The Jamaica Cat Bond — is it any good?
by Conor Meenan, Lead Risk Finance Specialist
The recent issuance of the World Bank Jamaica catastrophe bond is a good news story.
Hurricanes are a devastating force in the Caribbean, and small island states such as Jamaica are particularly exposed to these climate shocks. This $185 million of pre-arranged finance could make a real difference to Jamaica’s ability to respond and recover to this climate threat over the next three years.
The donor support for this transaction is also notable. The bond received funding from the UK and Germany through the Global Risk Financing Facility (GRiF), and from the United States Agency for International Development (USAID). The breadth of financial support for the Jamaica cat bond is a good sign of donor commitment to the pre-arranged financing agenda, and a strong signal that premium subsidy is now accepted as a viable option for donors. This is a marked change even from 5 years ago when the perceived issues of subsidies were still the main topic of conversation.
The crucial question now is―what have Jamaica and donors bought, and is it any good? The short answer is that, unfortunately, it is impossible to tell based on the limited public information currently available.
Forming a picture of the Jamaica cat bond
At the time of writing, the World Bank press release provides the most detailed publicly available information about the cat bond. From this we can form a basic picture of the transaction.
· The World Bank have issued a catastrophe bond on behalf of the Government of Jamaica, and the UK, Germany and US donors have paid for some, it not all, of the premium and design costs.
· The issuance provides Jamaica with three years of protection against Atlantic Hurricanes. Interestingly the bond was issued partly through the 2021 hurricane season, whereas ideally this type of coverage would be in place prior to the official start of the hurricane season on June 1st. At the time of issuance Jamaica had already felt the impacts of Elsa, the first hurricane of the 2021 season, though given the storm was relatively weak as it passed Jamaica it is unlikely this event would have triggered any payments.
· The cat bond uses a simple parametric ‘cat-in-a grid’ trigger, where payouts are determined based on a storm’s characteristics (e.g. track position, maximum sustained wind speed or central pressure) as it passes through the Jamaica region.
· A ‘Summary Terms and Conditions’ table provides a useful high-level overview, including the total ‘Size’ ($185 million) and the ‘Risk Margin’ (4.4%). Combining these numbers gives an estimate of the annual premium which comes in at $8.14 million.
What’s missing from this press release is any information relating to the risk metrics―i.e. what the likelihood is that the bond will actually pay out. Nor is there detailed information about the trigger mechanism, including the grid structure, payout thresholds, or historical performance. Without this information, it is unclear what is actually being purchased.
Helpfully, some key information is available through an ILS news site who publish information shared by investor sources. Additional information about the risk profile allows us to estimate the premium cost as a function of the expected loss, or the ‘risk multiple’, which comes in at 2.9x. This implies that on average Jamaica should expect around 35¢ in payouts for every $1 they pay in premium.
Placed in the context of other World Bank cat bonds, the risk multiple for the Jamaica cat bond (CAR 130) is higher than most, but comparable to other issuances with similar risk profiles (see ‘An aside on cat bond prices’ for more on cat bond pricing).
The question of cost is one thing - whether this structure offers good value for money for Jamaica and donors is a little more complicated. And on this we just don’t have enough information to be able to say much. Research by the World Bank on disaster risk financing for Jamaica suggests that if the insurance multiple is more than 1.62x, and all the insurance product is doing is providing fast cash for disasters response, then it could be funded more cheaply through post-disaster loans and tax increases. So the question is whether the insurance is doing more than just providing budget after disasters — is it allowing line ministries and wider society to plan for extreme hazards better?
An aside on cat bond prices
The price of a cat bond premium depends on a great many things: the risk type, the structure, trust in the modelling, market conditions… but in essence the premium is linked very closely to risk of the bond paying out, and this risk is captured by the ‘expected loss’ (EL) risk metric.
For catastrophe bonds, this and other risk metrics are estimated by a 3rd party risk modeller and presented to the ‘market’ of potential ILS investors alongside a price guidance range and a host of additional information about the bond including the modelling, structure, legal terms, and historical analyses of the trigger (collectively called the ‘Offering Materials’). Investors make bids based on their assessment of risk and return, the market price is found, and the bond is issued.
A (very coarse) rule of thumb for parametric cat bond premiums can be drawn using an ordinary least squares regression analysis of the 17 World Bank issuances completed since 2017 using data collected by an ILS news site.
There are other transaction costs associated with setting up a cat bond, beyond just the risk-based premium, so while this doesn’t paint the full picture, analyses like this can help to put these types of DRF instrument into better perspective.
A call for parity-of-information
When a cat bond is taken to market, potential investors are provided detailed information in a series of documents called the offering materials. A sensible investor wouldn’t consider for a second investing in a transaction without having scrutinised this information first.
The public, however, are also invested in the success these types of transaction. Not only the public in Jamaica who stand to benefit from greater protection, but also the public in donor countries who are contributing to the bill.
Transparency is a cornerstone of development projects and and donor-supported financing instruments. Indeed, Jamaica aims to start a “national conversation” around resilience and risk financing as it approves the development of a National Disaster Risk Policy. Clearly, the bond is freshly placed and there is time for the documentation to be published, but an easy win would be to host the materials already developed for investors.
A brilliant example was set when offering materials were originally shared for the cat bond underlying PEF, allowing for unprecedented scrutiny of the trigger. While these documents have now unfortunately been taken down, it shows that this level of information can be shared, and it demonstrates how it provides a basis for learning. As premium subsidy becomes more prominent, this precedent of sharing information should again become the default.
Jamaica, donors and the World Bank have a chance to show the workings of this bond and offer the sector and the public the same detail afforded to private markets investors. They should be encouraged to take this opportunity and allow others to scrutinise, learn from, and build on these high-profile financial innovations.
