Mexico, one of the most experienced emerging market countries in disaster risk management, has proactively sought to benefit from global diversification by sharing risks with international capital markets. It was the first country to issue a multi-peril multi-region cat bond using the World Bank’s MultiCat Program. The MultiCat Program allowed Mexico to efficiently transfer a pool of disaster risk to the capital markets. With these initiatives, Mexico moved from an ex-post Mexico is vulnerable to a number of natural hazards, response to natural disasters to an ex-ante including hurricanes, large earthquakes, floods, and preparedness approach. volcanic eruptions. In 1985, two earthquakes of FONDEN uses various instruments to support local magnitudes 8.0 and 7.5, respectively, killed more states and entities in responding to natural disasters, than 10,000 people and destroyed 100,000 housing including reserve funds and risk transfer solutions. In units in the country. When such natural disasters 2006, FONDEN issued a US$160 million catastrophe occurred, the government had to shift budgetary bond (CatMex) to transfer Mexico’s earthquake risk to resources away from planned public infrastructure the international capital markets. It was the first expenses into reconstruction efforts. To avoid this parametric cat bond issued by a sovereign. After the problem, in 1996 the government created a fund for CatMex matured in 2009, Mexico decided to further natural disasters — FONDEN — to which it transfers diversify its coverage by pooling multiple risks in budgetary funds for disaster relief and multiple regions. In October 2009, it issued a multi- reconstruction efforts. In addition, Mexico developed peril cat bond using the World Bank’s newly an institutional framework for disaster preparedness established MultiCat Program, which helps sovereign involving risk assessment, risk reduction, the promotion of a culture of prevention, and insurance. and sub-sovereign entities pool multiple perils in multiple regions and reduce insurance costs. The bond was oversubscribed, with broad distribution among investors. With this bond, Mexico transferred • Transfer disaster-related risks to the capital a pool of disaster risk to the market for the first time; markets and reduce pressure on public budgets secured multi-year protection for the covered risks at • Ensure that adequate funds are in place for a fixed price; and reduced potential pressure on relief activities public budgets. Mexico effectively locked in funding • Cover multiple perils for disaster relief prior to the event happening, rather than relying only on public budgets after the event. The demonstration effect of this transaction for other Mexico issued a four-tranche cat bond (totaling emerging market countries is significant. It has paved US$290 million) with a three-year maturity under the the way for other highly exposed countries to manage MultiCat Program. The issuer is a Special Purpose fiscal volatility and stabilize government budgets by Vehicle (SPV) that indirectly provides parametric transferring extreme natural disaster risks to capital insurance to FONDEN against earthquake risk in markets, while obviating the need to build up three regions around Mexico City and hurricanes on excessive budget reserves. the Atlantic and Pacific coasts. The cat bond will repay the principal to investors unless an earthquake or hurricane triggers a transfer of the funds to the Mexican government. Table 1: Summary of Terms: MultiCat Mexico 2009 Issuer: MultiCat Mexico 2009 Ltd. Class A: Class B: Pacific Class C: Pacific Class D: Atlantic Peril Earthquake Hurricane Zone A Hurricane Zone B Hurricane Notional (US$) 140 million 50 million 50 million 50 million 7.9; 8.0 magnitude 944 944 920 Trigger (Richter Central pressure Central pressure Central pressure Scale) S&P Rating B B B BB- Photo Credits Front: Curt Carnemark / World Bank Figure 1: Operating Structure 5 Event Collateral Loss Payment Payment Loss Payment Amounts Amounts Solution Account Swiss Agroase Reinsurance SPV mex Company Investors FONDEN 1 2 3 Collateral 4 Ltd. Account (Zurich) 1. FONDEN enters into an insurance contract with local insurance company Agroasemex. 2. Agroasemex enters into a reinsurance contract with Swiss Re to transfer all of the catastrophe risk. 3. Swiss Re enters into a derivative counterparty contract with a Cayman Islands-based special purpose vehicle (MultiCat Mexico 2009 Ltd.) to transfer the catastrophe risk. 4. The SPV issues floating rate notes (Cat Bonds) to capital markets investors to hedge its obligations to Swiss Re under the counterparty contract. The proceeds received from investors are invested in US Treasury money market funds and deposited in a collateral account. 5. A separate event payment account is established with a third party bank to allow FONDEN to receive parametric loss payments directly from the SPV, subject to the insurance contract. Miguel Navarro-Martin, Head of Banking Products, mnavarromartin@worldbank.org, +1 (202) 458 4722