There are new calls for a comprehensive assessment of risks and organisational objectives to justify cat bond adoption in a humanitarian environment.

The call has come from a whitepaper on humanitarian catastrophe bonds  published by parametric insurance provider  Global Parametrics part of the CelsiusPro Group.

The publication said humanitarian organisations are starting to adopt climate- and disaster-linked insurance to build more efficient responsiveness in their operations. With the frequency and severity of climate-related events increasing, there is now a growing interest in exploring the potential of cat bonds to support emergency support as humanitarian needs outpace available resources. In 2024, an estimated 300 million people needed humanitarian assistance.

“There are various forms of risk transfer modalities available in the insurance and capital markets,” it added. “For comparison, cat bonds and parametric insurance contracts are underpinned by similar objective climate- and hazard-linked triggers for the disbursement of payouts but differ in providing access to two different sources of private sector capital: capital and insurance markets, respectively.”

“The decision to adopt a particular financial instrument should be preceded by a comprehensive assessment of risks and organisations objectives,” said Mark Rueegg, chief executive of CelsiusPro Group. “Such an assessment can ensure a targeted engagement with capital (and (re)insurance) markets when the time, and rationale, is right.”

The white paper explained in a typical cat bond set up, a sponsor issues a bond via a Special Purpose Vehicle (SPV) to investors who make upfront capital contributions. The sponsor pays (via the SPV) a risk-adjusted rate fee. Investors receive this rate plus the interest/returns from the collateral account (the ‘coupon’).

If a pre-defined disaster event occurs, for example, a tropical cyclone exceeding a certain wind speed at a certain location, some or all the funds are transferred from the SPV to the sponsor to cover losses resulting from the event. At maturity, investors retrieve their remaining funds.

The cat bond structure may be robust and replicable across different triggers and territories and has been piloted in a sovereign context. Nevertheless, several hurdles remain for cat bonds in the context of humanitarian organisations:

1. Firstly, cat bonds may be typically much more expensive than (re)insurance for ‘non-peak zones.
2. Second, humanitarian support in the event of a catastrophe needs to be deployed at speed. The payout of the bond (and any re(insurance) for that matter) proceeds needs to be organised to match this speed. Delays in processing such proceeds may compromise their potential value add.
3. Third, while cat bonds (and (re)insurance or any other risk transfer instrument) potentially provide fast liquidity, their adoption can introduce new complexities in a humanitarian setup.

“Cat bonds are one part of a suite of financial instruments, and an optimal combination of these instruments is how many humanitarian organisations are financing emergency response and recovery,” said Simant Verma, disaster risk finance and insurance principal and whitepaper author. “With increasing frequency and severity of climate-linked hazards, cat bonds may play a part in finding a sustainable solution to the problem of humanitarian financing. But humanitarian organisations may consider all their merits, and these should include a range of other options.”