Financing the unpredictable: what role could sovereign catastrophe bonds play in disaster risk management?

This report aims to enhance understanding of sovereign catastrophe bonds, a type of insurance-linked security, as a tool in comprehensive disaster risk reduction. Traditional disaster risk finance tools, such as insurance and reserve funds, remain important, but catastrophe bonds are gaining attention as a specialised option. Interest in their use is particularly strong in developing countries, where multilateral development banks are expanding support for catastrophe bonds.

Main messages

• Extreme weather events, including droughts, heatwaves, tropical cyclones and heavy rainfall, are becoming more frequent and intense due to climate change, exacerbating physical risk, vulnerability and damaging impacts for people, infrastructure and nature.
• This is increasing the need for capital while also impacting borrowing costs for developing countries.
• Policymakers in affected countries are needing to increase their focus on how to ensure stability and climate resilience in their fiscal and economic policies and risk management practices.
• Sovereign catastrophe bonds provide ex-ante financial protection for governments and are gaining interest as a risk management instrument, particularly in developing countries – and notably Small Island Developing States (SIDS), to provide coverage to specific high severity, low frequency events.
• In emerging markets and developing countries, issuances through multilateral development banks and the coverage of secondary perils such as floods and droughts is expected to grow.
• However, catastrophe bonds are not a silver bullet. Furthermore, despite the building interest, information about the detailed structures of catastrophe bonds in the public space is limited. There is a significant lack of transparency about the challenges and trade-offs between bond characteristics, as well as operational aspects.
• This report aims to enhance understanding of sovereign catastrophe bonds in countries with different levels of climate risk exposure. It explores the role of these instruments, while addressing the complexities and challenges involved in their design and implementation, utilising case studies principally from Mexico and Jamaica.