Experts on MultiCat Mexico

April 2012 - The MultiCat transaction is proof of our commitment to working with governments and development banks to help them manage their risks using reinsurance and the capital markets. This activity complements our business activities with cedents and corporate clients. Reto Schnarwiler, Head of Public Sector, and Markus Schmutz, Head of ILS Structuring and Origination, explain the transaction.

Q: Why has the Mexican government decided to transfer these risks to capital markets? 

Reto Schnarwiler: Natural disasters have a negative impact on public finances as governments typically absorb a large portion of the economic costs of such catastrophes. For example, they must cover the costs of emergency and relief efforts as well as subsequent reconstruction of infrastructure. Most governments shoulder the burden of financing after a disaster event, for example by issuing debt, reallocating budget positions or raising taxes. With this transaction, Mexico is diversifying its financing mix with risk transfer instruments. By transferring catastrophe risk to the capital markets, the Mexican government is able to reduce pressure on public budgets in the event of a natural catastrophe, while ensuring that adequate funds are in place for relief activities.

Q: In 2006, Swiss Re already helped the Mexican government’s Fund for Natural Disasters (“FONDEN”) to transfer earthquake risks. What makes this particular transaction so innovative?

Markus Schmutz: Unlike the first FONDEN transaction, the MultiCat transaction covers multiple risks. Like the original, earthquake risks are covered, but in addition the MultiCat transaction now includes hurricane risks, both on the Pacific side as well as the Atlantic side of the country. This is a clear improvement and a real innovation that is going to bring benefits for the Mexican government and country as a whole.

Q: Why are development organisations such as the World Bank’s International Bank of Reconstruction and Development (IBRD) becoming more active in the field of risk transfer for natural catastrophes?

Reto Schnarwiler: Organisations such as the World Bank have started to realise that developing and emerging countries are particularly exposed to natural disasters and that reducing their vulnerability to natural disasters is one of the top priorities in terms of development work. Risk avoidance and risk mitigation strategies clearly remain the number one priority for these countries. But no matter what measures governments take, no country can fully insulate itself against extreme events. Countries that are particularly prone to natural disasters should therefore consider the transfer of these risks to capital markets. The World Bank has been very active in this field, supporting, for instance, the development of the Turkish Cat Insurance Pool after the devastating Marmara earthquake and the Caribbean Cat Risk Insurance Facility (CCRIF) which insures 16 governments in the Caribbean. It also provides drought insurance coverage for the government of Malawi. Swiss Re supports these efforts with risk transfer capacity and our expertise.

Q: Are risk transfer solutions such as these limited to covering natural catastrophes?

Reto Schnarwiler: Governments and development organisations are increasingly interested in integrated risk management approaches. In the past, the primary concern was civil protection in the event of war or natural disasters. The focus is now shifting to a more comprehensive approach which looks at a broad range of risks, from economic and financial to environmental, societal and political risks. Such an all-hazard approach requires a high level of coordination across government, political and private sector bodies. A country risk officer could be responsible for such a prioritised risk landscape, taking an holistic approach to risk before events occur and ultimately reducing the risk burden to society.

Q: What are the benefits of cat bonds to sponsors like the Government of Mexico and to qualified institutional investors?

Markus Schmutz: Specifically for this transaction, the MultiCat deal provides the Mexican government with rapid funding to finance disaster relief efforts after earthquakes and hurricanes. By transferring cat risk to the capital markets, the Mexican government can reduce the pressure on public budgets in the event of a natural catastrophe, while ensuring that adequate funds are in place for relief activities. MultiCat program helps Mexico manage its nat cat risks before an event occurs. Generally speaking, ILS complements traditional reinsurance solutions, providing additional benefits to issuers such as fully collateralised protection for both peak risks and multi-year protection at a fixed price. Within ILS, cat bonds typically transfer peak risks to the capital markets. In sponsoring a transaction, a (re)insurer can potentially improve both its risk and capital management effectiveness and flexibility. Insurance linked securities such as cat bonds can provide benefits to institutional investors as well. Investors are able to gain access to risks that help to diversify their current holdings and aid in their overall asset allocation strategies.

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