OPINION: Pioneering regional integration in risk management

OPINION: Pioneering regional integration in risk management

Bonds Capital Markets Debt Comment & Opinion

Last year was a wakeup call for Latin America and the Caribbean. Devastating hurricanes left a trail of destruction and hundreds of victims across the Caribbean. Two earthquakes rattled Mexico. Flooding and landslides followed heavy rainfall in Colombia and Peru. It was a stark reminder that our region is one of the most exposed to natural disasters in the world.

While these natural disasters may be beyond our control, mitigating the after-shocks isn’t. Natural disasters, pandemic diseases or even wild swings in commodity prices don’t have to become human disasters.

We can prepare ourselves, and preparation is often much cheaper than the effects of these shocks. Mitigating risk goes beyond simply protecting the lives and property of millions of people. It also means shielding key economic sectors from events that derail growth and ensuring the wellbeing of all. And we must keep in mind that it is often the poorest who suffer the worst when disaster strikes.

Latin America and the Caribbean has one of the lowest levels of insurance coverage in the world. There’s often a wide gap between the value of damage suffered and the value of damage covered. In the end, this frequently means that governments end up paying the lion’s share of the recovery bill. Spending swells and governments feel the strain. The problem is particularly stark in small economies, where the losses after a natural disaster can reach well over a full year’s gross domestic product.   

But now we are seeing an encouraging trend. Governments across the region are dedicating more and more resources to identifying and reducing risk. They are also locking in financial safeguards to quickly respond to emergencies.

Catastrophe bonds are a good example of this. These “Cat Bonds” serve as insurance, transferring the risk of disasters from governments to markets. The Pacific Alliance - an economic and development initiative bringing together Colombia, Chile, Mexico and Peru – is front and center in this effort, with the World Bank just issuing over 1.3 billion dollars in catastrophe bonds for them.  Mexico pioneered these types of bonds with four successful earthquake and hurricane transactions since 2006, but this is the first for the other three members of the Alliance. 

This bond transaction is the largest of its kind ever placed and the first involving multiple countries. Capital markets will assume the risk of earthquakes, shielding the governments from some of the financial damages and allowing them to rapidly respond to an emergency. The countries have ensured the quick mobilization of funds and fiscal resilience in the face of disaster.

 Demand for the Cat Bonds was strong, with investors attracted to the novel diversification of combined uncorrelated risks from four different geographies. Each of the countries crafted its own terms and scope of coverage based on their particular needs.

The successful placement of the Pacific Alliance Cat Bonds casts a spotlight on the innovation born from cooperation between the World Bank and countries across Latin America and the Caribbean.  They also add an important tool to the bundle of disaster response financial instruments and complement other mechanisms such as emergency funds and contingent lines of credit. The World Bank also helped develop the Caribbean Catastrophe Risk Insurance Facility (CCRIF), the source of the first payments made to the countries hit by the devastating hurricanes last year.

Building resilience is more than just reducing exposure to a number of threats. It is also crucial to design and implement policies that will ensure the wellbeing of all and allow economic growth to continue after a disaster hits.

Expecting the unexpected - and joining forces to mitigate the damage, as the Pacific Alliance countries have just done - is a huge step forward for regional integration. It puts Latin America on the vanguard of risk management in the world. We can expect other countries and other regions to look to this innovation as another important tool in the quest to end poverty and promote shared prosperity.