The Mexican government is launching a cat bond to reinsure future earthquake disasters.
Mexico will be the first government to issue a catastrophe bond as a way of funding relief efforts following future earthquakes without affecting the national budget. Officials from the Finance Secretariat said that a $450m issue could be in place by the end of this year. The bond will be used to reinsure Mexico's Fund for Natural Disasters (FONDEN).
Established in 1996, FONDEN is a last recourse fund and is subject to budget constraints. The government has not provided any details yet about the pricing of these bonds except to say that it will pay a risk premium on top of the yield rate which investors will find “interesting”. In the event of an earthquake the money paid to Mexico will be held in a trust fund containing liquid securities such as US Treasury bonds. If no earthquake occurs during the term of the bonds, then the money in the trust fund would be returned to investors.
The catastrophe fund will not cover the entire country, just the three most populated regions in the Pacific that could suffer the most extensive earthquake damage. In the capital, an earthquake with a magnitude of 7.5 or greater would trigger a payout while the threshold for other areas is a magnitude 8. The maximum payout per region would be $150m for a total of $450m. The government still has to appoint an intermediary for the transaction although interest has been expressed by Willis, Goldman Sachs, and Swiss Re in association with Deutsche Bank.
The largest Mexican earthquake in recent times was on 19 September 1985 in Mexico City registering a magnitude 8 on the Richter scale. The most recent strong earthquake registered 7.6 on the Richter scale in January 2003 hitting Colima.