Repost: Betting on the Chances of a Catastrophe


With the summer’s natural disasters so massive already, thought it would be a good time to again share this April post on the catastrophe-bond market. It focuses on volcanoes, so here are recent articles from an industry leader (see last link in post below) on Hurricane Ida (double-digit billions of dollars) and Europe’s floods and US wildfires. They last addressed the Caldor Fire — currently threatening South Lake Tahoe communities and forecast to cross the state line into Nevada tonight or early tomorrow unless firefighters are successful and lucky — on August 18th; any updates will probably appear here.


The Danish Red Cross has gone swimming with sharks. Don’t reach for a life preserver, though. This might be a very good thing.

That is, if it works as planned.

In brief, to raise $3 million for relief efforts after a covered eruption, they recently issued what is reportedly the world’s first volcano-disaster catastrophe bond.

To trigger a payout, the eruption must meet certain requirements and happen at one of these volcanoes:

Links go to each volcano’s eruption history page on the Global Volcanism Program’s website, in case you want to try figuring out the chances of a catastrophic event yourself. (The insurers use much more sophisticated methods, but the GVP information is interesting and there are more details about the volcano available, if you’re curious.)

You might be wondering how betting on an eruption could be a good idea, with so many of these fire mountains already in action now.

Well, as the GVP eruption histories show, those listed volcanoes, except for Mount Cameroon, erupt frequently and moderately (VEI 1 or 2, per the GVP site) but do have a few big eruptions — at least VEI 4 — in their past.

At Mount Cameroon, whose known events have been in the VEI 2 to VEI 3 range, there are lots of people living on the volcano’s lower slopes. Intense development is occurring there, too. (Del Marmol et al)

The presence of human beings and their stuff is what turns any natural process into a disaster. And large populations surround the other volcanoes on this list, too.

All volcanoes on the list are dangerous; they have destroyed property and killed many people. But except for Merapi in 2010, none has caused a broad-scale catastrophe recently — thousands of years have passed since their last VEI 4’s and 5’s.

And Mount Merapi tends to have about a century of relatively quiet behavior between its subplinian to plinian episodes, so the chances for another major disaster here are low right now.

So investment groups, looking for the high rate of return that catastrophe (or cat) bonds bring, are gambling that low-level volcanic activity is all that will happen over the next three years.

The Danish Red Cross, on the other hand, is risking nothing up front but will get some or all of that money to use in relief work if a qualifying eruption does occur before the bond matures in March of 2024.

If.

If everything plays out as expected by the people who thought up this volcano cat bond and brought it about.

No one can be sure what any volcano will do at any given moment. And I don’t know what volcanologists would say about the bond’s payout triggers.

Volcanoes are notoriously difficult to predict, let alone interpret.

But there is nothing wrong with the basic idea: giving humanitarian groups access to some fraction of the billions of dollars now invested in the catastrophe bond market as well as setting up a scheme that could release badly needed relief funds even before the ash stops raining down.



Mount Merapi in 2010.


Featured image: Nevada Fire Cameras



Sources:

Artemis. 2021. Dunant Re IC Limited (Series 2021-1) https://www.artemis.bm/deal-directory/dunant-re-ic-limited-series-2021-1/ Last accessed April 3, 2021.

___. 2021. What is a catastrophe bond (or cat bond)? Last accessed March 30, 2021.

Choumert-Nkolo, J., Lamour, A., & Phélinas, P. (2020). The economics of volcanoes. Retrieved from https://hal.uca.fr/hal-02556468/document

Del Marmol, M. A., Fontijn, K., Atanga, M., Njome, S., Mafany, G., Tening, A., … & Kervyn, M. (2017). Investigating the management of geological hazards and risks in the Mt Cameroon area using focus group discussions. In Observing the Volcano World (pp. 373-394). Springer, Cham., retrieved from https://link.springer.com/chapter/10.1007/11157_2017_3

Gould, J. 2016. Allianz bets on blockchain for catastrophe bond trading. https://www.reuters.com/article/allianz-blockchain-idUSL8N1961VY. Last accessed March 30, 2021.

Insurance Information Institute. 2021. Volcanic eruption coverage. https://www.iii.org/article/volcanic-eruption-coverage. Last accessed March 30, 2021.

__. 2021. Facts + statistics: Catastrophe bonds and other insurance-linked securities. https://www.iii.org/fact-statistic/facts-statistics-catastrophe-bonds. Last accessed March 30, 2021.

Mortimer, S. 2013. Cat bond sales finish 2012 near record high. https://www.reuters.com/article/insurance-bonds-2012/cat-bond-sales-finish-2012-near-record-high-idUSL5E9C2A2A20130102. Last accessed March 30, 2021.

Rabouin, D. 2017. World Bank issues $360 million Mexico catastrophe bonds. https://www.reuters.com/article/world-bank-issues-360-million-mexico-cat-idUSL1N1KP1H2. Last accessed March 30, 2021.

Reuters staff. 2021. Danish Red Cross launches volcano catastrophe bond. https://www.reuters.com/article/idUSL8N2LH4SC. Last accessed April 3, 2021.

Risk Market News. 2021. Don’t want to buy volcano insurance. How about a volcano bond? https://www.riskmarketnews.com/archegos-ties-to-modeling-and-insurance/ Last accessed April 3, 2021.

Smolka, A. (2006). Natural disasters and the challenge of extreme events: risk management from an insurance perspective. Philosophical Transactions of the Royal Society A: Mathematical, Physical and Engineering Sciences, 364(1845), 2147-2165.

Sparks, S. 2010. Global volcanic risk. Retrieved from Prevention Web: https://www.preventionweb.net/english/hyogo/gar/2011/en/bgdocs/Sparks_2010.pdf

Sparks, R. S. J., Aspinall, W. P., Crosweller, H. S., & Hincks, T. K. (2013). Risk and uncertainty assessment of volcanic hazards. Risk and uncertainty assessment for natural hazards, 364-398. Retrieved from. https://play.google.com/store/books/details?id=fHEhAwAAQBAJ
&
Strohecker, K. 2020. Coronavirus spread triggers World Bank pandemic bone payout. https://www.reuters.com/article/health-coronavirus-pandemic-bonds-idUSL8N2C861O. Last accessed March 30, 2021.

Wikipedia. 2021. Catastrophe bond. https://en.m.wikipedia.org/wiki/Catastrophe_bond. Last accessed March 30, 2021.

World Bank. 2019. Speech by Mara K. Warwick at the World Bank Catastrophe Bond Singapore Exchange Listing Ceremony. https://www.worldbank.org/en/news/speech/2019/11/25/speech-by-mara-k-warwick-at-the-world-bank-catastrophe-bond-singapore-exchange-listing-ceremony

__. 2020. Fact sheet: Pandemic Emergency Financing Facility. https://www.worldbank.org/en/topic/pandemics/brief/fact-sheet-pandemic-emergency-financing-facility. Last accessed March 30, 2021.

___. n.d. Disaster risk insurance platform at a glance. http://pubdocs.worldbank.org/en/179781581013532050/World-Bank-Treasury-FABBK-Disaster-Risk-Insurance-Platform-Brochure-FINAL.pdf (PDF)

Woo, G. (2011). Calculating catastrophe. World Scientific: Sample retrieved from
https://play.google.com/store/books/details?id=hsy6CgAAQBAJ



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