LatinFinance - May/June 2016 - 44

CAPITAL
MARKETS
CAT BONDS

Market-based solutions to help with the financial cost of natural
disaster recovery could be set to pick up in Latin America.
By Rodrigo Amaral

Managing natural
disaster risk

44 L ATINFINA NCE.COM - May/June 2016

Source: Reuters

arthquakes, hurricanes,
floods, droughts, hailstorms and even
volcanoes threaten lives, properties and
economies across Latin America. Yet there
are few sources of capital for governments
to rebuild after a catastrophe.
Could capital markets provide a solution?
Investment vehicles that bet against the
occurrence of severe natural catastrophes
have delivered attractive returns and, as a
result, have drawn ever more interest from
investors around the world.
But, apart from a few, scattered experiences in Mexico and a couple of other countries, they remain a rarity in the region.
That could change in the future, however,
as potential issuers are striving to learn
more about the market and costly disasters
highlight the need for economically efficient
ways to raise reconstruction funds.
The most commonly known investments
exposed to natural hazards are the so-called
cat bonds, which are issued mainly in the
United States and amount to around $23 billion of assets under management today.
They are liquid, relatively standardized
securities that can be traded in secondary
markets.
But there are other, often more complex
and less liquid structures known as insurance-linked securities, or ILS. This market
is three times bigger than cat bonds, and its
growth has been described as "phenome-

DEVASTATING QUAKE: An April 16
earthquake that struck Ecador killed
more than 600 people and prompted
the government to request aid from the
International Monetary Fund

nal" by analysts. It is a relatively new market
that virtually did not exist as recently as two
decades ago.
Insurance-linked securities have evolved
increasingly quickly recently, not least
because investors are showing ever more
appetite for reliable sources of performance
in times of low interest rates and high
volatility. "The ILS market has been growing pretty steadily in the past five years,"
says Bill Dubinsky, the head of ILS at Willis
Capital Markets & Advisory.
Cash has flown into cat bonds and ILS

thanks to their yields of around 4% to 6%
a year. Additionally, the capital provided
as principal or collateral to the contract is
hedged via money market funds or Treasury bills.
Further, ILS vehicles have a low correlation with other asset classes such as equities
or private debt, says Raffaele Dell'Amore, a
fund manager at Schroders, the asset manager. Therefore, they can provide an interesting option to diversify risk in a portfolio.
Cat bonds and ILS are similar to insurance and reinsurance transactions, in
which companies and government entities
transfer risks away to a third party, paying
a fee for their trouble, Dell'Amore says. "In
cat bonds and ILS, investors provide the
capital to the issuer of this transaction, who

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