Sovereign parametric catastrophe bonds as means to address the protection gap in emerging countries

By Kirill Savrassov

When disaster strikes, immediate steps need to be taken to protect survivors and provide them with temporary shelter and emergency food and clothing. In the medium and long term, homes need to be rebuilt, places of employment and local infrastructure reconstructed. Ideally, this to be done in a manner that is resilient to future disasters. All of this cost money. For this reason, the issue of disaster risk finance, especially when it comes to post-event response, plays a vital role in developing economies across the globe.

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For post-disaster emergency financing, these innovations include development of national disaster funds, regional pooling schemes with the use of parametric solutions, contingent credit lines and solutions from Insurance-Linked Securities market, especially Parametric Catastrophe bonds, which, if well structured, can pay out almost automatically when disasters hit. Through the issuance of parametric sovereign catastrophe bonds, governments could access revenue streams that can finance timely shelter and support to victims and then set about rebuilding in a resilient manner.

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Such instruments also allow a government to spread the cost of disaster response and prevention over several fiscal years, rather than creating a massive demand for funds in one particular year when the disaster occurs. In addition, as the money will flow from international financial markets, it will create a positive macroeconomic boost to the economy of the whole country and reduce dependence on foreign aid. Use of the catastrophic bond mechanism also can help in an effective solution for two important issues within emerging countries: addressing the "protection gap" on the macro level and dealing with low insurance penetration.