brand new asset class.

Here’s how the pandemic bonds worked. The World Bank would sell $320 million of debt to investors. In the event of a pandemic, that debt would be written off and the principal would accrue to the bank to be distributed to needy countries. Premiums were juicy – the safest slice of the offering paid 6.9% over the Libor benchmark rate, similar to returns typically found on junk-rated corporate bonds and far greater than the 2.2% available on 10-year U.S. government debt at the time. For the second tranche, which had looser triggers for a writeoff, premiums were a whopping 11.5%.

At the same time, the World Bank solicited some $205 million in donations from Germany, Japan and Australia. Part of that money went to pay interest on the bonds, and part of it funded $105 million in “swaps” struck with the two reinsurers – effectively insurance policies that would also pay out in the event of a pandemic. Some of the donations were set aside in a “cash window” that could be tapped by a steering committee to fight outbreaks that didn’t meet stringent criteria embedded in the bonds and swaps.

The hope was that the extra millions from the “Pandemic Emergency Financing Facility,” or PEF, as it was called, could be disbursed quickly before an outbreak spun out of control – like hoarding water to douse a kitchen fire before the whole house went up in flames. “Now when Ebola happens, with the first case, we have a bunch of cash that will go right out to try to stop it,” Kim said in a 2017 keynote to the Anthropology Association, to audience applause.

But the pandemic bonds weren’t designed to default at the earliest sign of a pandemic. The 386-page prospectus for the debt covered a range of outbreaks including Ebola, influenza and coronaviruses and spelled out very specific conditions for writedown – an effort to automate the typically political process of distributing funds. The list of triggers was long and complex, balancing investors’ desires for a long payout stream with the World Bank’s need to disburse the money to countries that need it.

“We had to think through how this instrument should actually function, what kind of diseases should be addressed,” said Ivo Menzinger, who leads the group responsible for public sector solutions at Swiss Re. “During that process it got considerably broader.”

In the case of an influenza pandemic, at least 5,000 infections needed to be confirmed within a rolling 42-day span. But in the case of Ebola, at least 20 deaths had to be recorded in each of two countries within a set time frame, a specificity that led investors to ask morbid questions about whether bodies carried over the border would trigger payment. Casualties also had to be growing at a rate determined by mathematical formula. Only then could Boston-based AIR Worldwide Corp., the bonds’ designated third-party arbiter, declare a triggering event, freeing up investors’ cash for relief efforts.

For public health experts and investors alike, the bonds were a convoluted compromise. “The whole reporting was very complex, with all those data definitions, what is an event etc.,” said Dirk Schmelzer, of Plenum Investments AG, which bought some of the bonds. “The idea was clear, but you have to keep in mind that investors look at property claims and so forth – they’ve never looked at how the WHO responds to pandemic outbreaks. How to get the data on this – it was all new.”

Regardless, investors were interested. When the bonds were finally sold in 2017, demand swamped available supply. A glossy video promoted the product, declaring that “if the PEF had existed in 2014, thousands of lives could have been saved.” Press releases and features from the World Bank championed the bonds as demonstrating “the evolution of capital markets as a force for good.”

But when Ebola returned in 2018 to ravage West Africa again, the bonds failed to trigger. The virus killed almost 2,300 in the Democratic Republic of Congo, but per the criteria in the prospectus, it didn’t spread far enough, fast enough to qualify as a pandemic. In an effort to avoid political grappling over donor funds, the pandemic bonds relied on mechanical triggers that failed to fire. So investors kept getting paid interest and retained their principal. Meanwhile, the World Bank allocated $61 million from the PEF’s “cash window” – the discretionary portion of money funded by donor contributions – to help fight the outbreaks.

Even when COVID-19 began to sweep the globe earlier this year, it was unclear whether the bonds would get written down. The coronavirus had killed almost 150,000 people in dozens of countries before the casualty rates aligned with the “exponential growth” requirement set out in the bond prospectus. On April 16, more than five weeks after the WHO had declared a global pandemic, AIR Worldwide issued a report confirming that the conditions for a writedown had been met, diverting $132.5 million to the World Bank for disbursement. A further $63.3 million came from the swaps struck with Munich Re and Swiss Re.

“The triggers had to be late and they had to be convoluted and complex to reduce the probability that the financing would be triggered,” says Olga Jonas, a critic of the bonds who worked for more than three decades at the World Bank, including as an economist specializing in pandemics. She points out that the World Bank already had billions in discretionary emergency funds through the International Development Association; it didn’t need to pay high interest to investors to have money at its disposal.

Investors ultimately earned a total $96 million in interest rate payments from the pandemic debt before the bonds were written down and $195.84 million accrued to the World Bank. It now plans to spend $160 billion over a period of 15 months to fight COVID-19, an amount that’s more than 800 times the size of the maximum coronavirus payout from the PEF.

Gunther Kraut, head of epidemic risk solutions at Munich Re, argues that risk premiums were reasonable for a new financial product: “It’s easy to criticize when there’s a high amount of premium paid to investors, but don’t forget premium paid is a factor of risk,” he says. “We had a broader vision than just doing the PEF transaction.”

Mid-September marked the end of the Ancient Roman summer sailing season, when “fierce storms” rocked the wine-dark sea of the Mediterranean, according to the 4th century writer Vegetius. It was at this moment that the interest paid for maritime loans — one of the earliest forms of insurance — would jump as early lenders sought to balance expectations of more perilous weather with potential profits from trade.

Insurers have always weighed risk and reward. At its best, the industry can provide a valuable backstop for catastrophic losses and be a powerful enforcer of safety standards. Lenders to one Greek trading vessel would increase their rate of interest from 22.5% to 30%, for example, if the ship returned after the mid-September period deemed safe for sailing.

At its worst, insurance can leave people and businesses unexpectedly out of pocket or even create perverse incentives through its policies. Running low on food and water, a British slave ship sailing in the 18th century threw 142 West Africans overboard, knowing their insurer would pay for lost “cargo” at the rate of 30 pounds per person (about 2,500 in today’s money), but they would get nothing if the slaves died of starvation. The court initially ruled the underwriters were obliged to pay; the decision was reversed on appeal.

It’s these kinds of consequences that worry Susan Erikson, a professor of health science at Simon Fraser University in Vancouver, B.C. She posits that pandemic bonds are a “harbinger of future global health finance,” allowing the responsibility of public health provision to shift from governments to financiers, and setting up a profit motive to address human suffering.

“What do we want to do about that? Maybe nothing, maybe something,” Erikson wrote in her paper. We may have to come to grips with “living in worlds where it may be necessary to translate the ethical obligation to help those who are suffering into financial devices that make people money, a trend we are clearly in the initial stages of.”

Even if the world grows comfortable with private investors filling a role traditionally played by governments, COVID-19 has exposed a more practical issue that casts doubt on future demand for pandemic bonds: correlation. Catastrophe bonds have been successful in part because hurricanes and earthquakes happen independently of the economic factors that typically influence financial markets, allowing the debt to be marketed as a hedge against portfolio volatility.

But global public health disasters, it turns out, can have significant economic implications, and the writedown of pandemic bonds added to investors’ losses instead of offsetting them. To sell a new round of coronavirus-linked debt, the World Bank would probably have to increase the coupon payments or otherwise sweeten the deal – underscoring the inherent tension between encouraging investors to buy debt and simultaneously making it useful as a public funding instrument.

“Extreme mortality, if very severe, can impact financial markets so there’s high correlation,” said Plenum’s Schmelzer. “If the World Bank had decided to issue a new series with a COVID-19 exclusion, we would probably have invested.”

Proponents of pandemic debt dispute that the World Bank’s creation was a failure, saying it should be refined rather than abandoned. Lawyers at Brown Rudnick LLP suggested in March that altruistic investors could do away with automatic triggers altogether and instead vote on whether pandemic bonds should be written-down. Andrew Baker, an associate in the firm’s special situations group, points out that while the bonds were sold as a way of generating money for early pandemic responses, they might be revived as a source of longer-term funding.

“The issue is how the bonds were marketed –they raised expectations that the bonds would help contain an outbreak immediately,” he says. “If the pitch wasn’t so focused on containing the virus but providing funding for a longer period, you wouldn’t have had this level of disappointment.”

At the reinsurers, both Munich Re’s Kraut and his counterpart at Swiss Re, Menzinger, say the PEF has jumpstarted the market for future pandemic bonds, inspiring the creation of risk models that can be used again. “This was a first, and first always comes with learning and is never perfect. But the fundamental idea of a rules-based pre-financing instrument continues to hold,” Menzinger said. “Regardless of what you build, the second time will be better.”

Private markets are already stepping in to provide money that can be used to offset the economic and social impacts of the coronavirus outbreak. Debt tied to the pandemic is fast becoming a staple of the booming market for environmental, social and corporate governance (ESG) investments. Such notes are more akin to traditional corporate bonds than the World Bank’s pandemic debt, and their sales have helped push total ESG issuance to a record in the third quarter. Chinese companies have also been advertising “anti-epidemic bonds,” though a Bloomberg investigation found the bulk of money raised was used to roll over outstanding debt.

But the sheer scale of the pandemic and its effects may spark wider acceptance of the role of government in backstopping economic and social crises. In the U.S., Congresswoman Maxine Waters has called for a pandemic reinsurance program resembling the Terrorism Risk Insurance Act put in place after the 2001 attacks on the World Trade Center. The bill would cap losses for private insurers that provide business interruption coverage for pandemics, with the federal government then paying for up to $750 billion in annual claims.

“Insurance is more expensive than borrowing. If a government can borrow then it should borrow first, it shouldn’t buy insurance,” says Jonas, now a senior fellow at the Harvard Global Health Institute. “Prompt responses to stop disease outbreaks are really something that governments are for. Imagining that there’s something ‘innovative’ that will work is just irresponsible.”

The World Bank declined multiple requests for comment. Summers confirmed the contents of his email to Bloomberg, adding that the amounts of money involved in the program were too small relative to the huge public health and economic stakes involved. He estimated in October that the virus may end up costing $16 trillion in the U.S. alone, or four times the cost of the Great Recession sparked by the 2008 financial crisis. Kim said, “The perceived ‘failure’ of the PEF must be studied. We might say that the money that was in it was not enough but it was the most we could raise at that time.”

Kim unexpectedly quit the World Bank the World Bank in January 2019 to join Global Infrastructure Partners, a private equity firm which invests in infrastructure including through public-private partnerships. Meanwhile, the World Bank quietly announced it would not be issuing a second round of the debt. Unlike the launch of the pandemic bonds, the news came with little fanfare; it was just one line added to their website.

“The issues raised by COVID-19 are profound and require a deep rethinking of our pandemic response infrastructure,” Kim said. “If we can say that the PEF got it wrong, it wouldn’t be the only institution or instrument that got it wrong.”

Top photograph: A healthcare worker tends to a COVID-19 patient in Sao Paulo on Dec. 4. Photo credit: Jonne Roriz/Bloomberg.

Topics COVID-19