Mexico’s bet on catastrophe bonds has paid off, with a ruling this week that an earthquake in the south of the country has triggered the insurance instrument.
The decision means the sovereign will receive $150m for rebuilding after the devastating earthquake in Chiapas, a southern province, on September 7.
Mexico’s finance minister says the use of catastrophe bonds is part of one of the world’s most sophisticated disaster insurance strategies.
“Mexico is one of the countries that has designed a more comprehensive framework in terms of risk management from natural disasters, be they earthquakes or hurricanes,” José Antonio Meade told GlobalMarkets.
“There is the possibility to get, in an agile and transparent fashion, support from the budget but also a lot of the public infrastructure is insured. There’s also excess coverage insurance that we have. And the Cat bond.”
However, the catastrophe bond will not provide coverage for rebuilding from an earthquake in the centre of the country on September 19 that killed more than 300 people, more than half of them in Mexico City, and caused extensive property damage. Among other conditions, the quake must be above 7.9 on the Richter scale to trigger the catastrophe bond. On September 19, the reading was 7.1. The Chiapas earthquake measured 8.1.
But Mexico’s package of natural disaster coverage offers broad financial protection, says Meade. Regular insurance continues to play a critical role, he says.
“The Mexican insurance market is well developed, it has a high degree of penetration and it’s being used more and more within the financial and real estate sector. It’s being used not only at the federal level, but that practice has trickled down into the states and municipalities.”
Still, he said there could be room for tweaking the model in future.
“We learn every time and every single challenge that we meet is different and from every single challenge we find that there are adjustments or things that we can do better and that we can improve upon.”
Mexico issued the Cat bond in early August. It paid 412bp over six month Libor for the three-year earthquake coverage instrument. Now that it has been triggered, that part of the bond will be redeemed and will pay out by November 13, meaning Mexico will need to issue another instrument for coverage against future earthquakes.
The bond also includes two tranches that offer $210m of coverage for hurricanes stronger than Category 4. The 2.5-year tranches have coupons of 892bp over Libor for protection from a hurricane on the Atlantic coast and 552bp over for a similar event on the Pacific coast.